This NY Times article reports that the recent uptick in oil and gas prices has not translated into an economic boom for the local Houston economy. The article does a reasonably good job of explaining that Houston’s economy is less dependent on the oil and gas industry that in prior eras, and thus less prone to the boom and bust cycles that resulted from past run-ups in energy prices. Accordingly, while Houston’s economy used to be largely countercyclical to the national economy (i.e., Houston would do well during times of high energy prices that would drive the national economy down), Houston’s more diversified economy now tends to be more in step with the national economy.
Curiously, the Times reporter neglected to interview the foremost authority on the Houston economy, Dr. Barton Smith, University of Houston professor of economics and director of the UH Institute for Regional Forecasting. Twice a year or so, Dr. Smith gives an oral presentation over lunch to Houston businesspeople regarding the state of the Houston economy and his predictions for the economy’s future. These meetings provide valuable nuts and bolts information and analysis regarding Houston’s economy, and are extremely popular among Houston businesspeople. Not mentioned in the Times article is that Dr. Smith’s model of the Houston economy currently predicts an annualized rate of job growth of 2.6 % that, if sustained for the next six months, would translate into about 50,000 jobs. That would be the best job growth rate in Houston since 2000.
In what can only be described as bizarre governmental intervention, this Wall Street Journal ($) article describes a politically-motivated Federal Trade Commission investigation that has been launched into the planned closing of an unprofitable Royal Dutch/Shell Group refinery in California and the FTC’s reinstatement of an antitrust complaint against Unocal Corp.
Shell announced plans last year to close its Bakersfield, California refinery Oct. 1 because a nearby oil field will run out of crude in coming decades and because the refinery is too expensive to repair and profitably operate. Given that relatively few refineries in the United States produce the type of environmentally-favored gasoline that California requires, the closure will likely crimp gasoline supply further in the West, where supplies are already tight and prices the highest in the nation. The small refinery handles 70,000 barrels of oil a day, providing 20,000 barrels of gasoline that amounts to 2 percent of California’s needs. It provides a larger percentage of diesel fuel, 15,000 barrels a day, which is the equivalent of 6 percent.
Shell lost more than $50 million over the past three years on the Bakersfield refinery and is facing between $30 million and $50 million in turnaround and environmental costs on the facility, which is old (the original portion of the facility was built in 1932).
So, let’s see here. Rather than encouraging companies to invest and build new refineries that would address the economic problem of tight supplies in the Western part of the United States, our federal government is taking expensive legal actions against one of the relatively few companies in the refining business to minimize its losses in the business. My sense is that forcing companies to operate refineries at a loss is not a sound policy for addressing the problem of tight gasoline supplies in the West.
Separately, the FTC overruled an administrative-law judge and reinstated an antitrust complaint against Unocal for pursuing patents for a special low-emissions gasoline at the same time that the company was helping California regulators mandate that gasoline as a state standard. The complaint originally was filed in March 2003, but was overruled by the judge in November.
Molly D. Castelazo is a research associate and Thomas A. Garrett is a senior economist at the Federal Reserve Bank of St. Louis. They authored this article that analyzes the bad economics of the St. Louis light rail system and includes a devastating chart reflecting how it would have been much more economically prudent to buy a new Toyota Prius for all the light rail riders than to build and maintain the light rail system. The entire article is well worth reading, particularly for Houstonians who have funded a similar boondoggle, and the authors make the following concluding observation:
If light rail is not cost-efficient, nor an effective way to reduce pollution and traffic congestion, nor the least costly means of providing transportation to the poor, why do voters continue to approve new taxes for the construction and expansion of light-rail systems?
One economic reason is that the benefits of light rail are highly concentrated, while the costs are widely dispersed. The direct benefits of a light-rail project can be quite large for a relatively small group of people, such as elected officials, environmental groups, labor organizations, engineering and architectural firms, developers and regional businesses, which often campaign vigorously for the passage of light-rail funding. These groups would benefit from light rail, not from the subsidization of cars and money to all potential riders of light rail.
