Marketing Live Chess Broadcast Rights

Background: Agog at Agon’s Candidates Broadcast Monopoly

The moves of chess games have always been in the public domain.  Anyone can quote them in any medium including whilst games are in progress.  Indeed, in recent years live internet broadcasts of commentary on games at chess tournaments and in matches have become very popular with the chess community.

It was in this context that several chess websites geared up to broadcast commentaries on the most significant chess tournament of 2016, the Candidates tournament in Moscow which opened on March 10th.  The winner of the Candidates gets to play the current World Champion in a match for the title of World Chess Champion, so we’re all looking forward to watching Sergey Karjakin challenge Magnus Carlsen in November. But two days before the Candidates started, the organisers, a company called Agon, working with the worldwide chess federation, FIDE, forbade anyone else from broadcasting the moves until 2 hours after each game.  They did this by requiring anyone accessing the official website to sign a “Clickwrap Agreement” agreeing not to retransmit the moves.  Presumably onsite spectators and journalists were subject to similar restrictions.

Malcolm Pein, the editor of Chess magazine, noted in the May 2016 issue (p.4-5) that Agon’s attempt “to impose a new order on the chess world” were “cack-handed” and it is indeed very unfortunate that FIDE has been involved in preventing a number of websites from supporting what I would have thought is its core objective, promoting the game.  The sites are likely to have incurred costs as a result, perhaps having committed to pay commentary teams.

Furthermore, as Pein notes in his Chess editorial, aspects of the Agon Candidates commentary left something to be desired.  He highlights an unfortunate incident when the moves were inadvertently shown swapped between games at the start of the last round.  I noticed that too, and was also confused for a moment by the disconnect between the commentary and what actually appeared to be happening, but much more serious was the quality of the commentary itself.  I felt it was interrupted much too often for breaks, usually to show the same couple of ads, plus what I’ll describe as “pen-portraits” of the players (cartoon-style drawing accompanied by commentary).  These were quite entertaining the first time you saw them.  Not quite so much the tenth time.  And, although the commentary team obviously worked hard to help the audience understand what was going on, I’ve enjoyed other commentators somewhat more.  The commentary is much more important in chess than say football, since (as non-players will appreciate!) there are periods of a game when there’s nothing much to see happening on the board.  I would have liked the choice to watch another broadcast.

Steve Giddings writes, also in the April edition of Chess (p.8-9), that preventing unauthorised broadcast of chess games is in “the commercial interests of the game”.  That may be so, but it seems to me that monopoly broadcasting is not the best way forward.

Given the goals of promoting chess by maximising the number of viewers of chess matches and tournaments and maximising revenue from the broadcast of elite events, simply in order to pay for them, a better option would be to license multiple broadcasters, if they’ll pay collectively more than would a single exclusive media outlet.  I outline in this article how the revenue-maximising number of broadcasters could be established by a simple process of bidding for a share of the rights.

First, though, let’s consider how other sports rights are sold and then whether times have changed – perhaps other sports might want to reconsider granting exclusivity – and how chess is different. I focus particularly on the case of domestic rights to broadcast the English Premier League.

The Football Precedent: English Premier League Live Broadcast Rights

When I was a kid, the FA Cup Final was always shown live simultaneously on both BBC1 and ITV.  So much for consumer choice – at the time there were only 3 channels (the other one being BBC2).  Nevertheless, there was competition, of a sort.  Sometimes we’d switch over to see what they were saying on the other side, though when the ads came on we’d switch back.

One might wonder why ITV would bother broadcasting the Cup Final when it was also on BBC (without ad breaks) and, indeed, why the FA would sell it to two broadcasters rather than just one.  I can think of two considerations:

1. There was some product differentiation between the broadcasts on BBC1 and ITV.  The channels employed different commentators and pundits.  This produces what I would argue is healthy competition for viewers between broadcasters.
2. Strange though it may seem to many younger readers, back in the day many – perhaps most – households watched either ITV or BBC almost exclusively, even though they both were (and still are) free-to-air.  It could be argued that the choice between watching BBC and ITV used to be very much driven by social class or at least the social class households identified themselves as belonging to, but that is actually irrelevant to the argument.  The point is that broadcasting the FA Cup Final on both ITV and BBC ensured that the product reached more people – ITV viewers and BBC viewers – than it would have done had it gone out only on BBC or ITV.

Presumably ITV could attract enough viewers and sell enough advertising to make it worthwhile to broadcast the FA Cup Final even though BBC1 was showing it too.

Sports Broadcast Monopolies

Why, then, you might ask, is almost all football shown in the UK now, in 2016, indeed, almost all sport (and much other content besides), broadcast on just one channel?  That is:

• why have sports broadcast monopolies developed?;
• why do sports administrators tolerate and even encourage broadcast monopolies?;
• and whose interests do sports broadcast monopolies actually serve?

Some years ago I had the dubious pleasure of a job interview with BT; actually they wasted an entire day of my time at their recruitment centre (and even more with some further interviews later on).  The question arose in discussion – I guess after we’d noted the ongoing convergence of internet and broadcast media – as to how BT could best grow their broadband market.  I suggested offering some exclusive movies.  Perhaps my interlocutor was playing Devil’s advocate, but I don’t think so; regardless, he seemed to be arguing that they should market on the basis of their whizzy new network.  No, no, no!  The vast majority of consumers care only about what appears on their TV; they don’t care at all about the underlying technology.  And if there is some exclusive content – I mentioned movies at my BT interview because Sky had already “done” sport – that is likely to be decisive in winning customers.

It seems clear from their enthusiasm to enter into them that exclusive deals for live sport transmission rights are in the interests of subscription broadcasters, particularly when  trying to build a customer base.  We have the example of the English Premier League (EPL) and much other sport (as well as films and other content) on Sky, now being contested by BT.  Netflix and Amazon are exclusively hosting supposedly must-see drama series.

As a consumer, I’m always wary when I’m told something is “exclusive”.  The very word suggests to me that someone is being ripped off.  Probably muggins.

But let’s not jump to conclusions.  Besides, what we’re really interested in is the health of the sport – that is, chess, when I get to the end of this preamble.

So, could exclusive sports rights sales be in the interests of the sports themselves?

Well, when broadcasters are trying to grow their business – think of Sky and the EPL – they may be prepared to pay what appears to be a substantial premium for a monopoly.  I say “appears to be a substantial premium” because at some point the broadcaster has to demonstrate income (advertising and/or subscriptions) commensurate with the expense.  Otherwise they go bust.

It’s not immediately apparent, and, indeed, somewhat counter-intuitive, that a single broadcaster of live events or TV series can unlock more advertising and/or subscription income than can multiple broadcasters of the same material.  Nevertheless, many sports administrators appear to believe monopoly broadcast deals are in the interest of their sport.   At least in the short term.

