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OPINION: The energy business is nuts…

OPINION: The energy business is nuts…

Apr 29, 2014

In this opinion piece, Dudley Baylis, Director, Bridge Capital Refco (Pty) Ltd, shares his views on the energy business, economic performance, politicians, power and nuts . . .

Say you have a business growing and packaging walnuts. It appears that the market is growing and you want to take advantage of the growth to expand your business and thus earn more (I don’t know too many business people who want to expand to earn less).

A walnut seedling takes seven years to nut production maturity so you calculate that the investment in new trees will require about three times your present savings. You will have to borrow to make up the difference, so a tentative approach is made to the Nut Bank via their website. In a few moments, you receive an indicative offer of funding (over the ensuing months, you will also receive numerous free and unsolicited offers from insurance, cellphone and funeral parlour services).

This offer enables you to work out that you can just about stay afloat with your existing nut earnings while paying the interest on the loan. The capital cannot be repaid to start with, so the Nut Bank offers to sculpt the loan so that in the beginning you are only paying interest. You are intoxicated with the idea of your future success, so you accept the loan putting up your farm as collateral and begin furiously planting new trees. Your friends and neighbours speculate in private as to which party in the transaction is actually nuts.

In the meantime, the market has gone wild. With supply shortages, prices have risen and you anticipate an enormous windfall when the nuts drop. Unfortunately at maturity the global nut crisis intervenes, and your own contribution to oversupply results in a dramatic fall in prices which puts your whole endeavour in jeopardy requiring a bailout from the Nut Cluster and the loss of all but your very last plot of land. Cluster’s last stand!

Your vice-chair of the NGO (not a charity) has meanwhile emerged from the crisis unscathed, pipping you at the post and gobbling up your erstwhile retirement investment at a fire-sale auction. His wisdom had lain in planting a variety of other crops in between the walnut trees during their rise to maturity, thus enabling him to pay off his debts faster and eventually putting him in a position to leverage his accumulated wealth and buy your (much better) walnut farm.

If we wait for the big trees to grow to maturity to produce fruit, there is a high probability that the market will have changed in the interim. Cabbages grow quickly and are a good cash crop and don’t interfere with the growth of the trees. Walnuts are a luxury, while cabbages (or Morogo in SA) a staple sustenance.

Energy is much the same.

When we rely on large 5 gigawatt power stations to provide all the electrical power that we need, and it takes a decade to build each of them, we suddenly find – as did our nutty alter ego – that the market has passed us by. We ought to have been building the smaller stuff all along too. But this article isn’t so much about energy as the accumulation of power.

When business has too much power and thus forces government to regulate energy prices and provision to accommodate its needs, then ultimately investors in power generation go away and the system eventually fails (as we have discovered). When central planning politicians overly regulate an economy and chase away investors, then the system fails. When power utilities insist on being the only game in town, the system fails.

When big is always favoured over small because big banks only think it’s worthwhile to fund large transactions and the small is neglected, then ultimately the system fails too. When capitalism starts to believe its own nonsense resulting in huge wealth accumulation for a few at the expense of the many under the guise of the free flow of skills and capital, then that system too will fail – eventually.

Chief executives and their coterie believe it is important to pay top management in the order of tens of millions a year, supposedly to ensure the attraction of the right sort of person in order to grow the business, and that ultimately this is good for the economy – the Chinese might disagree. Yet entrepreneur-led growth is considered vital to our prospects. What bright and driven mind would consider a start-up when the rewards for significantly lower risk are so much higher in the corporate sector? Is it any wonder that our leading politicians consider it acceptable to rob the public purse for personal palatial purposes when the political and “struggle” risks that they took to get there are immeasurably greater than those of the chattering classes?

Economics and money are a subset of the system of physical existence. Economics cannot defy the laws of the universe – no matter how hard the stock market tries to prove otherwise. Likewise, physical laws provide an insight into the workings of economics – beyond the banality of supply and demand theory. In this sense, the idea of entropy is a useful model to apply economically.

