Archive for July, 2016

The Global Economic Doctor

July 12, 2016

Global Economic Doctor_thumb



The Global Economic Doctor– Click link to read the full edition.



Welcome to the latest edition of The Global Economic Doctor.  This week, Dr. Scott B. MacDonald writes:

Life During Wartime

This ain’t no party, this ain’t no disco,
This ain’t no fooling around
No time for dancing, or lovey dovey,
I ain’t got time for that now
— Talking Heads, Life During Wartime.


The narrative for the global economy is going to be dominated by political risk factors through the rest of 2016 and well into 2017. Brexit was certainly a factor in the US Federal Reserve’s decision not to raise rates in June and July; the massive injection of uncertainty into markets in the aftermath of the British vote will pressure the US central bank not to raise rates again in 2016. There will be further pressure not to raise rates from the uncertainty surrounding the US presidential election in November. Other headwinds to global growth include what could be a worsening bank crisis in Italy, a recession in the UK and possibly other countries in Europe. Asia, the Middle East and Latin America have their own set of political risk factors, which add stress to markets. Moreover, Q2 2016 US corporate earnings, which start this week with Alcoa, are not likely to lift markets on a sustained or meaningful basis. The consensus view is that the S&P 500 Index companies are expected to see another drop; this time a 5.1% decline year-on-year.  This is better than Q1’s 6.8% decline in profitability. The thing to watch with earnings is the outlook for the rest of the year.  Markets will be keying in on what CEOs have to say about the business environment for the second half of 2016. Our view is that they will be saying what they have been stating over the last several quarters – it is difficult to forecast due to weak global growth, slowness in wage expansion in the US, and political uncertainty. The exclamation point on all of this was the tragic, racially-charged violence that very recently marked the US in Minnesota, Louisiana and Texas. It is, therefore, easy to look at the world through the lens of the Talking Heads song, some of which is quoted above. The path forward is through a fog of uncertainty and risk. If political and economic conditions deteriorate further, the issue facing investors is increasingly going to be not one of a getting a higher rate of return, but preservation of capital. Cash remains attractive and gold, gold stocks, utilities and US Treasuries are likely to have a good run as we sift through the variables in challenging markets and investors are driven to safe harbors.


Cal Green Stumble

July 11, 2016

Smith’s Critical Infrastructure Assessment of the US Public Power Supply and Transmission System has gone on high alert for potential catastrophic failure due to a collapse in baseload generation.  Smith’s has hosted webinars and participated in global energy conferences in the US and around world as a subject matter expert during the past six months.

Recently, California’s public power utility officials are warning that Los Angeles could face two weeks of “brown outs” this summer due to critical shortages in the natural gas supply.

Smith’s Event Risk Alert was issued in February when the California’s Aliso Canyon underground natural gas storage facility experienced a massive leak this past winter. Smith’s warned the L.A. region would be short of the fuel due to the massive gas leak that displaced thousands of people in the nearby Porter Ranch neighborhood.

Natural gas is California’s largest energy source.  It is transmitted via a pipeline system, which is a major vulnerability as well as a critical infrastructure asset.  The Aliso Canyon facility is one of more than 400 underground gas storage facilities that use old oil fields, aquifers, and salt domes.

Marcie Edwards, general manager of the Los Angeles Department of Water and Power (LADWAP), the nation’s biggest municipal utility, has take proactive measures by signing contracts for space on electrical transmission lines to import more electricity in the event Southern California Gas Co.  is not able to get enough natural gas to keep power plants running.

But, the contracts underscore California’s dirty little secret, which allows it to access coal-based generation.  Canada, which participates in the California cap-and-trade system, has members like Quebec that are threatening to exit over the coal-based energy contracts.

Last month, California’s quarterly cap-and-trade auction produced only 2% of the expected  bids. Typically, the California quarterly auction produces $500 million for the state.

A quick recap: In 1996, the California High-Speed Rail Authority (CHSRA) was established to begin formal planning in preparation for a ballot measure in 1998 or 2000. The ballot measure, Proposition 1A, finally was put to a vote in 2008 when 52.7% of voters approved the issuing of $9.95 billion in bond sales for the construction of the core rail segment between San Francisco and Los Angeles/Anaheim. The law, AB 3034 included an additional $950 million, approved for improvements on local railroad systems, which will serve as feeder systems to the planned high-speed rail system.

In 2010, California received $2.35 billion of its American Recovery and Reinvestment Act funding, with $2.25 billion dedicated for California High Speed Rail. Over the next 18 months, the federal government awarded the Authority a further $4 billion in high-speed rail funding, mainly from states that rejected building rail projects.

The cap-and-trade funding was approved in 2014,  when California announced it was apportioning the state’s annual cap-and-trade funds so that 25% goes to high speed rail (under the authority of CHSRA) and 15% goes to other transportation projects by other agencies. The state’s Legislative Analyst’s Office estimated that cap-and-trade income in 2015 and 2016 could total $3.7 billion, of which $925 million would be allocated to HSR. As of mid-2015, current funds allocated for designing and constructing the system total $6.302 billion, with another $2.024 billion for connectivity and bookend transportation projects.

In the wake of the anemic auction, an enormous number of projects across California have been told not to expect to receive their cap-and-trade allocations.  What’s more, the CHSRA mandate expressly prohibits any outside subsidies for the construction or operation of the projects, which makes it virtually impossible for the State of California to fill-in any temporary disruptions in funding.

Court Case
The California Chamber of Commerce and other business groups have filed a lawsuit that contends the cap-and-trade is a multibillion-dollar tax.  And, Smith’s Regulars know that new taxes  in California require a two-thirds legislative vote. The Air Resources Board (ARB), of course, dismissed the allegation by trying to pooh-pooh the auction proceeds as ancillary to the  emission regulation and not a purposeful revenue generator. However, the fact is much of the money has been spent for purposes with little or no connection to carbon emissions. For example, $500 million of carbon cap and trade was swept into the state’s general fund, which makes the Air Resource Board’s position almost absurd.

2020 Sunset Blvd.
California State Senator Jean Fuller, the Senate’s Republican leader, asked for an opinion from the Legislature’s legal counsel about whether AB 3034 must end in 2020 unless reauthorized.  The request was made in response to Governor Brown’s executive order setting new emission standards for 2030.

The Governor interprets the AB 3034 as requiring carbon reduction beyond 2020. However, in 2010, Californians voted to approve Proposition 26, which expressly limits any such ‘end runs’  around the California Constitution requirement for a two-thirds approval on new taxes.

What should be an easily understood concept is probably going to end up in court (again).