Earlier this year New Scientist foolishly tried to grab readers’ attention with a cover proclaiming that “Darwin was wrong”.  He wasn’t, of course, and a right old furore was the inevitable result.  It seems misleading headlines are an inevitable symptom of the editing process employed by magazines and newspapers.  The journalist – perhaps keen to be accurate – relinquishes control to editors with entirely different priorities. A large part of their job is to tempt us to buy their product, and, once we have, to read articles they may not have had time to properly digest.

An article in this Thursday’s Guardian (p.11) caught my eye with: “India: Last of ‘big four polluters’ sets target of curbing CO2 emissions by a quarter”.  As I’m paying a lot of attention to the climate change negotiations, I realised that this seemed very unlikely, so read further (the online version linked to has a more sober title).  Many readers will no doubt have been misled by the headline.

It turns out, of course, that India is not offering to reduce carbon emissions at all:

“…[India] could curb the carbon emitted relative to the growth of its economy – its carbon intensity – by 24% by 2020.  … emissions would continue to rise… , but by less than currently predicted.”

This is similar to the action China is proposing.

The Copenhagen offerings to global public opinion from both China and India are entirely inadequate.

First, it’s not yet clear how binding the commitments are.

Second, the targets may not be difficult to meet. For example, I noted recently that:

“China uses four times as much energy as the U.S. per dollar of economic output, and more than 11 times that used in Japan.”

But simple gains in efficiency may even be counter-productive, as I’ve discussed before. In particular, Jevons’ Paradox, or the Rebound Effect, notes that as we improve the efficiency of a technology, the internal-combustion engine, for example, we tend to consume more of it, because we are increasing the value – measured in this case, perhaps, as the distance travelled – that we can obtain for one unit of resource (petrol, aka gasoline, say). Increased driving would, in this example, offset any efficiency gains, and, over time, could even exceed them!

The Rebound Effect considers demand for a technology. But the efficiency problem is worse than that. There is also a supply-side aspect. The more efficient a technology – the internal-combustion engine, for example – becomes, the greater the hurdle to replacing it, with electric engines, perhaps.

Martin Wolf, writing in the FT this week, refers to a paper from the Bruegel think-tank, which discusses the issue in depth. Wolf finds the paper’s argument that “merely raising prices on carbon emissions would reinforce the position of established technologies” to be “persuasive”. The paper, which is well worth a read, suggests that, as well as setting a carbon price at “an appropriately innovation-inducing level”, the “EU should stimulate new technologies more vigorously” by “subsidising the diffusion of existing technologies” and increasing its funding of green R&D.

It seems to me that the basic green technologies we are going to need already exist. They require “D” rather than “R&D”. And, as every entrepreneur knows, the best way to fund product development is through the income from sales. I’m somewhat sceptical that a few billion euros of government support will allow new technologies to overcome the refinements made possible by – depending on the technology in question – 10s or 100s of billions or even trillions of euros of historic sales of fossil-fuel based products.

Worse, why won’t we use both fossil-fuels and renewables? Dirty industries might simply become more and more efficient alongside green industries reliant on subsidies. We might simply consume all the fossil-fuel based and renewable energy that we can produce.

The only way to wean ourselves off fossil-fuels is to target their overall consumption, maybe by breaking the problem down into national allowances.

Until China and India are prepared to accept national limits on their emissions they will not be contributing to the task of avoiding dangerous climate change. Carbon-intensity targets are no substitute for emission cuts.

A while back now, I thought it would be interesting to monitor the Lloyds rights issue to see whether, as I strongly suspect, the rights issue process itself tends to drive down the share price – temporarily, of course. Or, alternatively, whether the market for UK retail bank shares is deep and liquid enough to prevent a mis-pricing during the issue.

Little did I know what I was letting myself in for. There are rather more side-issues than I’d reckoned on. But I’ve started so I’ll finish. I feel obliged to put the record straight on one or two points.

I’ll write again about the TERP business separately, but first need to clarify the cause of the anomaly in share numbers I attributed yesterday to a typo. I guess when Lloyds based their TERP calculation on the closing price on Monday rather than the average price that day which their Prospectus said they would use, I was ready to assume they’d made other mistakes. On the other hand, the typo assumption does seem natural, given the coincidence of the numbers. Reminiscent, perhaps, of George Monbiot’s famous deduction of the erroneousness of David Bellamy’s claims about claims about [sic] advancing glaciers.

To recap, I noticed yesterday that the numbers in Lloyds Rights Issue Price Announcement don’t stack up. Specifically, the document stated the following:

“Basis of Rights Issue 1.34 New Shares for every 1 Existing Ordinary Share [A]

Number of Ordinary Shares in issue as at the date of this announcement 27,161,682,366 [B]

Number of Ordinary Shares to be issued by Lloyds Banking Group pursuant to the Rights Issue 36,505,088,579 [C]”

Naturally, one would expect C to equal A*B. But it doesn’t. In fact, C=1.34399…*B.

The “399″ sequence led me to suspect that maybe A should actually be 1.344 and not 1.34, perhaps a reasonably easy “typo” to introduce.

In fact, I’ve been advised (and in the best journalistic tradition will not be divulging my source!) that the correct explanation is entirely different.

Attentive readers will recollect from one of my earlier posts on the subject that there are a few limited voting rights shares in Lloyds. This is what I said:

“Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.”

At the time I thought perhaps the LV shareholders might contribute some of the £13.5bn being raised in the rights issue. It did not even remotely occur to me that the LV shareholders might be entitled to rights to buy Ordinary (i.e. full voting) Shares. This seems to me entirely illogical – you’d think they’d get more LV shares instead – but is in fact the case.

