Energy and Food Crisis: The Fallacy of Government Heroism

``The genius of capitalism lies in its ability to make self-interest serve the wider interest. The potential of a big financial return for innovation unleashes a broad set of talented people in pursuit of many different discoveries. This system driven by self-interest is responsible for the great innovations that have improved the lives of billions.” –Bill Gates

I’d like to profusely thank profound thinker and international fund manager, Mr. Louis Vincent Gave, CEO of the Hong Kong based Gavekal Capital for bequeathing two of their latest marvelous books to your lowly analyst, the Roadmap for Troubling Times and Jesus: The Unknown Economist. It feels wonderful to be in good graces with people whom I wish to emulate.

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Over the week we came across an article where a high ranking church personality, South Cotabato Bishop Dinualdo Gutierrez, threatened to withhold communion rites to rice hoarders because of “greed” and correspondingly called on the Philippine President to impose “political will” to resolve the crisis.

GMANews quotes Bishop Guiterrez ``Something is wrong. The reason is greed of the businessmen. Some people are hoarding and the others are taking advantage of the crisis to get more money….She has all the power, so use the power to solve the rice crisis because there is supply but the price is critical. There is rice so it’s only a matter of will power of the president."

In a world of villains and heroes, Bishop Guiterrez espouses “hook line and sinker” the government propaganda that business people are “evil” and government as the “savior”.

And since rice is only a “matter of willpower of the president” this implies that Philippine government has an infinite stash, or like money, can “print up” the supply of rice that the people requires-where all PGMA needs to do is to wave the magical fairy wand and everybody’s problem will be settled. What Hooey!

This is exactly the oversimplistic socialist fantasy that has brought about the present predicament. When absurd politicking overwhelms economic reality or commonsense, then populist solutions will only lead to short term appeasement at the expense of greater and prolonged pain.

In a skewed sense, Bishop Guiterrez is right. More government “power” leads…not to resolve the crisis but to further exacerbate it.

Since the food crisis is related to the soaring oil and energy prices we might as well give some illustrations on why more government “heroism” or euphemism of interventionism is nothing but a fallacy.

Saudi’s King Abdullah, US President Bush Does Not Need The Bishop’s Communion

Hoarders and speculators have been vilified by the government, the pious and the populace as having “caused” today’s troubles.

But at $135 oil who is doing the hoarding?

From Reuters last April 13^th (highlight mine),

``Saudi Arabia's King Abdullah said he had ordered some new oil discoveries left untapped to preserve oil wealth in the world's top exporter for future generations, the official Saudi Press Agency (SPA) reported.

``"I keep no secret from you that when there were some new finds, I told them, 'no, leave it in the ground, with grace from god, our children need it'," King Abdullah said in remarks made late on Saturday, SPA said.

``The U.S. President George W. Bush in January urged the Saudi king to help tame soaring prices by encouraging OPEC to pump more oil. On separate trips to Saudi Arabia this year, the U.S. energy secretary also asked for more oil, while the vice president discussed high prices with the king.

``The kingdom has spent billions on building over 2 million bpd of spare crude capacity and is the only country in the world able to bring online large volumes of crude supply quickly to deal with unexpected supply shortages.”

More from the Business Intelligence, ``During the meeting, King Abdullah highlighted the significance of oil revenue and said that as long as there is oil, the Kingdom would not experience economic problems. “I told them once, 'may God give it long life'... they asked me what is that... I told them petrol. As long as petrol is there, we will remain well. Our country will not have any problems,” he said.

So not only has the request of the US President, the world’s most powerful nation, been rebuffed, the world’s largest oil producer has openly declared that it has purposely been withholding supplies because “their children need it”.

According to Swaminathan S. Anklesaria Aiyar of the Cato Institute, ``But countries imposing export controls, have, in effect, become hoarders themselves, creating an artificial scarcity in the world market, and an artificially high world price.” (underscore mine)

This simply epitomizes the escalating symptoms of the politics of RESOURCE NATIONALISM where government themselves have been the major hoarders and price manipulators of oil! Stated differently, the world’s oil or food crisis has been MOSTLY about geopolitics, or global governments’ attempt to control natural resources as an instrument to exercise the political heft.

From this perspective it wouldn’t be a farfetched notion to expect the increasing likelihood of prospective military conflicts emanating from heightening resource competition.

Of course the recent volatility in the marketplace has prompted the Saudi leadership to moderate its outlook, according to the New York Times, ``Saudi Arabia is currently pumping 9.45 million barrels a day, which is an increase of about 300,000 barrels from last month.