The costs of light rail, while large in aggregate, are often small when spread over the tax-paying population. (The cost of light rail in St. Louis totals about $6 per taxpayer annually). A large group of taxpayers facing relatively minimal costs can be persuaded to vote for light rail based on benefits shaped by the interested minority, such as helping the poor, reducing congestion and pollution, and fostering development. Even if these benefits are exaggerated and the taxpayer realizes the cost-ineffectiveness of light rail, it is probably not worth the $6 for that person to spend significant time lobbying against light rail.
Proponents of light rail argue that it will create jobs, foster economic development and boost property values. While there is some academic evidence of these benefits, it is important to realize that they are not free to society?light rail is kept afloat by taxpayer-funded subsidies that amount to hundreds of millions of dollars each year.
Concentrated benefits and dispersed costs are one economic reason for the existence of inefficient public projects. The many who stand to lose will lose only a little, whereas the few who stand to gain will gain a lot. Of course, if other public projects exist where overall costs outweigh benefits, then $6 a year per project could add up to quite a hefty boondoggler?s bill.
Dr. Barton Smith, University of Houston professor of economics and director of the UH Institute for Regional Forecasting, is the leading expert on the regional economics of the Houston metropolitan area and has prepared a similar analysis regarding the Houston Metro light rail system.
Alas, I do not expect the Houston Chronicle to address this issue anytime soon. Hat tip to Professor Gordon for the link to this study.
This NY Times article reports on Repsol, YPF‘s (Spain’s largest oil comany) hiring of a Norwegian drilling platform at a cost around $200,000 a day to search for oil in a narrow sector of the Gulf of Mexico off the northwestern coast of Cuba. The venture, which was established with the Cuban government-owned oil company CubapetrÛleo, is being watched closely in Houston’s oil and gas community.
If Repsol is successful in making a major find, that would be a boon for Cuba, which imports most of its fuel from Venezuela and struggles economically. It would also shake up the dynamics of oil and gas production in the Gulf of Mexico, which has been dominated for decades by United States companies.
If there is a big oil find in Cuban waters, then that will also be an interesting test of the Bush Administration’s Cuba policy, which has been to maintain and even strengthen sanctions in hopes of isolating and weakening the Communist country’s economy. However, such sanctions might be rethought if Mr. Bush’s supporters in the oil and gas industry are faced with the prospect of sitting on the sidelines while foreign companies develop good oil and gas prospects in Cuban waters.
Stay tuned on this one.
This Wall Street Journal ($) article reports on how the consumer credit industry is generating huge profits by charging exorbitant interest rates and penalties on credit cards that the industry provides to the riskiest consumer borrowers:
For consumers who pay off their credit-card balances each month, shop aggressively for interest rates as low as 0%, and take advantage of generous credit-card rewards programs, consumer credit has never been cheaper. But for others . . ., the trend is in the other direction.
Card users, consumer advocates and some industry experts complain that banks are attempting to squeeze more and more revenue from consumers struggling to make ends meet. Instead of cutting these people off as bad credit risks, banks are letting them spend — and then hitting them with larger and larger penalties for running up their credit, going over their credit limits, paying late and getting cash advances from their credit cards. The fees are also piling up for bounced checks and overdrawn accounts.
Many folks are surprised to learn that bad check fees are a lucrative profit center for many banks. Similarly, banks make a nice return on late payment fees to their consumer credit card holders:
. . . credit-card fees, including those from retailers, rose to 33.4% of total credit-card revenue in 2003. That was up from 27.9% in 2000 and just 16.1% in 1996. The average monthly late fee hit $32.01 in May, up from $30.29 a year earlier and $13.30 in May 1996, the company said. In 2003, the credit-card industry reaped $11.7 billion from penalty fees, up 9% from $10.7 billion a year earlier, according to Robert Hammer, an industry consultant.
Banks say that penalties and fees are a necessary component of new models for pricing financial services. Gone are the days when banks collected hefty annual fees on all credit cards and charged fat interest rates to all customers. Now, the banks say, they must rely on risk-based pricing models under which customers with the shakiest finances pay higher rates and more fees.