Lloyds’ Prospectus notes that:

“Number of Limited Voting Shares in issue as at the date of this document 78,947,368 [D]

Number of Limited Voting Shares to be issued pursuant to the LVS Capitalisation Issue 1,973,683 [E]”

And this is what the Prospectus has to say about the Capitalisation Issue (the award of additional shares to existing shareholders, similar to a scrip dividend, though feel free to shout me down on this) in the Glossary:

“LVS Capitalisation Issue: the proposed issue of new Limited Voting Shares pursuant to Article 122 of the Articles”

My dedication to the task has reached its limits. At least until I get a second wind, I will not be trying to find “Article 122 of the Articles”. (Isn’t this legalese gone mad? Shouldn’t that just be “Article 122″? Or next time I tell someone my address should I say “number 47 of the numbers”?).

Anyway, if you add D + E to B and then multiply by A, you do indeed get C, to the nearest share.

I mentioned the possibility of rounding yesterday, i.e. that shareholders would not in general be entitled to a whole number of rights. I presume, since no allowance is being made for this, that such rights are being created and will be sold in the market. Perhaps shareholders will receive a small amount for the sale of part of a right they were entitled to; perhaps they won’t. I’ll let you know if I find out.

I hope that clears the typo issue up. Sorry, Lloyds, though I still think you calculated the TERP differently to how you said you would, and indeed, as I’ll explain next time, I still think you’ve taken liberties with the TERP concept. As I said before, and will elaborate, the one true TERP is that based on the closing price just before the shares go ex-rights, that is, on tomorrow’s closing price.

And if that isn’t a teaser for the next post, I don’t know what is!

I don’t believe this – another discrepancy!

Not only have Lloyds apparently managed to put a typo in their rights issue announcement and seem to have based their TERP calculation on the closing price of the shares yesterday and not their average price, they also seem to have calculated the TERP on the basis of raising £13.5bn and not the £13bn I used. Since the rights issue is costing the bank £500m (see Prospectus), my logic was that £500m has to be subtracted from the amount raised.

Lloyds claim:

“Discount of Issue Price to theoretical ex-rights price based on the Closing Price on 23 November 2009 ….. 38.6 per cent.”

We can reproduce their calculation, based on last night’s closing share price of 91.47p.

Total value of bank after rights issue/no. of shares after rights issue = £((0.9147 * 27,161,682,366) + 13,506,882,774)/(27,161,682,366 + 36,505,088,579)) = £(38351673634/63666770945) = ~60.238p.

Discount = (60.238 – 37)/60.238 = 38.58% i.e. the 38.6% stated.

But perhaps we should knock off the £500m cost of the rights issue:

Now we get a TERP of £(37851673634/63666770945) = 59.453p.

Discount = (59.453 – 37)/59.453 = 37.77%.

I presume the argument for doing the calculation the way Lloyds have is that the cost of the rights issue is in the share price already. The trouble is you could only really say this if you consider it 100% certain the rights issue will go ahead. To be fair, it’s probably not far off 100% since it’s very unlikely that the shareholders’ meeting on Thursday will vote down the rights issue. And if they did, this would in itself undermine the share price…

So perhaps the basis for the TERP calculation should be the price just before the rights issue was announced. But this would presume the rights issue was a complete surprise, which it wasn’t.

Then there are other aspects of the fund-raising that materially affect the share price: the £2.5bn fee to HMT to avoid the Asset Protection Scheme which was the alternative and the issue of “CoCos” that is part of the same restructuring exercise (and the success of which has given Lloyds shares a bit of a boost today).

So I suppose, on reflection, I will go along with the way Lloyds have done the TERP calculation and their figure of a 38.6% discount, based on last night’s closing price. The implication is that my original calculation of the rights issue price gave a figure that was slightly too low.

My main point is that it should be normal for rights issues to be heavily discounted. The share price of companies raising funds via rights issues can be volatile:

Lloyds share price over last 3 months

The difficulty in pinning down the share price that should be put into the calculation leads to a certain slipperiness in the basis for calculating the TERP – maybe the T for “theoretical” is the operative word – and suggests caution should be the name of the game in setting a rights issue price. But Lloyds is being very cautious.

Afterthought (13:45): The “slipperiness” is in calculating the TERP in advance. The TERP is only a valid measure once the rights issue is 100% certain to proceed. In the case of Lloyds we can only really say what the TERP and the rights issue discount to TERP is, based on Thursday’s closing price, just before the rights are created, and after the meeting to approve the rights issue. At this point everything is certain, and, in particular, the fees for the rights issue are committed, so the full amount raised by the rights issue should be included in the calculation (as Lloyds did it). So we (Lloyds, professional commentators and myself) are all mistaken in trying to determine a TERP until the rights issue is definite. At best the figures we’ve all been discussing are just (educated) guesses.

In my earlier post, I expressed some bafflement that LLoyds say:

“Basis of Rights Issue 1.34 New Shares for every 1 Existing Ordinary Share”

since if you divide the number of new shares to be issued by the number of existing shares you get 1.34399. Suspicious those 9s, aren’t they?

I now suspect that what Lloyds meant to say was 1.344 new shares for each existing share. This would result in 36,505,301,100 new shares, 200,000 odd above the 36,505,088,579 stated. This is much closer to what would be expected since there will be some rounding down of the number of rights as 1.344 times the number of existing shares will not in general be a whole number. (Perhaps Lloyds had the data on shareholdings to calculate the number of new shares exactly).

If I’m right, the cash you need to find is 1.344 * 37p = per share or 49.728p, closer to what I was expecting than 1.34 * 37p which is only 49.58p.

Confidence-inspiring, eh?

[Note 16:40, 25/11: It turns out this isn't a typo - there's a different reason for the discrepancy].

I made a confident prediction yesterday that Lloyds would price its rights issue at 33.13p.

In fact the rights are being priced at 37p.

How and why did Lloyds arrive at this price?

I first saw a calculator on Tomorrow’s World when it was so valuable it had to be guarded. The programme claimed that such devices would eventually cost less than £5. Everyone scoffed. Of course they understated their case. Today I have a calculator included in my PC at an additional cost to me of effectively nothing – if it didn’t exist I’m sure I could download some freeware.

So, luckily I can easily check Lloyds’ figures.