An example of what can happen in the longer term is provided by EPL broadcast rights in the UK.  Sky held the exclusive rights from the start of the Premier League in 1992 until 2007.  After the European Commission ruled that Sky should not have exclusive rights to all matches, they had competition, first from Setanta, who ran into financial difficulties, then ESPN, who took over Setanta’s rights and most recently BT who came into the market in 2012 prepared to bid aggressively against Sky for a whole range of football and other sports rights and apparently with equally deep pockets.  Guess what happened once there was competition?  The total paid for EPL live transmission rights went up.  Considerably.

Note, though, that what Sky and BT bid for is how much of the monopoly each enjoys.  They are not in direct competition, in the sense of broadcasting the same matches, as BBC1 and ITV used to be in the case of the FA Cup Final.

The only logical conclusion is that – given that live broadcast rights to the EPL have a definite value represented by the income they can generate – they were previously being sold too cheaply!  Who’d have thunk it?

Players on £50K a week 5 years ago should be a bit miffed.  They could have been on £60K!

Why are BT and Sky paying more than Sky alone did?

Is it a conspiracy against the consumer, as I once read a commentator claiming?  Apparently, he wrote (I think it was a “he”) EPL fans would now have to buy two subscriptions.  As someone who only buys one, it might be worth pointing out that, unless it’s your team playing, or a key fixture (in which case there’s always the option of going to the pub – a form of pay-per-view) it doesn’t make that much difference which match you watch.  You don’t know in advance whether a particular match is going to be exciting.  In other words, if you’re only going to watch 20 matches a season, there’s not much point paying for 200.

Are BT and Sky trying to buy or defend market share and therefore overpaying?  Well, there may be an element of this, but, first, from the point of view of the sport this is a good thing.  Second, companies can’t do this for ever.  BT is now established in the market.  I doubt they’d be paying so much for 3 years of broadcast rights if they didn’t think they’d make money on the deal.

Has BT unlocked market segments Sky wasn’t reaching?  Yes, I believe so.  I pay a small add-on to my broadband internet deal to receive BT’s sports channels, which I watch online, on a PC.  For the number of matches I actually manage to watch I can justify this cost, but not a Sky subscription (plus charges for set-top boxes and so on).

But it may also have been that Sky was paying less than the EPL transmission rights were worth and making excess profits as a result.  These have not necessarily all appeared as profits in its accounts, but may have also been reinvested, for example, in establishing a dominant position in the UK in the broadcast markets for other sports, such as cricket.

A market needs to be competitive to establish the real value of a product.  It’s in the long-term interests of sports themselves, I suggest, to maintain a competitive market for broadcast rights and not allow monopolies to develop.  Such monopolies might end up underpaying until a competitor eventually challenges them, as, I argue, appears to have happened for EPL live broadcast rights in the UK.

In addition,  it’s in the long-term interests of sports for as many people as possible to be able to watch them.  This is best achieved by a number of broadcasters with different business models reaching different segments of the market.  It’s worth pointing out that sports administrators sometimes ensure that at least some events are “free-to-air” in order to show-case their product, for example the World Cup and, this summer, the UEFA Euro 2016 tournament (at least in most European countries).  This month’s FA Cup Final was broadcast on the BBC as well as BT Sport.

Differences Between Chess and Football

After that somewhat longer discussion of football than I had intended, let’s get back to chess.  As I’ve argued, even football could consider selling live transmission rights to multiple broadcasters, but are there differences between chess and football) that make monopoly broadcasting a less attractive option in the case of chess?

I believe there are several relevant (though interrelated) differences:

First, live chess is typically broadcast globally, over the internet.  This means that the peculiarities of local markets are much less relevant.  For example, in the UK the playing field for broadcasting football was uneven when Sky entered the market.  Sky had to have content that was not available to the free-to-air channels ITV and the BBC or no-one would have subscribed; and it needed subscriptions to fund the cost of its satellites.  OK, there is at least one place where chess appears live on TV: Norway, home of the World Champion, Magnus Carlsen.  But given the general reliance on the internet for broadcasting chess, it makes sense to simply leave distribution to the broadcaster and not sell rights separately for different platforms (TV, internet, mobile devices etc).

Second, and related to the first point, the world has moved on in the quarter-century since the EPL broadcast model was established.  To some extent sports channel subscription revenues funded a dramatic increase in the number of channels available by enabling satellite and cable TV.  But with the growth of TV over the internet, the potential number of channels is vast, and the entry-cost considerably lower than in the past.  Broadcasters don’t need huge guaranteed revenues to justify their business models.  Furthermore, given the flexibility of advertising charging that is possible on the internet – essentially payment depends on the actual number of viewers – advertisers do not need historic broadcast data.  They’ll just pay for what they actually get.

Third, the commentary and presentation is a more significant part of the overall package in the case of chess than it is for football.  Personally, for normal tournament commentaries I’m as much interested in who’s commentating than who’s playing.  I’d be much more likely to tune in if Maurice Ashley, Danny King or Peter Svidler are explaining a game.

Fourth, chess is still at the experimental stage, still trying to explore what works best in live transmission.  It doesn’t make a lot of sense to stifle this process by restricting the number of broadcasters to one.

Fifth, interest in chess is global.  Viewers might appreciate broadcasts in their own language as well as English.

Sixth, there are a limited number of marketable chess events.  To promote the game, as well as maximise revenues, it makes sense for these to be available to as many viewers as possible.

Seventh, I don’t believe there is a pot of gold waiting for someone able to sell advertising round chess events.  Compared to football, it’s always going to be a niche market.  Indeed, for many of the chess sites – Chess.com. Chess24.com, the Internet Chess Club (ICC), Playchess.com and so on – that broadcast (or might broadcast) elite chess events, covering live events is, unlike in the case of football, only part of their offering to visitors to their site (who may pay a subscription).  These sites also allow you to play online, host articles and instructional videos and so on.  Unlike the sports channels of Sky or BT, losing live transmission rights is not an existential threat.  They are therefore unlikely to pay huge sums for monopoly rights.  Collectively, though, they may pay a decent amount for something that is “nice to have”.  The resulting choice for viewers would also be beneficial to the game and raise broadcast standards.

For all these reasons it seems to me that it makes sense for chess events to be hosted by multiple broadcasters.

Price Discovery for Chess Broadcast Rights

Before considering the mechanics of an auction for chess broadcast rights, let’s first establish a principle: all broadcasters will pay the same price.

Live sports transmission rights are generally sold territorially.  That’s messy already – people cheat by importing satellite dishes from neighbouring countries and so on- but in the age of internet broadcasting its unworkable.

One might also consider language restrictions.  Why should a broadcaster be able to reach the whole Chinese population or the English, Russian, French or Spanish-speaking world for the same price as an Estonian native-language broadcaster?  Well, don’t worry about it.  The market will take care of things.  Broadcast auctions will be a repeat exercise and, if the price is low compared to the size of the market in a specific language, that will simply encourage more broadcasters.