``While they are reaping record profits, the Saudis are concerned that today’s record prices might eventually damp economic growth and lead to lower oil demand, as is already happening in the United States and other developed countries. The current prices are also making alternative fuels more viable, threatening the long-term prospects of the oil-based economy.”

As you can see, when the winds of the political interest shifts, the Saudi leadership has shown its willingness to adjust accordingly in order to maintain its advantage.

But this is not just about Saudi, the US is the MOTHER of all “hoarders” with an above ground oil stockpile of 702.7 million barrels or representing 97% of capacity which is more than twice the size of private crude inventories with enough reserves to cover against 58 days of supply disruptions (AFP) through its Strategic Petroleum Reserves. Nevertheless, the US congress recently compelled the Bush administration to halt its shipments to the SPR.

And this is not restricted to the US alone, above ground stockpiles or strategic oil/petroleum reserves in China has been estimated at 292 million barrels or 30 days of import (eMediawire) and keeps growing.

Coming from both the supply-export side to the demand-import side, the proverbial 800 lb gorilla in the room has been global governments in the race to corral oil stockpiles! Yet it has been the small fries, who have been simply responding to the incentives set by the authorities, who always take the blame.

Unfortunately, for our beloved Bishop Saudi’s King Abdullah, US President George Bush and China’s Premier Wen Jiabao won’t need his blessings.

The Tragedy Of The Commons

Has the world run out of oil to justify today’s price?

Figure 1: BP: World Oil Reserves in 2007 at 1237.9 billion barrels!

Not if you ask British Petroleum, see figure 1.

From BP’s website, ``Reserves have grown 107.8 billion barrels since 2001 and 168.5 billion barrels, or 14%, over the last decade.” Proven Oil Reserves are estimated at 1.23 TRILLION barrels! Wow that’s a lot of oil out there.

So why has oil prices been climbing?

Like us, British Petroleum chief honcho, Tony Hayward argues that it is due to policy instituted distortions.

From the Economist (highlight mine), ``Mr Hayward blames poor policy-making or, in his florid phrase, “the madness of men”. Some 80% of the world’s oil reserves, he says, are in the hands of state-owned oil firms, which tend to allow firms like his only limited access. He believes that if these riches were fully exploited, the world could easily produce 100m barrels a day (b/d) or more. That’s a big increase on last year’s figure of 82m b/d, and a level that other oilmen, such as the boss of Total, another big Western firm, think impossible.”

Figure 2: API: Myth of Big Oil, 80% of Oil Reserves are Controlled by National Oil companies!

Figure 2 from API shows that government owned companies control 80% of oil supplies!

Since global government owned companies control 80% (some says more) of the world’s proven reserves, any speculation or hoarding can handily be counteracted upon simply by the release surpluses or by producing more supplies as previously discussed in If Oil Is A Bubble, Then It Is A Government Sponsored Bubble!, but has this happened? Unfortunately for us the answer is a NO.

In theory, in a well functioning market, rising prices should trigger supply side responses by attracting and increasing investments that should lead to more production output that would meet demand thereby lowering prices in the future. But, with national governments essentially CONTROLLING and RESTRICTING ACCESS to oil for political (resource nationalism, environmentalism et. al.) or other reasons (lack of capital or technology, unrest and etc…), this hasn’t happened.

And this applies within the US too. High prices simply mean demand far exceeds supply, so much so as bidders are willing to bid up prices for whatever reasons. In corollary, this means that the solution to high prices is to introduce more supplies.

Figure 3: Prof. Mark Perry: Environmental Restrictions

Figure 3 courtesy of Professor Mark Perry at the University of Michigan demarcates the areas from which the US government has restricted oil or energy drilling because of environmental concerns.

To consider, even the world’s premiere capitalist country can be shackled by politics.

CNSNews notes that there are about 279 million acres under Federal management with a potential 117 billion barrels broken down into onshore 31 billion barrels onshore (19 billion barrels inaccessible & 2 billion barrels for standard lease) and offshore 85.9 billion barrels (all off limits).

This is a concrete example of how political based regulations have basically stymied the supply equation contributing to the imbalances reflected in today’s record high oil prices!

Nonetheless, the distortions are also seen from the demand side, Christof Rühl author of the BP’s Statistical Review of World Energy 2008 says taxes and subsidies likewise impact the demand dynamics, again from the Economist, ``According to Mr Rühl, consumption is falling in countries with heavy taxes and rising only sluggishly where taxes are moderate. But in countries with subsidies, it is rising faster than normal, and fastest of all in the countries with the highest subsidies.”