First off, let’s see what’s accurate and what isn’t.

The various reports e.g. on Yahoo! are traceable back to this statement from Lloyds.

1. 37p is accurate

Lloyds provide the following data:

Number of Ordinary Shares to be issued by Lloyds Banking Group pursuant to the Rights Issue…. 36,505,088,579

Expected gross proceeds of the Rights Issue receivable by Lloyds Banking Group…. £13,506,882,774

The proceeds divided by the number of new shares to be issued is precisely 37p.

2. 1.34 is not accurate

Lloyds provide the following data:

Number of Ordinary Shares in issue as at the date of this announcement… 27,161,682,366

Number of Ordinary Shares to be issued by Lloyds Banking Group pursuant to the Rights Issue…. 36,505,088,579

The number of new shares divided by the number of existing shares is in fact 1.3439921757…

I confess myself slightly baffled, since I can’t find a more detailed statement from Lloyds.

Is there a rounding error? But to issue more shares than implied by the 1.34 entitlement per existing share would imply rounding the millions of small shareholders’ entitlements up, whereas I would expect the number to be rounded down (you can’t have part of a right).

3. What is the discount to TERP?

The 3rd November Prospectus defined the TERP as follows (p.240):

“Theoretical Ex-Rights Price or TERP:

the theoretical ex-rights price of an Existing Ordinary Share calculated by reference to the volume weighted average price on the London Stock Exchange’s main market for listed securities of an Existing Ordinary Share on 23 November 2009″ [my stress]

Today’s statement says this:

“The Issue Price represents a discount of 59.5 per cent. to the Closing Price of the Company’s Ordinary Shares on 23 November 2009 (being the latest practicable date prior to the publication of this announcement) and a discount of 38.6 per cent. to the theoretical ex-rights price based on this Closing Price.” [my stress]

Yahoo! gives yesterday’s closing price as 91.47p, but, as can be seen from the graph in my post yesterday, it seems “the volume weighted average price” of Lloyds shares yesterday must have been maybe 90.7p.

At 90.7p, the total value of the existing shares is (27,161,682,366 * 0.907) = £24,635,645,906.
Add in the £13bn net being raised and divide by total number of shares after the rights issue (all in millions): £37,636/(27,162+36,505) gives TERP = 59.11p.
37/59.11 = 0.626, so on this basis the discount to TERP is only 37.4%, outside the range they gave of 38-42%.

Why 37p, then?

It seems Lloyds have been very bullish on the rights issue price.

Maybe they’re right – the shares right now are trading up more than another penny at 92.73p, according to Yahoo!

But a company’s share price is an arbitrary value. What matters is how many shares you have multiplied by the share price.

It seems to me that it is in shareholders’ interest to price rights issues as low as possible. This makes it much less likely that a rights issue will fail, because the rights will have more value. This in turn will reduce the underwriting fee. As I pointed out a while back, the underwriting fee is not a trivial sum.

I can only explain a desire to price the rights at a higher price than necessary in psychological terms – macho posturing, perhaps.

I still don’t expect this to happen in the case of this rights issue by Lloyds, but the risk is that the normal effects of trading I described yesterday depress the share price and hence the rights price so much that the rights become effectively an option to buy the shares. Shorting the stock (and buying the rights) then becomes an attractive trade, since, if the rights issue fails, the new shares that would have been bought in the rights issue have to be sold in the market by the under-writers. This depresses the price further, added to the speculators’ profits. Of course, it also undermines confidence in the company itself, further depressing the share price…

The reason this won’t happen with Lloyds is I don’t believe the issue is so much underwritten as that commitments to take up rights have been obtained from the holders of the majority of the shares (possibly of a large majority). I suspect Darling’s 43% (discussed previously) is not the whole story.

I wasn’t expecting a twist in the story quite so soon! Let’s hope everything goes smoothly…

The Lloyds rights issue price is to be announced in less than 9 hours, at 7am tomorrow (Tues 24th). I can barely contain my excitement!

Lloyds has been trading at between 90 and 91p today, the reference day for calculation of the theoretical ex-rights price (TERP):

Lloyds share price 23/11/09

I based my calculations on a share price of 90p which gave a TERP of ~55p and a rights issue price of ~33p. I’m pleased to see the Observer agrees, though I do worry who their “analysts” are. If they’ve merely found my blog (and it’s happened before) then their support is rather circular. I noticed, though, that Joseph Dickerson at Execution has been quoted as expecting “a rights in a 30-35p range”, which gives me rather more confidence that I haven’t done something silly.

I’m therefore going to stick my neck out and predict a rights issue price of 33.13p [see Note]. How do I arrive at this? Simple: it’s 3 rights for every 2 shares which is such a simple multiple that I expect Lloyds to be unable to resist it. Remember, we have to put in around 49.7p per share we currently hold. 2*49.7 is 99.4, divided by 3 is 33.13 to two decimal places.

What will happen to Lloyds share price then, though?

We’re coming up to the interesting part of the exercise, and I’ll be watching like a hawk.

My prediction is this:
1. Lloyds will start trading at 55p [see Note] immediately the market opens on Friday morning (when the rights are created and the shares go ex-rights).
2. The rights will start to fall from their value of 21.87p (55p – 33.13p) as some rights are sold in the market by those who simply do not have the cash to take up their entitlement.
3. The shares are dragged down, as arbitrageurs (hedge funds, say) buy rights and sell shares (or short the shares), knowing that they can exercise the rights and make a profit.
4. Other market participants with money to invest in Lloyds exploit the undervalued stock, and buy both the rights and the shares, pushing the shares back up towards 55p.

In other words, I expect supply and demand to depress Lloyds shares below the TERP over the fortnight or so before the rights issue closes. How far the shares fall is the proverbial million-dollar question. I doubt very much the shares will drop as far as 33p, but the natural depression of the price during a rights issue makes it very difficult to use this method of raising capital in a crisis, as we saw last year.