What if some broadcasters are mainstream TV channels, in Norway, for example?  Again, don’t worry about it.  Just leave distribution up to the broadcasters.  TV channels are competing with internet broadcasters.  The only restriction should be that a one licence – one broadcast rule.  If a broadcaster wants to transmit to multiple audiences, in different languages, say, or by producing different versions tailored to experts and the general public, then they have to buy two or more licences.

What would the broadcasters buy?  An automatic feed of the moves (top events nowadays use boards that automatically transmit the moves electronically) is obviously essential.  Since you don’t want numerous video cameras in the playing hall, the organisers (or a host broadcaster) would also provide video feeds of the players, often used as background to the commentary (generally in a separate window).  Post-game interviews or a press conference are also usual and these could be part of the package, as could clips from the recent innovation of a “confession-box”, where players can comment during their game.  Broadcasters would edit these video feeds together with their own commentary to produce their final product.

Let’s make one other thing clear about the objective of the auction process.  The goal is to maximise revenue.  This is not in conflict with the goal of maximising the online audience and thereby promoting the game.

So, how would the auction work?  How can we maximise revenue from an unknown number of broadcasters all paying the same price per transmission stream?

Here’s my suggestion.  The broadcasters would be required to submit a number of bids each dependent on the total number of broadcasters.   That is, they would bid a certain amount to be the monopoly broadcaster, another amount (lower, assuming they act rationally!) to be one of two broadcasters, another amount to be one of three, and so on, up to some arbitrary number, for example to be one of more than ten broadcasters.

The chess rights holder – FIDE, for example – would simply select the option that generates most revenue.  All bidders would of course pay what the lowest bidder offered to be one of the specific number of bidders chosen.  E.g., if 2 bidders are successful, one bidding $70,000 to be one of two broadcasters and the other $60,000, both would pay $60,000.  In this case, neither broadcaster, nor any other, would have bid more than $120,000 for exclusive rights and no 3 more than $40,000 to be one of 3 broadcasters, nor 4 more than $30,000 to be one of 4, and so on.

For example, it may be the case that one bidder bids more to be the sole broadcaster than any two bid to be dual broadcasters, any three to be the only three broadcasters and so on.  In that case, one broadcaster would secure a monopoly.  Or, at the other extreme, 12 broadcasters might, for example, bid more to be one of “more than ten” broadcasters than any sole broadcaster bid for a monopoly and so on, and more than 13/12 times what the unlucky 13th highest bidding broadcaster bid to be one of “more than ten” broadcasters, 14/12 times what the 14th highest bidder bid, 20/12 times what the 20th bid and so on up to the total number of bidders.

It’s my guess that revenue will be maximised for a World Championship match by a relatively large number of bidders.  And the crucial point is that the more broadcasters, the larger the audience and the greater the choice for viewers.

 

We Need Rules, not Rulers: Culture, Bankers and the Mervyn King Question

The aim of any self-respecting blogger is to make original points. I’m no exception, so it is time to start to wind down this thread on the Libor “scandal” (previous instalments: Saint Mervyn: King by Name, King by Nature; Bashing Barclays Badly and Battling for Mount LIBOR, the Moral High Ground), for the world has in many respects come round to my way of thinking.

Yesterday’s City a.m. egged on the politicians with the momentarily confusing headline:

MPs CALL FOR CAP ON KING’S POWER

and opening salvo:

“REGULATORS grossly overreached themselves by forcing Bob Diamond out of the top job at Barclays, top backbench MP Andrew Tyrie declared yesterday…”

And the refrain “Who will guard the guards?” echoes through the land (and I noticed has even seeped, with the rapid mutation typical of memes, into the consciousness of the brigade of the commentariat more concerned with the easy target of the G4S Olympic security fiasco).

One of our heroes, already mentioned in despatches from the front-line, Hugo Dixon, has another piece on his Reuters blog, discussing how the Governor might be reined in:

“Holding the next governor accountable will be as important as choosing one. The Bank of England was rightly given considerable independence in 1997 to prevent politicians meddling in monetary policy in order to advance their electoral interests. But the institution and its leader have slipped up on enough occasions that leaving them entirely to their own devices isn’t a good option either.

For example, King didn’t sound the alarm loudly enough during the credit bubble and was slow to act when there was a run on Northern Rock, the mortgage bank, in 2007. He then long resisted any investigations into the Bank of England’s own failings in managing the crisis. Now its hands-off approach to the Libor scandal is being revealed.

Based purely on its record, the central bank wouldn’t be receiving extra powers. However, the Conservative-led government has tried to pin the blame for the credit crunch on the previous Labour government’s policies – in particular, its decision to take away the central bank’s responsibility for banking supervision. Hence, it has become politically convenient to reverse that move.

Given this, the priority should be to enhance the Bank of England’s accountability. Under the current system, the government sets inflation targets and picks the governor. It also chooses the deputy governors and members of two committees: the monetary policy committee which sets interest rates; and the financial policy committee which will soon be responsible for financial stability. Their independent members help prevent the governor becoming too dominant.

The Bank of England also has a board, called the Court. But this has been largely ineffective. Though it has recently stepped up its scrutiny of the central bank’s executives, it is hamstrung because it rightly has no say over policy or who is the governor.

Meanwhile, parliament can call the governor and other senior officials in to give evidence. Although this is a potentially important check to the central bank’s power, MPs haven’t yet used this tool effectively.

…

One way of improving democratic control would be to give MPs the right to hold nomination hearings and, in extremis, reject the government’s choice for governor and other top positions. Indeed, that’s what parliamentarians want. But the government is resisting. If MPs are to change its mind, they must first show they are up to the job.”

Let’s come back to this when we’ve diagnosed the problem.

Because I still feel I haven’t made my point fully.

What the Libor affair shows us is that regulation must be mechanical, not moral.

This is a lesson we failed to learn from King’s behaviour during the financial crisis, despite his starving the UK banks of liquidity in a misguided attempt at preventing “moral hazard”; his expressed desire to stitch up Lloyds shareholders with a backroom deal to take over Northern Rock; and the actual outrageous stitch-up of Lloyds shareholders with a backroom deal to take over HBoS without adequate due diligence, to which he must at least have given a nod.

My first post on the Libor-fiddling topic touched on the subject of culture:

“The excuse for laying into Diamond seems to be some problem with the ‘culture’ at Barclays. Is it any different to that at any other investment bank? Doesn’t the ‘culture’ in any occupation go with the turf? Presumably they don’t want traders to behave like, say, Premier League footballers, or Hollywood actors. Something less flash perhaps: doctors, say or IT guys. But would they still be able to do the job? These occupations surely require quite different qualities and aptitudes. Maybe something a little more sales oriented, perhaps, then: used car dealers or estate agents. Or politicians! But are these professions more or less honest than investment banking? I’m stuck. Perhaps our politicians could spell out exactly how they want investment bankers to behave.”