RGE Monitor quotes CIBC (Hat Tip: Craig McCarty), ``Fuel subsidies breed soaring rates of domestic fuel consumption, particularly in OPEC countries, where gasoline is 25 cents/gal in Venezuela and 50-60cents/gal in Saudi Arabia, Kuwait and Iran. No sign of plans to remove subsidies soon in any of these countries.”

Yes, with oil prices drifting at near record levels, additional revenues for oil exporters is expected to reach $400 billion while official assets of oil exporting economies could expand by $800 billion at a conservative estimated average oil price of $115 bbl (Brad Setser), thus curbing consumer subsidies is indeed an unlikely scenario.

True enough, some countries mostly in Asia have acted to ease the government’s fiscal burden by passing the price increases to its consumers at some political costs as previously discussed in Philippine Politics: The Nationalist Hysteria Over Energy Issues.

But overall, where it counts most, like China which accounted for 50% of the global energy consumption growth in 2007 (Tanser-Kiplinger), gasoline prices remain heavily subsidized ($2.6 per gallon-LA Times), which means they are unlikely to get negatively impacted compared to other countries with less subsidies. Let us not forget China’s forex reserved climbed to a new record $1.76 trillion at the end of April (AFP) which also means China can afford to sustain such subsidy for a longer period. This is bad news for us because China and the other Oil exporting countries will continue to ravenously consume oil from which the pain of higher prices will be felt by those incapable of subsidies.

The Economist concludes, ``In other words, the root of the high oil price in BP’s view is not a mismatch between strong demand and feeble supply, but failure on the part of various governments to allow markets to work their magic. There are hints of an improvement on the demand side: several Asian governments have recently decided they can no longer afford subsidies. But it is hard to imagine the world’s ardent energy nationalists suddenly throwing their doors open to foreign investment.”

Politics, Not Greed Result To Higher Food Prices!

Basically, the same dynamics apply to food crisis seen in rice or the wheat markets but with an additional twist,

This quote again from Swaminathan S. Anklesaria Aiyar of the Cato Institute,

``International rice and wheat prices have doubled or tripled in the last two years, but world grain production will reach a record high this year. So how come millions are falling into poverty and starting food riots across the world? The answer lies not in any outsized surge in world demand or fall in world supply, but in the fact that several countries have imposed duties, quotas and outright bans on agricultural exports. This has reduced the amount of grain available for world trade.

``The United Nations Food and Agriculture Organization estimates that world production of cereals was a record 2,108 million tons in 2007, and will hit a new record of 2,164 million tons in 2008. Rice production will rise by 7.3 million tons and wheat by 41 million tons. World cereal consumption has been growing slightly faster (3%) than production (2%) for a decade, so global stocks have fallen to 405 million tons. But this is not a disaster scenario, and it hardly explains skyrocketing prices.

``In the U.S., one-fifth of the corn crop has been diverted to ethanol, and in Europe, some vegetable oil has been diverted to biodiesel. These ill-conceived policies have induced farmers to switch significant acreage from wheat to corn, soybeans and rapeseed, but world wheat output has nevertheless risen from 596.5 million tons in 2006 to an estimated 647.3 million tons in 2008. Corn-based ethanol cannot explain the runaway increase in the price of rice, which grows in very different conditions.”

Yes the added twist comes with the subsidies to biofuels, which was nobly aimed at reducing dependence on fossil based fuels. Of course since regulations by nature are responses to unfolding predicaments then the great tendency for the lack of indepth appraisal. Hence, unintended consequence occur, in this case biofuel subsidies distorts the farmer’s incentives for cropping, see Figure 4.

Figure 4 courtesy of Prof. Mark Perry: Corn From Food to Gas

Figure 4 courtesy of Professor Mark Perry at the University of Michigan shows of how agriculture as signified by corn production originally intended for food to feed people now has to compete with feeding the gas tank…US Corn production for ethanol is expected to climb to nearly 30% of total harvest in 2008!

Nonetheless, since growing corn requires fertilizers- about 90% of the cost of manufacturing nitrogen fertilizer depends on natural gas prices- this leads to a parallel increase in demand for natural gas which means higher prices for natural gas!

From James Finch (highlight mine), ``Nearly 95 percent of U.S. ethanol distilleries use natural gas boilers. Citigroup analyst Gil Yang estimated 28 billion cubic feet of natural gas would be consumed for every one billion gallons of ethanol produced. Cumulative ethanol production could surpass 12 billion gallons. Some analysts are predicted a natural gas demand increase up to one percent from the ethanol boom. But their estimates do not include increased fertilizer demand to increase corn yields.”