It’ll be very interesting to see how much the tendency of Lloyds shares to drop in price is counteracted by those who see the rights issue as a buying opportunity…

I’ll be keeping an eye on things. Watch this space!

[Note (18:45 24/11): Lloyds have actually priced the rights issue at 37p, implying a "TERP" of ~60.24p. This is based on the closing price yesterday, 23rd, but the shares would be expected to start trading on 27th, when they go ex-rights, at a true TERP based on the closing price the previous day, 26th.

The reasons for the difference between the actual rights price and "TERP" and my estimates for these, above, are discussed in a Note to my previous post on this topic].

It’s incredible what you see if you keep your eyes open. This AP story about Chinese electricity prices popped up on my screen today, courtesy of Yahoo!

The article begins:

“China raised electricity rates for businesses and industries Friday, part of a long-term effort to adjust prices to reflect costs and promote energy saving as the country struggles to meet soaring demand.

The 5.7 percent increase was the first rate-hike since July 2008, when electricity tariffs for nonresidential use rose 5 percent. Residential electricity rates have remained stable since a 1 percent hike in July 2006, but a residential rate increase is planned for early next year, China’s main planning agency said in a notice late Thursday.”

So far, so good.

The story even goes on to report that:

“Rates for residential users will be adjusted to charge more to heavy users, while keeping the costs for those who consume little more or less unchanged.”

Amazing what an all-powerful state can do! And sensible, I suppose, if you’re into social engineering.

But there’s a kicker:

“Friday’s hike raises the tariff for industrial and commercial customers to 0.522 yuan (3.4 U.S. cents) per kilowatt hour. That compares with rates averaging about 10.4 U.S. cents in the U.S. and 12 U.S. cents in Japan, according to figures from the U.S. International Energy Agency.”

So let’s see… An American company could have its widgets manufactured in China and exported to the US (or anywhere else for that matter) and, denominating everything in dollars, save nearly 70% (67.3% to be more precise) on electricity costs alone!

AP goes on to report that:

“China’s power consumption [presumably "power" is synonymous with "electricity" here] rose nearly 16 percent in October from a year earlier, to 313.4 billion kilowatt hours, the fifth straight month of increases as the economy recovered from a slowdown early this year.

Earlier this week, Shanghai and other major cities reported brief shortages of power and natural gas due to surging demand due to dropping temperatures.

The government is on a long-term campaign to reduce energy waste, especially by industries. While cost-conscious families tend to skimp on electricity use, overall China uses four times as much energy as the U.S. per dollar of economic output, and more than 11 times that used in Japan.” [my stress]

I included the first couple of paragraphs for other interest – 313.4 billion kilowatt hours (why, oh why can’t journos use units in a sensible fashion? – what next? “million MWh”?) is 313.4TWh, i.e. about 10 times the UK’s electricity consumption (around 400TWh/yr, according to the source I used in a previous post).

I wrote yesterday that:

“…let’s suppose France succeeds in reducing oil consumption. What else might they buy? If they buy manufactures, the ‘embedded carbon’ in each $1bn worth will very likely be higher than in $1bn worth of oil! Why? Because manufactures require energy which will likely come from cheap indigenous (or Australian) coal, in China, say. Oil has a scarcity value because it is so useful. $1bn worth of oil might therefore contain less carbon than $1bn worth of manufactures!”

I remember thinking I should tone this down. I can’t remember exactly what I changed – I guess I put the “might” in the last sentence – but I obviously missed a “very likely”. Now, though, I’m beginning to wonder if I shouldn’t have been more committal!

I’m very disappointed to see policy-makers trying to solve the problem of global warming by ineffective – and possibly even counter-productive – measures such as raising efficiency standards and imposing carbon taxes.

What, for example, will California’s TV owners do with the money they save on their electricity bills? Maybe they’ll upgrade their set more often which will likely lead to more emissions per dollar than would have been incurred had they spent the money on California’s partially decarbonised electricity!

I touched on the problem with efficiency – the rebound effect – when I summarised the various problems with policies which put a price on carbon with the aim of reducing CO2 emissions.

All these problems arise because we are so reliant on fossil fuels. Virtually everything we do – and in particular everything we spend money on – is likely to result in CO2 (and often other GHG) emissions to the atmosphere.

Today I just want to look at the problems with taxes on carbon. After all, now that the middle word has been dropped from “Copenhagen or bust”, it seems national policies, rather than a global emissions trading regime, are to be the focus, at least for the time being.

I worry whether my previous attempts to explain the Man in the Wardrobe Fallacy, here and then here, were too theoretical. So I’m going to try to work through the argument, step by step, with examples.

The Nature of Money

Too many people are failing to consider what money really is. One way of looking at money as a means of allocating resources. The price of a good is not, as many suppose, a fundamental quality, but reflects its supply and the demand for it.

Consider Geoge Monbiot’s recent piece on peak oil. Maybe its the late noughties zeitgeist, but again I feel obliged to express my disappointment, this time that George seems to think an “end is nigh” attitude to oil helps in the fight against global warming. Indeed, the first comment on his article, by NeverMindTheBollocks, has been deleted, but the second, by Daveinireland points out the problem:

“Isn’t the oil running out a simple so[lu]tion to global warming then? No oil means billions starve and the number of those pesky carbon footprints drops d[r]amatically.

Isn’t that what you want?”

In actual fact, if we want to stop catastrophic global warming, we can’t afford to use up oil the all, given that we’re also using all the gas we can find and most of the coal.

George’s predictions of chaos as oil output declines are also wide of the mark. For the activities that use oil – driving and so on – to decline globally, it would be necessary for oil output to decline faster than the rate of increase in efficiency in use of oil plus the rate of substitution of the use of oil, e.g. by the use of electric cars and (though it doesn’t help us on the GW front) the use of liquid fuels from coal (and indeed biofuels). Oil output would only decline by a few percent a year, max, which – given the EU thinks we can generate 20% of our energy supplies from renewable sources by 2020 – is of the same order as the rate at which we can replace it. And this doesn’t even take account of forced energy efficiencies.