The aim of yesterday’s post was to develop the idea that the “scandal” is being treated as a moral issue. There’s something “bad” about Barclays, we’re told, and the Bank of England Governor, with ex officio moral authority, judges it comes from the top and fires the Chief Executive.

But what is “culture”?

This is what an editorial, “Culture shock”, in yesterday’s FT (I’m getting my full £2.50 worth!) suggested:

“Culture is not a fluffy chimera of business how-to books or self-congratulatory corporate reports. Culture, real and unnoticed as the air we breathe, is the web of unspoken mutual understandings that frame what people expect from others and think is expected of them. This web shapes the fortunes of any organisation or social group. Bob Diamond, Barclays’ disgraced ex-chief executive, knew this; he once declared ‘the evidence of culture is how people behave when no one is watching’. He was right…

… [non sequiturs omitted]

A culture cannot be heavy-handedly ‘managed’ by legislation or compliance rules alone. It must be more subtly cultivated and tended.”

OK, we can all agree that behaviour within an organisation is determined by executive example and communications; organisational stories; dress code; building architecture, location and decoration; the presence or absence of game rooms; and so on and so forth – as well as the nature and demands of the work, as I previously stressed. But within all that complexity, all we’re really concerned about here is that rules are followed. There may be indirect ways of achieving this goal by means of some kind of arcane cultural alchemy – would Fairtrade coffee, beanbags and dress-down days work? who knows? – but most people would consider it sensible to simply focus on the outcome.

Obviously the “rules alone” are not enough. There also needs to be an expectation of enforcement. A rooting out of dishonesty. And maybe by spending £100m on investigating Libor-fixing rather than, say, carrying out some “routine email housekeeping” (didn’t something like that come up with News International?), Barclays have shown a willingness to steer their internal culture in the direction of obeying the rules.

With this unsatisfactory view of “culture” in mind, let’s consider the crucial question for the future, the “Mervyn King Question”: Is it possible for the Governor to both exercise moral authority AND for there to be effective oversight of the role?

No, of course not. The Governor can’t both exercise his judgement AND explain the detailed reasons for a decision. If he can explain the precise reasons to whoever he, the Governor is accountable, for example those for firing Bob Diamond (“he broke rule 44b clause 3, which is a sacking offence”), then by definition he isn’t exercising judgement.

The Mervyn King Question suggests then that we have to decide which way we jump. Do we want, in the modern world, to trust the personal judgement of an unelected official, or do we want a team expert in banking regulation to ensure that the rules and sanctions for breaking them are clear to banks and that bank behaviour is monitored and the rules enforced?

Do we want a ruler or do we want rules?

The traditional role of the Governor of the Bank of England was one of arbitrary power. This is where Mervyn King believes we should return. No wonder the job of Governor is so coveted.

But there’s a different path. Surely we’d be better off rejecting the moral approach and focusing on the technical aspects of the role of Governor of the Bank of England?

Let’s take as an example the critical case, where it all started to go wrong, when I first became concerned about the outlook of Mervyn King. Instead of arbitrarily allowing banks (such as Northern Rock) to fail to try to prevent “moral hazard” shouldn’t the Bank have made the rules absolutely clear in advance? NR would not, I’m sure, have relied on interbank funding had it’s executives known that funding may be allowed to dry up and they would have to retire in disgrace.

I would suggest that the Bank start by announcing that it will not allow any Bank to fail due to systemic problems (as opposed to Baring-style sudden catastrophic losses), but will provide liquidity as lender of last resort. What constitutes “systemic” would need clear definition, as would the cost of such support which would include a requirement for banks to raise capital. We have to recognise that we can never allow banks to fail under stress – such failures simply cascade through the economy – and dismiss the nonsense that such a backstop is some kind of subsidy for institutions that are “too big to fail”. This is like saying that Tesco is subsidised because the State provides resources for the prosecution and punishment of shop-lifters.

The Libor-fiddling that mattered – that before the financial crisis – was arguably criminality, pure and simple. It was orchestrated by a small group of traders who knew they were breaking the rules, as their emails make clear: “I would prefer this not be in any book!”, “if you breathe a word of this I’m not telling you anything else” and so on. It became a “scandal” because politicians – principally Ed Miliband – immediately made hay. But business isn’t politics. It’s not primarily about character (neither should politics be, of course, but the UK political process is becoming ever more Presidential and less policy-driven). The danger of allowing the political process to drive banking or other business regulation is that there is no satisfactory answer to the Mervyn King question. Even were we to confer moral authority on the Governor as we do the Prime Minister (who is not only elected, but easier to get rid of than the Governor – men in grey suits and all that), business is not hierarchical like government. It is fundamentally about choice and competition. Differences in outlook are necessary.

Dismissing company bosses in an attempt to change the corporate “culture” would seem to necessarily worsen group-think. If all our banks had been the same perhaps they’d all be part owned by the State now. Perhaps they’d all been like HBoS. As it is, Barclays managed to recapitalise without calling on government funds, Santander expanded and the “elephant” HSBC simply marched on barely affected. Diversity matters.

At worst, of course, there is no difference between condemning a bank’s culture and firing the boss simply because you don’t like the cut of his jib.

I promised I’d return to the points Hugo Dixon made. We may well need some or all of the means Dixon suggests for holding the Governor to account. But before we can do that, Parliament needs to step back and look at how the Governor’s role is defined. They need to review his Terms of Reference. Make sure he’s clear what the rules are.

Scraping Greece off the Floor

Wolfgang Munchau writes very pessimistically today at the FT that “Greece will default, but not this year”.

The core of the problem is a self-fulfilling prediction. Because of the risk of Greece defaulting, the yield on its bonds, and consequently the cost of new borrowing, is 3% over Germany’s. As Munchau points out, the market implies that there is a 17% chance of losing 17% of the value of Greek bonds (1.7 is approximately the square root of 3 so 17% of 17% is approx. 3% – you could also say a 30% chance of losing 10% of value or vice versa, etc – just thought I’d point out the basis of Wolfie’s calculation). The Greek national debt would obviously become even more unmanageable after a few years of borrowing at such a premium, with debt repayments becoming an ever-increasing proportion of government expenditure. The cost of borrowing would rise even higher… Hence Munchau’s gloom.

A sacrilegious thought has occurred to me. To avoid the interest-rate death-spiral self-fulfilling prediction, why doesn’t Greece simply say that existing bonds will bear the first loss? They could then issue “New Bonds” (TM) at something close to the rate for German bunds (as they call them in the trade). Hopefully, the Greek public finances would be in better shape by the time the stock of New Bonds is large compared to the Old Bonds. Maybe it would be best practice for countries to issue long-dated junior debt when times are good, to prepare for the next financial crisis…

My cunning plan might even reduce the yield on existing bonds, free as they would be of interest-rate death-spiral risk. Everybody would be happy. Except Wolfgang Munchau, of course – he’s never happy.