The laws of thermodynamics dictate that the entropy of a closed system must increase over time. What this means is that the order of a system slowly decays to the point where a state of “primordial soup” is attained. Alternatively, in another five billion years or so, our sun will expand to subsume all of us eventually tossing us out back into the universe as planetary nebulae. In some cases this mass accumulates to the point where a black hole is created, and there is a lot of confusion about what happens after that.

So too, accumulation of wealth is important in the development of an economy. If all money and resources were spread about equally among all people – as socialists and communists would like to see – then nothing really happens. Everyone stays mired in poverty. In numbers, the total world annual product amounts to $530 a month on a per person basis. To be sure, a lot for a poor person, but hardly enough to encourage significant investment in capital accumulation and wealth creation devices like power plants. We need investment and accumulation of wealth in a smaller number of hands so that it might be effectively directed for the benefit of the whole – in much the same manner as the accumulation of atoms we call earth wouldn’t be of much use to us if we were collectively allocated our portion in some far flung corner of the multiverse.

We can each have 2 x 1040 atoms, so please go and get yours now – oh, and can I have mine in gold please? If we divide all the atoms by all of the money on earth we get 26 x 1035 atoms for each dollar. Put another way, we think gold is worth about 35,000 trillion times more than the average atom. Makes the whole thing seem rather pointless doesn’t it? And explains why I want mine in gold. But I digress!

Without accumulation of wealth in few hands, the whole doesn’t grow. But what is the ratio that we should seek? How many rich for how many poor? Capitalists might be a good thing but too much of a good thing . . .?

I heard a scary number the other day that said that if you earn more than R17,000 per month you earn in the top 5% of the worlds’ earners. Since that places me firmly in the top 5% (albeit only fractions removed from the great unwashed) it is very disappointing, as I was rather hoping to ask for a raise. Puts the whole question of the minimum wage for striking platinum workers into some perspective too . . .
I have no idea what the right ratio is, but I do know that the inequality of our society is right out there at the wrong end of the scale and there has to be some sort of policy issue to address it – as suggested by Peter Bruce in his Business Day article on 22 April 2014.

It’s much like the physical universe. If we accumulate too much mass in one place then eventually we create a black hole and God knows what happens when you get too close to one of those!

Closely aligned to the problem of inequality in riches is the inequality in allocation of resources, and particularly electric power. The ANC has made great strides in the last 20 years to improve access to electricity to the point where over 70% of South African’s now have electricity access. But as I have argued elsewhere before, there is a very close correlation between the provision of electric power and economic performance. It astounds me that having inherited a power system that oversupplied the economy (admittedly a much smaller economy than we have now, and one that catered for only a tenth of the population) we have allowed things to lapse to such an extent that we now experience blackouts or the threat of blackouts on an almost continuous basis. There is also a big difference between access to power and access to significantly useful amounts of it.

Personally, I don’t blame Eskom – I think they do an astounding job with what they have. I also don’t blame government – they have many priorities, and somewhere along the line they (like most of the rest of the world) have failed to appreciate how important to economic performance the provision of power is. I can’t blame business or its lobby groups either. They campaign for low electricity tariffs as is their right and motivation and the fact that this has resulted in under investment in the very sector that provides their lifeblood isn’t their fault. The electricity regulator is also an easy whipping boy but also not an appropriate target for our finger pointing.

But I do blame the whole system. The fixation on large power plants, the idea that individuals or businesses have no responsibility and only rights, the under-pricing of electricity, the financial system that seems to think fixed special tariffs are the only way to create financing opportunity for such capacity. It’s all of us.

So let’s not blame the land or the farmer or the seed or the tree. Collectively we need to find a way to ensure that our nut farm survives the ravages of market turmoil so that we don’t start out giving the farm away to the guy who had poorer land to start with.

Otherwise we all go the wall.


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