Why do I say “forced energy efficiencies”? Because at some point, an individual’s spending on fuel is limited by the price. If they still want to get to work they’ll simply have to trade in the SUV for a hybrid. Money determines how the available fuel is allocated.

Of course, in a world of massive financial inequality, some will carry on driving their SUVs, whilst others are forced to use even cheaper means of transport, such as buses, trams or trains. But this is the fault of the economic system, not the oil supply. Since we’re using oil so inefficiently – maybe on average we get 50% fewer mpg than is possible with current technology – the supply could decline by at least 50% before it was necessary in energy rather than financial terms for anyone to reduce the distance they drive at all.

Monbiot oversimplifies by attributing economic problems to resource constraints. He suggests, for instance, that:

“a permanent oil shock would price food out of the mouths of many of the world’s people.”

If we assume the food supply does indeed decline, or at least fail to keep up with population growth, then it is indeed the case that food prices could rise if nothing else is done. But food, like gasoline, is being used unevenly and inefficiently. Many of the world’s people already have too little to eat, for economic reasons rather than because of limits on global resources. Further, many of those with least to eat are not part of the global market economy. Rather they are subsisting (or not) on small patches of land, relying very little on oil-based fertilisers and oil-powered machinery.

It’s the urban poor who are most likely to be affected. But in many countries, the prices of basic foodstuffs are regulated by the state, so problems will arise only when countries are no longer able to afford imports. Meanwhile the price mechanism will reduce consumption in developed countries, specifically those which are net importers of food. Here, though, minimum wages (and state pensions and benefits) are generally negotiable and index-linked, negating the effect of price rises.

Who would have to reduce their consumption, then? It’s a mixed, even slightly rosy picture, but it seems the burden will fall on two groups:
- those whose governments are no longer able to import sufficient food;
- those urban poor presently existing on slightly more than subsistence-level food supplies, who will become relatively poorer compared to those reliant on social or government safety-nets.

In other words, more people will be food-poor, but famines, as now, will be associated with collapsed governments and environmental or social crises.

The point I am trying to make is that money is simply a way of allocating resources. And there are other ways.

Food is so fundamental that you can’t naively apply simple supply and demand economics. In the UK, for example, food was rationed for a decade just over 50 years ago, well within living memory. In the event of a complete food-supply catastrophe (and actually I think a bigger threat than a slowly declining oil-supply is a major volcanic eruption which could reduce harvests for several years), I have no doubt we’d see rationing again.

The effect of a decline in global food supply is complex, but one tentative conclusion might be that it would be governments rather than the individuals themselves who ensure their populations have an adequate food supply. Or not.

The Likely Ineffectiveness of Carbon Taxes

Let’s now consider the policy of taxing carbon, as is being implemented in France, for example. The idea is to tax gasoline, heating oil and so on. Fine, but the critical question is what happens to the money:

“But things get tricky. The €4.3 billion ($6.39 billion) raised annually by the tax would actually be returned to taxpayers in the form of tax reductions or ‘green checks.’ A family living in an urban area, for instance, would get a break of €112 ($166.53) on their income taxes. A family living in the country, which presumably would mean higher carbon taxes because of the lack of public transportation, would get an even bigger reduction of €142 ($211.14).”

What amuses me most is that the French have decided that carbon consumption because of a rural lifestyle is somehow legitimate! Apparently we should subsidise those who have profligate lifestyles in rural areas – a ludicrous position that is also taken for granted on this side of La Manche. An intelligent policy would instead pass on the various extra costs arising from their inefficient lifestyle to those in rural areas to encourage more to adopt a less costly urban lifestyle.

But the real problem is that the money raised by the carbon tax is simply redistributed. Only two things have happened:
- the spending power of the poor has been increased at the expense of that of the wealthy;
- the price of highly carbon-intensive activities has been increased relative to less carbon-intensive activities.

The first effect could actually make the situation worse, as some of those who could not afford to (say) use their car often or heat their homes as much as they’d like, can no afford to do so. This could (in fact very likely will) outweigh the effect on the wealthy, who may simply save less of their money!

The whole policy therefore rests on the magnitude of the second effect. Will people switch to less carbon-intensive technology? There are at least two reasons why they might not and even if they did, this would not necessarily reduce global or even French carbon emissions:
- first, it’s often difficult to tell which option is least carbon intensive;
- second, there may be insufficient supply of renewable energy;
- third, consuming less fossil fuel will simply allow its price to fall, allowing others to consume more.

Let’s explore the third problem a little more. Take the example of the oil price which is set globally in dollars. If the French purchase less oil, its price will drop slightly and someone else – China, say – will be able to purchase a little more of it. France acting on its own cannot reduce global oil production.

But it’s worse than this. France can afford a certain level of imports, over a long period of time equivalent in value to their exports. So, if France earns on average $100bn a year in exports (let’s assume imports and exports are all priced in dollars), then, on average, it will import an annual $100bn worth of goods. Money can store value but ultimately must be spent – in itself it has no intrinsic utility.

The carbon tax has no effect on France’s trade position – if anything it will help them increase their exports, by promoting more efficient use of fossil-fuel imports – so they still have (at least) the same hypothetical figure of $100bn to spend each year.

Likely a similar proportion of the $100bn will be spent on fossil-fuel such as oil. But let’s suppose France succeeds in reducing oil consumption. What else might they buy? If they buy manufactures, the “embedded carbon” in each $1bn worth will very likely be higher than in $1bn worth of oil! Why? Because manufactures require energy which will likely come from cheap indigenous (or Australian) coal, in China, say. Oil has a scarcity value because it is so useful. $1bn worth of oil might therefore contain less carbon than $1bn worth of manufactures!

And it gets worse. Whatever France buys, even if it’s software, they’ll give their dollars to the producers, let’s say in India. And the producers will then be able to import oil. Or manufactures.