Come on Greece, you’re a sovereign state. Almost. You can do what you like! Why borrow at +3% (that was yesterday, it’s +4% today, apparently) when you don’t have to?

And did I say the idea is sacrilegious? For starters, corporates can and do reorganise their capital by buying back their own debt below its nominal value and issuing more under different terms. And in fact many governments have reduced the cost of paying down the national debt by increasing the risk of existing borrowing. They do it simply by selling assets, up to and including the right to raise taxes. Buyers purchasing an income stream – for example, in the UK, the right to collect tolls on the Dartford Crossing is apparently for sale – are logically the same as bond investors. The difference is that asset purchasers don’t have to worry about the rest of the national debt – which, of course, becomes more difficult to fund without the income stream. Essentially, asset sales or privatisations are a conspiracy between governments and the asset purchasers against existing bond holders. In stark contrast to asset purchasers, new bond purchasers only rank pari passu with existing lenders. At least, until Papandreou reads this…

If the interest-rate death-spiral trap can be avoided by selling off income streams anyway, why bother with the pretence? Simply issue “New Bonds”.

Hansen vs. Krugman: Second (Third and Fourth Order Effect)s Out!

Yesterday’s NYT includes a right royal spat. Well, online it does, at least. In a piece titled Cap and Fade, James Hansen argues that carbon taxes would be more effective than cap and trade. Paul Krugman responds under the heading Unhelpful Hansen, by first telling Hansen to stay off his turf. Climate scientists shouldn’t dabble in economics, apparently. Tosh. Ideas have to stand on their own merits.

Having highlighted the intellectual ring-fencing which is at the root of many of the world’s problems, Krugman proceeds to un-blot his copy-book. He points out very convincingly that, from an individual consumer’s point of view, it matters not a jot whether gasoline is more expensive because of a tax or because of a cap and trade mechanism.

Krugman is right as far as it goes. But both Hansen and Krugman fail to mention the second, third and fourth order effects of pricing carbon emissions. And it is the second, third and fourth order effects that will determine the effectiveness of policy.

Let’s start at the end, because it’s more fun. The fourth order effect of pricing carbon will simply be a redistribution of spending power in the economy. I’m sure I’ve said it before, but I’ll say it again: money is just a means of distributing resources. The economic system will adjust so that the available resources are used.

Perhaps I should try to explain a little further. Money circulates. There is not a fixed quantity. Let’s imagine we put an astronomical tax on carbon. The money raised by that tax must be spent. Let’s say we decide to spend it on more doctors. Suddenly there will be more doctors to fly off to junkets round the world. Or maybe they’ll spend their money on art (or more expensive houses, or televised sport…). In which case the previous owners of the art (or houses, or sportsmen, their agents and other freeloaders) will be able to afford to fly more…

But before we even get to this unhappy state, we should consider, first, a second order effect of pricing carbon. Pricing carbon will tend to reduce the price of fossil-fuels. All that might happen is that the price of petrol at the pump remains the same, but less of the motorist’s money ends up going to the oil-producer and more goes to the government. Maybe a good thing in itself, but we’re trying to stop global warming here, not change the shares of unearned spoils divided with the Saudis. Sure, depressing the global oil price might have the desirable third order effect of reducing investment in the most expensive fossil-fuels for a while (until the lack of supply pushes prices up again), but we need to reduce consumption of fossil-fuels that cost virtually nothing: coal, in particular.

And unfortunately the second order effect of carbon pricing on the oil price is dwarfed by the third order effects of another second order effect. The second order effect (I’m trying to be rigorous, here!) is that taxes raise money. So does carbon trading. We need to consider the effects of how that money is spent.

Hansen argues that the money should be distributed to the population. This will, at least in the short-term, increase equality. And, unfortunately, when you’re trying to reduce consumption of mass-market products, equality is not your friend. Money will be taken from those whose consumption is not constrained by their financial situation and given to those who would like to spend more. Likely on heating, driving, flying and so on. Oh dear!

But there are problems with carbon trading, too. The precise outcome will depend on how carbon permits are distributed. If they’re given away to power companies, then any excess permits will accrue to these companies’ shareholders in the first instance. (Over time, these profits will encourage new market entrants, although this may not happen if only incumbents are able to access the permits). If permits are auctioned, though, then we reach a situation similar to the carbon tax. The outcome depends on what the government does with the revenue. Simply distributing it to the population would fall foul of the same equality problem as for the tax. Direct or indirect subsidies for renewable energy production would clearly be by far the best policy choice, in the hope that, once renewable energy has a huge cost advantage over fossil-fuels, everyone will switch to clean energy. Maybe.

In perverse support for Krugman’s argument that taxes and cap and trade are equivalent, government could spend tax revenues in the same way as those from auctioning permits. Very similar to Hansen’s position is the idea of tradeable personal carbon allowances. These would have the effect of transferring wealth from the rich to the poor. And remember, equality is not our friend…

Let’s make some tentative conclusions and observations:
1. The indirect ramifications of carbon pricing policies are more important than their immediate effects.
2. Carbon trading is philosophically preferable to carbon taxes, because it at least imposes a limit on total consumption. The problems arise from leakage (the concept is explained in a previous post). Unfortunately, these are very big problems – probably deserving a post of their own.
3. If there is a limit on the carbon price in a carbon trading system, then it becomes almost equivalent to a tax. However carbon is priced, governments must be prepared to push the price up indefinitely. Otherwise, I suggest, the economy will simply adjust to the price.
4. Carbon trading is a superior policy if you’re really serious about reducing fossil-fuel emissions, because government doesn’t have to set a tax at an eye-watering level. It can simply say: “this is all the fossil-fuel we can afford to burn, it’s supply and demand in the market-place which has pushed the price up.”

Unfortunately, I don’t see too many governments around the world that are about to bite the bullet and set an effective carbon price.

Why Expedient Offers of Energy Efficiency Improvements must be Rejected at Copenhagen

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.

The Nature of Money and the Consequent Likely Ineffectiveness of Carbon Taxes: Revisiting the Man in the Wardrobe Fallacy

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.

Lloyds Rights Issue: Timetable and TERP

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.]

Lloyds Rights Issue: A Reason to Buy?

I’m rather surprised by the number of hits I’m still getting on a previous post, which noted the unnecessary complexity of the upcoming Lloyds rights issue and the way it’s been presented. I rather thought the weekend papers would clear the matter up, so was unsurprised to read the Guardian Money front page headline “Buddy, can you spare me £13.5bn?”. I immediately followed the injunction “>>Pages 4-5” and fast-forwarded to read Jill Treanor’s examination of the “implications for small shareholders” and Patrick Collinson’s suggested “plan of action”.

I have to say I was rather disappointed.

Collinson suggests that:

“You got some Halifax shares when it floated. Now we at Lloyds want you to cough up a couple of hundred quid (we won’t tell you the exact sum till later)…”

[my stress]

Treanor also sheds considerable darkness on the point.