Oddly, the approach of gouging the riskiest customers is the result of competing for the best ones:
Until the early 1990s, most banks offered one main credit-card product. It typically carried an annual interest rate of about 18% and an annual fee of $25. Cardholders who paid late or strayed over their credit limit were charged modest fees. Profits from good customers covered losses from those who defaulted.
Then card issuers, in an effort to grab market share, began scrapping annual fees and vying to offer the lowest annual interest rates. They junked simple pricing models in favor of complex ones they say were tailored to cardholders’ risk and behavior. Eager to sustain growth in a market approaching saturation, they began offering more cards to consumers with spotty credit.
By the late 1990s, banks were attracting consumers with low introductory rates, then subjecting some of them to a myriad of “risk-related fees,” such as late fees and over-limit fees. A 2001 survey by the Federal Reserve showed that 30% of general-purpose credit-card holders had paid a late fee in the prior year.
In a survey of 140 credit cards this year, the advocacy group Consumer Action said 85% of the banks make it a practice to raise interest rates for customers who pay late — often after a single late payment. Nearly half raise rates if they find out that a customer is in arrears with another creditor.
Meanwhile, the Bush Administration’s response to the foregoing travesty is to support the ill-advised and consumer credit industry backed Bankruptcy “Reform” Act, which attempts to make it more difficult for consumers to discharge their personal liability for such consumer credit.
As with health care finance, income tax simplification, and overall government spending, this is another issue on which the Bush Administration has sadly dropped the ball.
A wise old class action plaintiffs’ lawyer once observed the following to me:
“Accrual accounting is a particularly valuable annuity for the legal profession.”
A new study validates my friend’s observation. This Wall Street Journal ($) article reports on a Criterion Research Group LLC study that suggests that the companies that are most aggressive in using accrual accounting — i.e, booking noncash earnings — are much more likely to be the subject of a shareholders’ lawsuit than companies that use the cash accounting method.
Under the accrual accounting method, companies book revenue when they earn it and expenses when they incur them rather than when they actually receive the cash or pay the expenses. Accrual accounting is common and accepted, but problems arise when companies fail to estimate properly the revenue that they have earned in a given period or the expenses that it cost to generate that revenue. Although intentionally cooking the books is a violation of generally accepted accounting principles, merely miscalculating the numbers is not.
Criterion’s study concludes that companies that are most aggressive when using accrual accounting are four times more likely to be sued by shareholders as less-aggressive peers. The new study builds on earlier research that showed companies that use more accruals generally underperform companies with fewer accruals. In that earlier report, Criterion screened 3,500 nonfinancial companies over 40 years and found that those using the most accruals had poorer forward earnings and stock returns. and also had more earnings restatements and SEC enforcement actions.
Several well-known companies are in the two highest accrual categories in the report. Among those, Rite Aid Corp., Waste Management Inc., MicroStrategy Inc. and Gateway Inc. recently settled shareholder litigation involving accounting issues. Other companies in Criterion’s highest-accrual category that are not the subject of pending litigation include Chiron Corp., eBay Inc., General Motors Corp., Yahoo Inc and the ubiquitous Halliburton, Inc.
This NY Times article reports that Russian governmental officials ordered court bailiffs to take the extraordinary step of freezing Russian energy giant Yukos Oil‘s bank accounts and demanding payment of a $3.4 billion tax debt within five days. Here are earlier posts about Yukos’ problems with the Russian government.
Yukos is one of the world’s largest oil companies. It produces around 1.7 million barrels a day, which is about 2 percent of the world’s total output. It is the leading exporter in Russia, which is heavily dependent on oil revenue and, along with Saudi Arabia, is one of the world’s top oil-producing countries.
Founded by Russian financier Mikhail B. Khodorkovsky, Yukos has been fighting with the Kremlin for the past year over taxes and related issues. Mr. Khodorkovsky has been in jail since November, 2003 on charges of fraud, embezzlement and tax evasion related to his creation of Yukos during the wild privatizations of Russian state assets in the 1990’s. The trial was commenced and adjourned last month, and is scheduled to resume on July 12.