The Man in the Wardrobe Fallacy

The Man in the Wardrobe Fallacy is simply that an internal change in an economy – a redistributive tax on carbon, say – has no direct effect on the external effects of that economy, its ability to import fossil-fuels, for instance.

At the present time, supply-side constraints – the rate at which low-carbon energy is being rolled out – are limiting our ability to reduce fossil-fuel consumption and hence carbon emissions. When gigawatts of wind energy capacity are held up in the planning system, all carbon taxes will do is act as a redistributive tax, increasing economic equality (all else being equal).

And, mirroring the case of the likely effect of production capacity constraints on food consumption, economic equality is, sadly, not your friend when you are trying to reduce consumption of a resource. Think about it. Consumption of any resource is surely minimised when the poor majority are constrained by their finances (or access to the resource), and the wealthy minority by their appetites!

In the example of food, the response to a drop in supply would be to increase the numbers of the poor majority, that is, those constrained by their finances. The number able to eat as much as they want, whenever they want, would tend to decline.

In the example of fossil-fuels, redistributive effects – such as from taxes – tend to increase consumption, the reverse effect. Indeed, we can see on a global scale how the spurt of development over the last couple of decades, and especially since the start of the millennium – a massive equalising of global spending power – has led to an increase in, for example, demand for oil.

Successful strategies to reduce global carbon emissions must involve a limitation on overall emissions. Kyoto – with crucial terms dictated by the hyperpower of the time, the USA – was intended to lead to such limits. Copenhagen, forged in the new multi-polar world, will consist of no more than a series of unenforceable, and, in many cases, vague, national undertakings, and will be entirely ineffective.

I see that this week’s Guardian Money letters page includes the clarification that, as I’ve also pointed out, the Lloyds rights issue does amount to “about 50p for each current share”.

The Guardian also publishes a letter (sorry, the online version of their letters page has no internal links, so you’ll have to scroll down), noting how the Equitable Life “was operating a Ponzi scheme under the very noses of the regulators”. I couldn’t have, and, in fact, didn’t put it better myself.

Hey, here’s an idea. If Guardian Money doesn’t really know what it’s talking about, why don’t they simply list issues in the news, inviting correspondence for publication the next weekend? It’d save on journo costs. I doubt the other papers are any better – I’m picking on the Guardian because that’s the paper I take, so really, guys, this is all a vote of confidence!

Anyway, about this 50p.

Late last Thursday, I think it was, I thought I’d check the exact amount due in the rights issue per current Lloyds share held. And I found that the shares are being sold a little cheaper to the Treasury.

The reason I checked is that there are (at least) two slight complicating factors in the Prospectus.

First, I noticed that:

“Ordinary Shareholders in the United States or any other Restricted Jurisdiction will, in any event, not be able to participate in the Rights Issue.” (section 3.2, p.32).

If such shares didn’t qualify for rights (which is not what’s stated, though is not excluded by the statement), then obviously the rest of us would have to put in a bit more to raise the £13.5bn. But one would imagine the rights would end up being sold in the market, which is what p.77 of the Prospectus seems to say (Section 15: “What should I do if I live outside the UK?”). So shareholders in Restricted Jurisdictions shouldn’t be a problem.

Second, there are a small number of Limited Voting (LV) shares – 79 million, compared to over 27bn – in fact ~27,162 million – Ordinary Shares. These LV shares also have an entitlement to rights. What I don’t know, though, is how much these LV shares are worth. If each is worth much more than an Ordinary Share, and, more to the point, if the holder of each contributes significantly more than 50p to the rights issue, then the rest of us would have to put in a bit less than 50p.

On the other hand, the Prospectus clearly states that they will issue up to 90 billion Ordinary Shares. The lowest price the new shares could be issued for is 15p, and 90bn * 15p is precisely £13.5bn.

So it seems the £13.5bn is indeed being divided equally amongst the 27bn shares – 27,161,682,366 to be exact – so shareholders will have to put in 49.70p, to 2 decimal places.

Nevertheless, I thought of another way of checking the 50p figure. I realised it was possible to work out how much the Treasury is paying for new shares in the Rights Issue. Their press release on the topic notes they’ll be “investing £5.7bn net of an underwriting fee”.

According to the Prospectus (p.104), the taxpayer currently owns 43.43% of Lloyds’ Ordinary Shares (the Treasury press release gives 43%, which is disappointingly imprecise).

43.43% of the shares comes to 11.8bn – 11,796,318,652 to be as precise as we can.

£5.7bn divided by the number of shares the Treasury holds, comes to 48.32p, not 49.7p.

My first thought was that, since the proportion of shares owned by the Treasury was rounded to 43%, perhaps the £5.7bn is a rounded figure too. But even if the real figure was £5.7999999bn, that would only be 49.17p a share, significantly less than our 49.70p.

In fact, as the holder of 43.43% of the shares, the Treasury should be putting in £5.86305bn, not “£5.7bn”.

Then I paid attention to the words after the figure £5.7bn in the press release: “net of an underwriting fee” [my stress].

Yes, what appears to be happening is that the Treasury is underwriting its own share purchase!

And, sure enough, the Prospectus has this to say (p.216):

“7.2 HMT Undertaking to Subscribe

Under the HMT Undertaking to Subscribe, subject to certain terms and conditions, including that the Resolutions relating to the Rights Issue and the HMT Transactions are passed, HM Treasury has irrevocably undertaken to procure that the Solicitor for the Affairs of Her Majesty’s Treasury (as nominee for HM Treasury) (i) votes in favour of all of the Resolutions in accordance with the recommendation of the Board (except for Resolution 4, as set out in the notice of General Meeting, regarding the HMT Transaction) and (ii) takes up its rights to subscribe for all of the New Shares to which it is entitled under the Rights Issue, at or prior to 11.00 a.m. on 11 December 2009, each at the Issue Price. Conditional upon (ii) above, the approval of Resolution 4 by the Ordinary Shareholders and the receipt by the Company of the aggregate subscription proceeds payable by HM Treasury (the ‘‘HMT Subscription Proceeds’’), the Company has agreed to pay to HM Treasury (or to such other person as HM Treasury may direct) the HMT Commitment Commission, being a fee equal to: (A) the Base Fee multiplied by the aggregate number of New Shares for which it has subscribed, plus (B) the Per Share Discretionary Fee multiplied by the aggregate number of New Shares for which HM Treasury has subscribed, in consideration, amongst other things, for the undertakings given by HM Treasury in the HMT Undertaking to Subscribe. The HMT Undertaking to Subscribe contains certain representations and warranties and indemnity provisions in favour of HM Treasury which are the same as those given in favour of the Banks (and certain other indemnified persons) under the Rights Issue Underwriting Agreement.” [my stress].