Now it simply isn’t true that Lloyds haven’t advised the exact sum investors will have to “cough up” (though they could have been clearer). As I pointed out last time, it’s quite simple: Lloyds wants £13.5bn, which will be divided equally amongst the ~27bn shares in circulation. That’s ~50p a share. If you own 1000 shares you’re going to be asked to put in £500. How many new shares you’ll get and at what price each is yet to be determined.

This is actually a step forward in the organisation of rights issues. The problem is that when a company announces it is going to sell a lot of shares, the price tends to fall – supply and demand – since not every share owner will be able to and want to put more cash into Lloyds equity. By delaying the announcement of the price of the new shares until the last minute, Lloyds has somewhat reduced the risk of the share price falling below the rights issue price, which would be a disaster, since, if you could just buy shares in the market for a lower price, there would be no point taking up the rights issue. The under-writers would end up with all the new shares.

What worries me most about Collinson’s comment piece and Treanor’s Q&A is that they omit part of the case for participating in the rights issue. What I’m about to say should not be construed as financial advice, but there are obvious reasons why a company’s share price might be depressed ahead of a rights issue and that in general a rights issue may be a good opportunity to invest.

The key point is supply and demand for the shares, that is, precisely what Lloyds is worrying about and the reason for the confusion about the offer price for the new shares. Many investors – funds or individuals – may simply be unable to put more money into Lloyds shares. They may just not have the cash. Or, especially if they’re a fund, they may not want Lloyds shares to rise as a proportion of their portfolio. This could even be against the rules of the fund.

Of course, some investors, such as index tracker funds, may be compelled to increase their holding in Lloyds in line with the increase in volume of its equity. But it’s difficult to think of a fund that would be compelled to take up more than its share of rights.

Therefore, it’s often argued, a rights issue is a good time to buy, because there is a surplus of sellers of the stock.

As Jill Treanor points out, you can sell some or all of your rights in the market, for example, to raise enough cash to take up the rest of your rights, a practice known as “tail-swallowing”. Such selling activity will tend to make the rights cheaper. But it’s important to understand that if the price of the rights falls, then so does the price of the existing shares. The reason is the (arbitrage) opportunity to simply sell shares and buy the rights.

Example: To simplify a little, say Lloyds shares fall to 60p when rights have been given to all the shareholders. The rights might entitle you to buy new Lloyds shares for 40p each (so you’d get 5 for every 4 shares you held at the qualifying date for the rights issue) so should sell for about 20p each (since once you’d put in the 40p you’d receive a new share exactly equivalent to the existing shares). If so many people sell their rights that the price is not 20p but drops to (say) 18p, then someone could sell shares for 60p, buy rights for 18p, subscribe to the issue for 40p and make (60 – 18 – 40)p = 2p a share. Do this for a few million shares and you’re building up a tasty bonus pot! What happens when people sell the shares to buy the rights, of course, is that the share price tends to fall until the price of the shares and the price of the rights are aligned again.

So, according to this argument, it may be a good time to buy Lloyds shares, e.g. by subscribing to the rights issue.

It might also be worth noting that Lloyds stated that it will not pay a dividend for 2 years. This may be another reason why some investors (income funds) will not want to hold the shares, though they may already have sold their holdings in the stock.

Of course, there are many reasons why it could turn out to be a bad time to buy Lloyds. They might screw up. Or we might experience the dreaded double-dip recession. And if so many people decide it’s a good time to buy Lloyds, this will push up the price and make it a bad time to buy! Though it is the largest rights issue in the UK to date…

At the end of the day, investors must make up their own minds, and, as I say, I’m not providing financial advice. Patrick Collinson (or his editors) are bold enough to allow themselves a headline “Lloyds looking unattractive” (or “Lloyds rights issue looks distinctly unattractive” in the online version). I just feel investors might also want to take into account the argument that rights issues can be a good time to invest.

Disclaimer: I worked for Lloyds in the early 1990s and own some Lloyds shares.

Why US & China, and not Europe, will Enjoy the Green Technology Bonanza

I’m still reading “Carbonomics” and, whilst mulling over some of Stoft’s (plot spoiler alert) somewhat unconvincing arguments for a carbon “untax” (actually it’s just a regular tax, the un- is an attempt to circumvent the public perception problem), I’ve had a rather nasty thought.

The question is, do aggressive policies of high fossil fuel prices and/or high green energy subsidies or passive policies of low fossil fuel prices and/or low green energy subsidies most favour the development of renewable energy technologies? My argument assumes that in Europe, fossil fuels will be kept expensive due to taxes, carbon trading and so on and renewable energy will be heavily subsidised, whereas in US (& China etc) fossil fuels will remain cheap and there will be limited subsidies.

Obviously my assumption is an over-simplification. In particular, there are sectoral differences, with transport fuels particularly expensive in Europe. But I’m trying to develop a general argument here, so bear with me.

Now, high fuel prices (and renewable subsidies) will encourage the early development of alternatives. So we see, for example, early leaders in solar appearing in Germany and wind in Denmark. Risk-free profits are a wonderful incentive!

But what market conditions will encourage the large-scale roll-out of renewable energy technologies? Well, it’s competition that eliminates the least efficient and forces the survivors to up their game. And, I suggest, competition is going to be most intense where energy prices are lowest and subsidies the most difficult to obtain.

Consider. If, say, two wind power technology players start out and are successful in selling in their home markets, the US and Germany, which will most easily penetrate the other’s market?

The US company will definitely be able to sell in the tough conditions for renewable technology in the US. The German company, on the other hand, has demonstrated only that it can sell in the easier German market with a higher cost of carbon and feed-in tariffs.

Obviously each case is different, and lots of other factors come into play (I’ve assumed that subsidies and fuel prices are higher in Germany than in US, which may not be the case for every renewable technology), but the company accustomed to easy sales is, in general, going to find it much more difficult to compete than the company that has had to fight harder.

The argument is related to the first-mover problem. It may not always be the case that the first company in a market ends up dominating it.

This is all rather awkward, don’t you think?

What it suggests to me is that the best policy at a national level must be not to tax fossil-fuels, nor to subsidise renewable technologies, but to limit fossil-fuel consumption and encourage renewable energy generation other than by price.

The best policy globally is to progressively reduce total use of fossil-fuels, thereby ensuring a level playing-field.

At the moment, no global policy is in place. It’s every country for itself, though there are rewards for reducing fossil-fuel dependency:
– greater energy security;
– a stronger position when a global deal is finally done, as it must eventually be if we’re not all to fry;
– the long-term economic advantage of lower cost – maximised if energy is produced most cost-effectively;
– the potential to export technology (and even energy, e.g. in the form of electricity), similarly maximised when the technology developed is most efficient.

For a country that wants to switch to home-grown renewable energy, policies that make sense therefore include:
– a progressively tighter limit on carbon emissions, implying internal emission trading;
– mandating the use of increasing proportions of renewable energy;
– removing obstacles (e.g. dysfunctional planning processes) to the production of renewable energy;
– a level playing-field for the various renewable energy technologies.

