Archive for June 24th, 2008

Catch: Newt “Inspired” McCain’s Prize Idea

June 24, 2008

Yesterday, candidate  McCain called for “a $300 million prize to whoever can develop a battery that will leapfrog the abilities of current hybrid and electric cars.”

On page 199 of Real Change, Newt Gingrich says “There ought to be a billion-dollar tax-free prize for the first hydrogen car that can be mass produced for a reasonable price.”

Observations:

If you’re going to jack somebody else’s ideas, give them credit — especially if the ideas are whacky.  This one meets both criteria — jacked & whacky.

At least McCain showed fiscal restraint by making the prize only $300 million — but why $300 million? In marketing jargon, that’s not a “price point” — he could have gone down to $250 million and not lost any impact, or gone up to $500 million and referred to it as “half a billion dollars” — that has some punch.

If Obama also cops the idea, it certainly won’t be tax-free.  In fact, anything over $250,000 would probably get hit with payroll taxes …

The posted reward for capturing Bin Laden is $50 million.  By inference, it must be 6 times as tough to develop a hydrogen car — and will take at least 7 years (and still counting).    

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Numbers – Oil – Financial Speculation vs. Physical Hedging

June 24, 2008

The Wall Street Journal reports that “financial speculators” currently hold more crude oil ftures than “physical hedgers” who are simply forward buying a necessary, price-escalating “factor input” to their operations.  Think: refiners and airlines.  See the prior post for data on Southwest Airline’s hedge positions.

Note : Data is from the New York Mercantile Exchange (NYMEX).  The prevailing view is that financial speculation is an even bigger piece of the action on the less regulated ICE (London based Intercontinental Commodities Exchange) and the DME (Dubai Mercantile Exchange)

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Numbers – Oil Hedging – Southwest Airlines

June 24, 2008

As oil prices go up, financial speculators are garnering a lot of press and political attention, potentially obscuring the importance of commodities hedging to commercial operations (i.e. companies that actually use the oil).

When there is a scarcity projected for critical commodities — the key “factor inputs” to a company’s operations (e.g. oil for airlines) — or when prices on critical commodities are expected to increase — many companies will “forward buy” the commodities — i.e., hedge them .

One of the ways that Southest Airlines keeps costs (and prices) comparatively low has been by hedging oil.  For example, SWA bought 65% of its projected 2008 fuel requirements (roughly 1.5 billion gallons, 35 million barrels) in advance — at an average price of $49 per barrel. 

 

A couple of observations:

  • Only well capitalized companies can substantially hedge key commodities — that rules out most airlines.
  • Financial speculators certainly push up the price of futures contracts — though the “players” may eventually be left hanging if spot prices fall.
  • Even SWA will feel the pressure of the ‘hot’ futures markets starting in 2010 — when their proportion of relatively cheap hedged oil falls below 50%.

Heads-up to politicians: If an operating company such as SWA hedges via exchange-traded futures contracts, then raising the margin requirements on future contracts would require an enormous inflow of capital.  For example: SWA uses about 35 million barrels of oil annually.  At $135 per barrel, that’s almost $5 billion per year.  So, if SWA hedges 50% of their oil requirement over a 4 year time horizon (as they averaged for the past couple of years), then SWA would need another $10 billion in capital to support the higher margin requirements.  As a frame of reference, SWA currently has $18 billion in “total assets” (e.g.planes. airport facilities).  That would be a challenge for them, and an impossibility for more financially fragile airlines.  (Note: I’m not sure if SWA hedges via exchanged-traded futures contracts —  they may contract directly with oil suppliers — and be outboarded from exchange margin requirements)

 

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