Remember that £13.5bn? Well, as I had to allow for in calculating the “TERP”, only £13bn of it goes to Lloyds.

If we calculate how much the government is paying on a basis of the total rights issue being £13bn and not £13.5bn then 43.43% is £5.6459 which is much closer to £5.7bn. Not all of the £500m will be the underwriting fee. If the Treasury is putting in exactly £5.7bn (and owns exactly 43.43% of the shares), then that implies the issue will raise £13.12bn (rounded) including arrangement fees, but net of underwriting costs. The latter therefore come to around £388m. Shocking.

My understanding is that in fact this little perk is not special to this rights issue, nor to HM Treasury. Large shareholders are routinely underwriting their own subscriptions to share issues.

Now, all this really represents is an early commitment to subscribe to the issue.

Let’s just consider how much this is worth. The issue will be at a ~40% discount to the TERP, as discussed last time. As we saw, the TERP will be around 55p, and the new shares issued at ~33p.

Is there any real chance of the share price falling below 33p before the completion of the rights issue?

Not really. Cyclone Lehman has passed through the markets and all is now calm. Lloyds raised £4bn at 38p a share back in April, when the recession and its own position looked much worse than it does now.

More to the point, would I have taken the same deal as HMT to save my share of the £388m? Yes, I would.

Before Darling got his feet under the desk at Number 11, there was a principle that shareholders were protected by “pre-emption rights”, that is, existing shareholders had to be offered the same deal offered to new shareholders. Similarly, the interests of minority shareholders are supposed to be protected from the big guys. Now, an ignorant media (and Vince Cable) eggs on the government to act exclusively in the interests of “the taxpayer”. In fact, companies must be run in the interests of all shareholders. That’s why they are legal entities. In using its stakes in the banks to impose stealth taxes on the organisations, the Treasury is dangerously close to indulging in the same sort of behaviour that put Conrad Black behind bars.

Mr Darling, might I perhaps have the temerity to suggest that, rather than whinging about bankers’ bonuses, a better strategy would be to examine some of the ways in which business insiders make massive amounts of easy money at the expense of, very often, the private shareholder, among others? And underwriting rights issues isn’t even the worst offence. Start by looking at the bankruptcy process – e.g. Telewest, Cobra Beer, Jessops and Woolworths and list the winners and losers…

There is a massive conflict of interest if large shareholders receive underwriting fees for rights issues. I have no idea whether £388m is an objectively reasonable figure or not. But I do know two things:
1. The holders of large blocks of shares who also act as underwriters – including the Treasury in this case – have no incentive to question the underwriting fee.
2. I wasn’t offered the chance to underwrite my own share purchase – i.e. commit a few weeks early – which I would quite happily have done. I’d have liked a “Commitment Commission” too, Mr Darling.

Small shareholders can work out how much the under-writing will cost them: it’s £(~388m * no. of current shares)/total number of shares i.e. ~27bn, a bit over 1.4p per share or ~£14 per 1,000 shares. Adds up, doesn’t it?

No wonder investment bankers are rolling in money when the Treasury – far from ensuring fair play – is happy to be complicit in yet another systematic mugging of Joe shareholder.

And what’s more, it’s not difficult to think of better ways of carrying out rights issues.

This is my third post on the topic of Lloyds upcoming rights issue. My aim is to provide a little clarification for those affected. Why am I doing this? Despite everything, I still believe in a “share-owning democracy”.

The Guardian’s Patrick Collinson wrote this recently:

“An equitable figurehead

In recruiting Honor Blackman as a Joanna Lumley-esque figurehead, the Equitable Members Action Group has chosen well. With-profits annuitants such as Blackman, who had no choice but to stay with Equitable, have suffered more than any other category of policyholder. The others were given a choice in 2000 to get out with a 10% cut in policy values. Those that didn’t take it want compensation galore instead. Are they really that deserving of taxpayer money?” [my stress]

Maybe I’m a bear of little brain, but the Equitable Life non-GAR with-profits policy-holders have had a large chunk of their assets arbitrarily confiscated – a court put the rights of GAR holders above theirs. If this doesn’t deserve compensation, I don’t know what does. More another time.

The lesson I take from this is that you’d better look after your own finances because you can’t trust the media to look out for you when the pros screw up.

When Lloyds announced their upcoming rights issue my initial reaction was to whinge about the complexity of “deferred shares”, which I concluded are worthless, just a device to get round some stupid rule.

I also noted on that first post and subsequently that you can determine how much cash you’ll need to take up your rights. You’re going to need ~50p per share you hold going into the rights issue.

I have no idea why Lloyds didn’t spell out in the various documents they’ve issued about the rights issue that you’ll need to find ~50p per existing share to take up your entitlement to new shares. If I may be permitted to give them some feedback as a shareholder, my opinion is that it would have been a good idea to specifically include the amount of money shareholders would need to find. Perhaps those involved and the officers of any other company doing something similar in future could bear this point in mind.

In my second post on the subject I also presented the argument that a rights issue can temporarily depress a company’s share price so might be a good time to buy shares either by subscribing to the issue or otherwise. [Nothing I write on this blog should be taken as financial advice].

From the search terms that are being used to reach this blog, there are two other significant areas of confusion: the timetable and the use of the term “theoretical ex-rights price” (TERP) to determine the issue price of the new shares.