Policies that don’t make sense are those that support over-priced renewable energy:
– carbon taxes (where these price fossil-fuels more highly than necessary to achieve the desired rate of renewable energy uptake);
– feed-in tariffs, that provide guaranteed profit for renewable energy production, regardless of whether or not it is more expensive than other available technologies. Paying ~35p/kWh for electricity generated by solar PV on UK roofs, which I understand may well happen, must be one of the worst renewable energy policies that could possibly be devised.

Of course, whether you use taxes or emission limits supported by carbon-trading, there’s still the risk that if you try to go too fast you’ll spend a lot of money on renewable energy technologies that later turn out to have been very poor value for money. Another reason for insisting on global policies.

In my simplified world, renewable technologies that can survive without subsidies or inflated fossil-fuel prices are the ones that are ultimately going to dominate. Maybe this favours US and Chinese companies, even though Europe is adopting the most aggressive emission-reduction policies. Isn’t economics unfair?

Some Contrarian Climate Change Ideas

I had a day (well afternoon and evening) out of the home-office yesterday. I took the train to Cambridge and caught the first hour or so of a Cambridge Energy Forum on UK buildings before heading to the Guildhall for a well-attended public meeting on “what Copenhagen means for you”.

Maybe I’m an unreconstructed contrarian, but I find myself disagreeing with much of what I’m being told on the topic of global warming. Here are my latest musings.

What’s the target?

The Guildhall meeting started with a very competent whirlwind summary of the science of climate change by Emily Schuckburgh of the British Antarctic Survey. In particular she showed a rather longer graph than I’d seen before of historic temperatures and CO2 concentrations derived from ice-core analysis: around 800,000 years worth. During all this time the level of atmospheric CO2 had varied only between 180 and 280ppm, in close correlation with the temperature.

Furthermore, when temperatures have briefly spiked up during inter-glacials they have reached levels somewhat higher than at present (or in the entirety of recorded human history for that matter). Schuckburgh suggested temperatures may have been 4C higher than her baseline (presumably the pre-industrial average temperature, 0.8C lower than at present) for brief periods (and -8C lower during ice ages). Scary stuff.

Why then, do we think we’ll manage to keep temperatures within 2C of pre-industrial levels – and they’ve already risen 0.8C – at the sort of CO2 concentrations implied by the discussions at Copenhagen? We’re at around 390ppm right now and it doesn’t look like the proposed policies have much chance of keeping us below, at best, 450ppm.

And on top of that, CO2 isn’t the only greenhouse gas. Some have only just been invented! If we can’t get all the methane (CH4) and nitrous oxide (N2O) down to natural levels and the anthropogenic alphabet soup of CFCs, HFCs and so on down to negligible levels, then we’ll be even warmer.

Here’s my contrarian position (1): we need to get CO2 levels back down to the natural range of 180-280ppm. Presumably we’d aim for 280ppm, since 180 implies an ice age!

At present the strongest mainstream position – supported by reputable scientists and prompted by James Hansen’s landmark paper – is that we should aim for 350ppm.

The theory – perhaps I should say hope – is that we can “stabilise” levels at 350ppm and a 2C temperature rise. This is wishful thinking poppycock. In fact, the climate system is not a stable one. In particular, it will not be stable at 350ppm and a 2C temperature increase. It will have a tendency to warm further, for example, as ice melts, darkening the planet’s surface; as CO2 levels rise further as forests burn in the occasional much hotter summers we’d experience; as wetlands dry out and release their carbon too; and as the ocean circulation gradually slows due to the reduced temperature differential between the poles and the equator, removing less and less carbon from the atmosphere as time goes on.

We’ve opened Pandora’s box – we have to put all the demons back in, not just some of them.

Will the Gulf Stream slow and keep Britain cool?

This was meant to be a post about policy, but I’ll get the other science point out of the way, since this old chestnut came up in the Q&A at the Guildhall.

The point is that the Gulf Stream (as the North Atlantic branch of the ocean’s circulation is popularly known) can be disrupted by lots of fresh water flowing into the North Atlantic. Such water floats (because it’s fresh which makes it lighter, even though it’s cold which tends to make it heavier) and would prevent the circulation whereby (salty) cold water sinks as it approaches the pole, drawing more warm surface water up from equatorial regions, keeping Northern Europe, including the UK, a lot warmer than other regions at such a high latitude.

As the world emerged from the last ice age (and previous ones), it seems vast quantities of meltwater from the North American ice-sheet poured into the North Atlantic as ice-dams gave way. This disrupted the oceanic circulation and caused warming to reverse for a while, at least in the North Atlantic region.

It’s possible that meltwater from Greenland could have a similar effect to that from Canada, but unless someone’s asleep on the job, this isn’t imminent, since we’d see the water pooling in Greenland.

So, what will happen to the Gulf Stream in the absence of disruption from a sudden flood of meltwaters?

Here’s my contrarian position (2): the ocean circulation will strengthen in the short-term (which, depending largely on future greenhouse gas emissions, is likely to be a century or two), then gradually weaken as the ice-caps disappear. There’s no get out of jail free card for the UK, certainly not in our life-times.

The point is that the circulation is ultimately driven by the temperature difference between polar and equatorial regions.

More heat is captured by the atmosphere in the tropics than at the poles, that’s why you have a circulation in the first place. With the presence of greenhouse gases, even more heat is captured in equatorial regions and tends to be transported poleward either in the oceans or the atmosphere. More warm water stays near the surface until it cools as it approaches the poles. The result is a stronger circulation.

The presence of ice (Antarctica, Greenland, permafrost) keeps the polar regions from warming. Until this ice melts, more heat will be transported poleward. Indeed, the heat uptake by ice melt that drives the circulation.

Of course, the heat transport itself progressively melts the ice. When it’s eventually all gone, temperatures will tend to equalise between the poles and the equator, weakening the circulation. We’re not there yet, though.

I should remind readers that the ocean circulation is one of the major ways in which carbon dioxide is removed from the atmosphere.
[5/11/09 Afterthought: Oops, this throwaway comment could be a bit misleading. In fact, the ocean circulation returns CO2 to the atmosphere, so, if the circulation increases in strength, as I’m suggesting it will over the next century or two, the net effect will be for the ocean to take up less CO2 (net, the oceans are currently absorbing CO2 because the ocean and atmosphere are out of equilibrium because of the “extra” anthropogenic CO2 in the atmosphere). This mechanism represents a positive feedback during deglaciation warming phases, and, if my hypothesis is correct, during the current phase of global warming. When the ocean circulation is interrupted, then there is a positive cooling feedback as the ocean releases less CO2 due to the reduced circulation, taking up more net. This could explain the persistence of cooling phases during deglaciations (warming periods after ice ages), such as the 1000 year long Younger Dryas event.].