``Corn acreage is one of the largest consumers of nitrogen-based fertilizer. And because of the recent ethanol subsidies, more corn will be planted this year than in the past six decades. According to the U.S. Department of Agriculture, corn growers intend to plant 90.5 million acres in 2007. Because forecasts of ethanol production are expected to increase, expect more corn to be grown. In 2008, about 25 percent of U.S. corn production is planned to produce ethanol. By 2012, 4.3 billion bushels of corn are anticipated for ethanol production. It takes about 450 pounds of corn to produce 25 gallons of ethanol fuel to power an SUV.”

So by tweaking on one sector’s incentives, i.e. corn for biofuels, via policy directives, this creates a feed back loop- where more demand for natural gas equals higher energy-and a vicious chain effect of rising energy and food prices!

Moreover, the US corn based ethanol story doesn’t here.

Brazil’s sugar based ethanol, the world’s largest and the most efficient producer (Ethacane is twice as productive as ethacorn -- 6,800 liters per hectare for the former and 3,100 liters per hectare for the latter. It also produces 24 percent more fuel per hectare than the beet- or wheat-based ethanol common in Europe.-Alexandre Marinis) has been restricted entry to the US by virtue of a tariff of 54 cents per gallon. The tariff was introduced in 1980 with the intention of protecting US corn based ethanol producers.

Yet who benefits from the tariffs and farm subsidies instituted by the US government?

Figure 5: Heritage Foundation: Subsidies for the Rich, Famous and the Elected

The rich, the famous and the elected as shown in Figure 5 by the Heritage Foundation.

According to Heritage Foundation’s Brian M. Riedl, ``Eligibility for farm subsidies is determined by crop, not by income or poverty standards. Growers of corn, wheat, cotton, soybeans, and rice receive more than 90 percent of all farm subsidies: Growers of nearly all of the 400 other domestic crops are completely shut out of farm subsidy programs. Further skewing these awards, the amounts of subsidies increase as a farmer plants more crops.

``Thus, large farms and agribusinesses--which not only have the most land, but also are the nation's most profitable farms because of their economies of scale--receive the largest subsidies. Meanwhile, family farmers with few acres receive little or nothing in subsidies. Farm subsidies have evolved from a safety net for poor farmers to America's largest corporate welfare program.”

The recent passage of the expanded subsidies of the Farm bill has generated uproar among other WTO member countries. Why? According to Reuters, ``Critics say high U.S. farm subsidies distort the world trading system and squeeze poor-country farmers out of their markets, as well as putting a burden on U.S. taxpayers and giving incentives to U.S. farm businesses that do not need them.”

So again you have governments subsidizing the rich and maligning market signals (which impacts spending investment cropping etc) to the detriment of less fortunate American farmers or the taxpayers as well as farmers in the emerging markets as the Philippines.

Of course, subsidies in the US or Europe (Common Agriculture Policy) isn’t the only story. It’s almost everywhere. And collectively speaking such imbalances have been building overtime.

An example, Steve Hanke of Forbes magazine on Japan’s subsidies, ``Japan announced last month that it wants to export rice. The Japanese rice industry is superprotected, and the government holds huge stockpiles. Part of these stocks are accumulated because Japan agreed, as part of a World Trade Organization deal, to make regular purchases from foreign producers, mainly the U.S. To keep domestic rice prices high, the Japanese government hoards its WTO-mandated imports. Now that Japan wants to unload some of its rice, opposition is flaring up in Washington and other capitals, claiming that re-exports are not allowed under the agreement. When it comes to filling or releasing government stockpiles, politics clearly rules the roost.”

Again with politics as the top agenda for global governments instead of allowing market forces to seek direction, we can be assured that energy and food prices will continue with its upward trek until market forces will ultimately prevail via a recession or crisis of sorts.

The belief that governments can micromanage an economy in a highly globalized world is an illusion. Why? Because, to quote Steve Hanke, ``it assumes that government bureaucrats possess the same knowledge of market fundamentals and face the same incentives as well-financed, farsighted private traders. It also assumes that politics will not raise its ugly head. Both of these heroic assumptions are not met in the real world. Government buffer-stock schemes are rife with politics, and instead of generating profits from buying low and selling high, they tend to generate losses.”

So we suggest that our venerable bishop visit instead the embassies of the countries mentioned above and deliver his sermon of “greed” on the politicos.