Timetable

As I understand it, for the retail investor there are only 3 key dates and the first of these appears to be another anachronism (this whole process could do with a bit of simplification):

- 20th November (Friday): the “Record Date” for entitlement to receive rights. If you’re planning to buy shares near or after this date, then, if I were you, I’d check with a financial adviser or stockbroker as to whether the deal will be in time to qualify and whether there’ll be any extra bureaucratic hassle. The Prospectus says this:

“7 If I buy Ordinary Shares after the Record Date will I be eligible to participate in the Rights Issue?
If you bought [sic] Ordinary Shares after the Record Date but prior to 8.00 a.m. on 27 November 2009 (the time when the Existing Ordinary Shares are expected to start trading ex-rights on the London Stock Exchange), you may be eligible to participate in the Rights Issue.
If you are in any doubt, please consult your stockbroker, bank or other appropriate financial adviser, or whoever arranged your share purchase, to ensure you claim your entitlement.
If you buy Ordinary Shares at or after 8.00 a.m. on 27 November 2009, you will not be eligible to participate in the Rights Issue in respect of those Ordinary Shares.”

So what’s the point of the Record Date if it’s not a real deadline?

- 27th November (Friday), 8am: rights created and can be traded or exercised. This is when I’d expect them to appear in (online) nominee accounts.

- 11th December (Friday), 11am: rights must be exercised by this time, though if you have a nominee account they’ll probably advise you of a deadline earlier than this. The new shares can be traded from start of business on the Monday (14th December).

TERP

The Lloyds Prospectus (p.6) implies that the:

“…Issue Price [will] be set at a 38 per cent. to 42 per cent. discount to TERP…”

They also define the TERP as:

“the theoretical ex-rights price of an Existing Ordinary Share calculated by reference to the volume weighted average price on the London Stock Exchange’s main market for listed securities of an Existing Ordinary Share on 23 November 2009″.

Got that?

I thought I understood how to work out the TERP, but tried to check anyway. Wikipedia’s entry is little help. It doesn’t seem to me to contain any falsehood, but then it doesn’t provide a lot of information either.

Unfortunately, Wikipedia references something called Investopedia which has this to say:

“Although the stock price is not likely to change immediately following the new rights issue, it will change as the rights expiration date approaches.”

Rubbish. No wonder we’re all confused!

The whole point is that as soon as the existing shares are split into ex-rights shares and (nil-paid) rights (at 8am on 27th November in the case of Lloyds), the (ex-rights) share price adjusts – to the TERP – to reflect the split. The rights should theoretically trade at approximately the TERP minus the subscription price for each right (i.e. how much you have to pay to exercise the right). Once all the rights are exercised, which they will be, since rights issues are underwritten, the new shares will be identical to the existing shares and should trade at the TERP, plus or minus the effect of any changes in sentiment due to events after the start of the rights issue or just because sentiment changes.  I say “should” trade at the TERP, because there’s also the effect of the additional supply of shares, which may depress the share price below the TERP, as I discussed last time.

So what would we expect the TERP to be for Lloyds?

TERP Calculation

This is how I think the TERP should be calculated.

At present the shares are trading, handily, at exactly 90p. If we round down to 27 billion in circulation, Lloyds is currently worth £24.3bn.

The rights issue involves putting in more money (£13.5bn less £500m expenses) and creating more shares – we don’t know how many yet.

After the rights issue Lloyds should theoretically be worth £(24.3+13)bn = £37.3bn.

The TERP depends on how many new shares are created. For example, if the new shares are priced at 50p, there will be another 27bn. There will therefore be 54bn in circulation after the rights issue and each share would be worth £37.3/54 = ~69.1p.

In this case the rights would be expected to trade at around 19.1p.

If, in this example, the rights were trading at less than 19.1p or the shares at less than 69.1p after the start of the rights issue, then the implication is either Lloyds’ prospects have changed, or the rights issue has reduced the share price.

Lloyds say they want the rights price to be at a ~40% discount to the TERP. 50p is therefore too much (it’s more than 0.6*69.1p). You could iterate to an appropriate price but I expect they did some algebra:

No. of shares after issue = 27bn + 13.5bn/P (where P is the price of the rights issue)

TERP = (Share price before issue (known, let’s take this to be 90p, as now) * 27bn + £13bn) / no. shares after issue

P = 0.6 * TERP

Therefore, P/0.6 = £(24.3+13)/(27 + 13.5/P)

P (27 + £13.5/P) = £37.3*0.6

27P + £13.5 = £22.4

P = £(22.4 – 13.5)/27 = £8.9/27,  i.e. 33p.

and TERP = 33p/0.6 = 55p

Check: No. shares after issue = (27 + 13.5/0.33)bn = 67.9bn

TERP = £(37.3/67.9) = 55p

Easy, peasy! [But see Note below]

So, if Lloyds shares are trading at 90p on 23rd November (the date Lloyds is using for their calculation), I’d expect the the rights to be priced at around 33p (I’ve indulged in a little rounding, so let’s not try to be too accurate now) and the TERP will be around 55p.

It’s quite possible I’ve made a horrendous error (or even more than one).  If so, I’ll be happy to post a correction if someone points it out. [22:00 12/11: I've already corrected a small error I spotted myself!]

[Note (18:30 24/11): As discussed in a later post, Lloyds have actually gone for a rights price of 37p, implying a "TERP" of ~60.24p. The difference from my estimate is due to a number of factors:
- some rounding down on my part;
- my assumption of a 90p share price before the issue. Lloyds took the closing price of 91.47p on 23rd (even though they said they'd take the average share price that day);
- Lloyds priced the rights issue towards the bottom of the 38-42% range of discount to the "TERP" they'd announced - ~38.6% - whereas I assumed a 40% discount;
- I deducted the £500m in fees from the proceeds of the rights issue - this shouldn't really have been done (and has a significant effect, showing how much those fees are costing shareholders), but then again, the only true TERP is that calculated on the closing price just before the rights are created.]