Therefore, as I said in my first heresy, we’d better get temperatures and CO2 levels back down before the ocean circulation strengthens too much. [5/11/09: Amended this sentence, see previous note in square brackets].

Burning wood is not a good idea

Everyone loves Julian Alwood! (He taught on my MBA programme). He told an amusing anecdote yesterday about how some well-meaning foreigners had tried to introduce a more efficient stove in Malawi. The problem was Malawians bash the meat while its cooking, apparently, and the new stoves didn’t last very long.

But the main point is that the big problem in Africa is burning wood. It releases carbon (and, almost as important, retains moisture). “Reducing deforestation” (George Orwell would have loved the double negative!) was mentioned by Chris Hope, among others, yesterday as the cheapest way to avoid deforestation. What’s really needed in Africa is a robust solar stove design, but more about that another time.

So why then was a picture shown at the Cambridge Energy Forum of a supposedly virtuous Briton carrying some logs to put on his fire?

I’ve harped on about the biofuel topic on this blog previously and will no doubt do so again (see the Biofuel category in the box on the right), but here’s my contrarian position (3): Everyone should avoid the use of all forms of biomass as fuel.

Here’s something you may have missed. A radio programme a day or two ago was discussing a satellite that has just been launched to detect moisture levels from space. The point was made that if forecasters had realised that European soil moisture levels were so low in 2003 they would have been able to forecast that year’s heatwave much more accurately.

Interesting factoid. I don’t know about you, but it suggests to me that one way we could adapt to global warming here in Europe is to increase soil moisture levels. How do we do that? More trees (including decaying ones), less arable farming, that’s how. And how do we achieve that change? We ban agrofuels (the right-on term for biofuels) and discourage biomass burning. Simple isn’t it, when you think things through?

Trying to reduce UK (or other comparable country’s) energy consumption is a waste of time, effort and money

I have to say I was stunned by the facts and figures thrown at me by the Cambridge Energy Forum (and in Michael Kelly’s talk on a similar topic in the Guildhall). I think they’ll put up a report of the meeting and slides on their site, in due course, so I won’t try to cover everything that was said.

Let it suffice for me to report that improving the energy efficiency of the UK’s housing stock turns out to be a Sisyphean task. (And even if we succeeded, energy consumption would tend to rebound as we spent the money saved! I won’t go into all this again – my most recent post on the topic is here). After you’ve insulated the loft and put in the low-energy lightbulbs – and anyone who doesn’t take the simple steps is an idiot – it starts to get really expensive.

And you can’t wait for new low-energy houses to be built to replace the existing housing stock because that would take 20,000 years. Or something.

The UK will not reduce its energy consumption by 50%. It won’t happen. The effort is futile. It’s a dead parrot of a policy.

The reason is economics. Importing solar-generated electricity can be achieved at a fraction of the cost per kWh. Promoting that sort of scheme is what everyone should be putting their effort into. And the Desertec plan was only mentioned once, en passant, in the Guildhall.

And then there are the economic reasons. People want to be richer, not poorer. They don’t want to be turning their thermostats down. And what’s more, people are tending to get richer over time – despite a raft of policies promoted by governments round the world designed by a secret global committee with the objective of halting this process – ultimately because technological (and learning) advances mean productivity tends to steadily increase (especially when regular economic recessions purge the least efficient).

The fact that more people are getting richer all the time suggests that policies based on changing people’s behaviour through taxation have had their day. We need to think again about behavioural taxes on everything from alcohol to carbon.

The main advantage (probably the only one, at least in this contrarian’s view) of a carbon tax (championed by the even more lovable Chris Hope last night), or any other way of pricing carbon, is that it makes dirty energy more expensive than clean energy, encouraging companies to invest in renewable energy production. This presupposes, though, that the main reason companies aren’t investing in renewable energy projects is price. And when I read in New Scientist magazine on the train home that “over 5 gigawatts of [UK] wind power are currently stalled by aviators’ objections” to possible radar interference alone, I really wonder whether price rather than the planning system really is the problem.

Nevertheless, internalising the carbon cost must be part of the solution. The problem with introducing a UK tax on carbon is that it will use up an enormous amount of political capital. To be effective there would have to be a huge shift to carbon taxes. And I can see the headlines already. “Driving is just for the rich in Cameron’s Britain”! Not going to happen, is it?

People certainly don’t like being morally preached at (as Chris Hope pointed out), but they like being taxed, and changes to how they’re taxed, even less.

The problem with a tax on carbon in general is that it sets no limit on emissions – so, since a tax simply redistributes spending power, could turn out to be ineffective.

A lot of intellectual effort seems to be going into working out what is the “right” price for carbon. The Kyoto idea of carbon trading may have had a lot of problems, but the principle of letting the market determine the carbon price (by squeezing supply) was the right one.

So what’s my contrarian position? OK (4): Right now energy policy should focus entirely on removing all obstacles to the development and roll-out of renewable forms of energy. Let’s see how far that gets us.

Guilt is not an appropriate emotion for dealing with this problem

Chris Hope was the only one last night who explicitly mentioned that the West caused the problem and should pay to fix it.

Well, I’m sure that “from each according to their abilities”, despite its connotations, might be a principle that could reasonably be applied in the context of international climate change negotiations. But what appears to be happening in the Copenhagen negotiations (I was hoping to find out more last night) is that the aid agenda has taken over the global warming agenda.

For starters, I don’t see a lot of evidence of binding emission targets being linked to these large transfers of money. But for the main course, we’ve brought some more presuppositions with us. There are serious doubts that aid is what’s needed to promote development. Yeap, for decades we’ve been following a seriously flawed policy. For example, Paul Kagame, President of Rwanda, wrote in yesterday’s Guardian, that “Africa must attract broad investment, not rely on handouts, if we are to sustain development”.

What’s needed is trade, not just aid.

Aah, you say, the Copenhagen largesse is investment. Well, maybe some of it will be spent wisely. But there is plenty of money in the world – too much in fact (that’s what caused the credit crisis) – looking for investment opportunities. Why do we need billions more?

A cynic, and I am one, so I’ll carry on, might even conclude that the $100bn or whatever comes out of the wash in Copenhagen, is in fact a further Keynesian stimulus for sluggish western economies. Think about it. Many of those pounds, dollars and euros are going to be spent on – to hazard a guess, as the details are not very clear – engineering projects that will be carried out by western companies. And I would have thought Gordon Brown (who’s driving this handout) is savvy enough to know this. Watch shares in Aggreko and Balfour Beatty when this deal is done!

And what happens when the money runs out? When we eventually decide we don’t need to pay developing countries for a climate deal, or decide that they’re not keeping their side of the bargain (whatever that is)? The money will be like aid, creating dependency.

On the other hand, and let’s call this my final contrarian position (5): paying for ecosystem services – and here’s some good news that could come out of Copenhagen – and/or energy, such as desert solar, will (if executed properly) provide countries with sustainable income streams which will support their further development.