The federal Air Transportation Stabilization Board announced today that it was not going to change its its June 17 decision to deny United Airlines government backing for a government credit enhancement that was the central component of United’s reorganization plan in its pending chapter 11 case. United will now be forced to retool its reorganization plan based upon the higher financing costs that it will incur in the private market.
Hurt by a slowing economy and the Sept. 11, 2001 terrorist attacks on New York and Washington, United initially applied for $1.8 billion in loan guarantees in June 2002, just before the deadline for airline applications. The company’s request was the largest of the 16 carriers that applied to the panel that was created after the September 11 attacks to help airlines lower the cost of new capital.
The loan board initially denied United in December 2002, which resulted in United filing its chapter 11 case. United has reduced costs and shrunk its operations in chapter 11, but the company’s operations still are not particularly competitive with the emerging low-cost airlines that have expanded their market share dramatically over the past two years.
As noted here earlier, the ATSB’s decision is the correct one. The creditors and employees with stakes in United’s survival should share the full economic risk of reorganizing the company. The risk of loss and threat of failure are much better and more powerful inducements to reorganizing a big company correctly than government largesse that often covers up and delays changes that need to be made.
Howard Blake is the pen name of a small businessman from the Midwest, who has written this AEI Online article that is brilliant in its simplicity. By Democratic Party standards, Mr. Blake and his wife are wealthy and should be taxed more. However, Mr. Blakes points out that appearances can be deceiving, particularly in economic matters:
From that $71,000 of actual cash flow, subtract our federal tax payments of $24,539 and our state income taxes of around $4,000, and you find that our cash available for living expenses is actually around $43,000. Sufficient for our needs. But clearly a good deal short of true wealth.
I suppose my wife and I do what we do because we like to. We must, because if you divide our $43,000 of spendable income last year by the 6,000 hours of labor, much of it manual, that the two of us put into our business (we kept track), our time works out to be compensated at around $7.50 an hour. Just the same, incentives do matter. And it is a concrete fact that cash alone fuels our growth. With more cash, our business will grow faster; we’re a small player in a big industry, and the market is there for additional growth. We’re constrained only by the availability of investment capital, and that has to be generated by our business.
My wife and I have a passion for our little enterprise. It’s been our life for 20 years, demanding whatever creative abilities we have, consuming most of our waking moments, focusing our energies on producing the best products we can, and beckoning us to work seven days a week to ensure good service for our customers.
Then every four years the Democratic nominee for President informs us we don’t pay enough taxes. We are called greedy and self-serving special interests. We’re told that we are “rich,” and that we have wealth only because we are lucky.
I have described my financial situation in some detail in the hope that this snapshot will help people understand who most of the top 5 percent of taxpayers really are, and how taxes affect the folks who make America work. I know I’m fortunate, but I certainly don’t feel rich. I have fond hopes of some day becoming wealthy (a goal I share with most of my fellow citizens), and a tax policy that encourages my efforts toward that end would not only benefit me, but the rest of society as well. But the reality is that my wife and I have to work extremely hard every day just to hold our current position.
We’ve been managing our finances with care, investing in our business with the kind of concentration that comes from spending our own money, and providing jobs for dozens of our neighbors. I dare say that the country benefits from our stewardship–and that of hundreds of thousands of other “rich” people just like us–more than it would from any of John Kerry’s plans for our money.
In representing business people over the past 25 years, I have learned that non-business people often grossly underestimate how hard it is to run a business profitably and well. Also overlooked or underappreciated is the great benefit that communities derive from the employment that is generated through small businesspeople’s willingness to undertake the risk of their enterprise. Mr. Blake’s article explains a big part of the reason why running a business is such a formidable task, made even more so in this current climate in which many normal business practices are being criminalized. Hat tip to Newmark’s Door for the link to Mr. Blake’s piece.