Praying at the Church of the News | Fancy Some Tax Free Moral Hazard? | Who Has the US By the Balls? / by Adam Howard


I want to start this week with a brief discussion of the Lindt Café siege in Sydney this week.  Not an exposé of terrorism, a discussion on government action in this area or predatory media reporting of tragic events.

It’s about our need for these events to be put into a context that we understand and the role the media plays in providing that context.   For this, humans need a story (called a narrative by smart folk) which puts abstract events into a package that helps us see things from someone else’s perspective.

And while the media portray themselves as focussing on reporting facts and objective information, providing subjective context is really what it’s about.

Put it this way; using Zoolander terminology, terrorism is so hot right now.  Al Qaeda, Al Shabab, IS, ISIS.  I can’t keep up.  A bloke with a black flag with Islamic script takes hostages in a café and Channel 7 broadcasts that there is an ISIS terrorist attack occurring in the Sydney CBD.

A reasonable assumption to make… but making assumptions is not meant to be the province of the media.  Their gig is reporting FACTS (after all, that’s what Mel Doyle told me on the afternoon of the siege).

But, this assumption is made on the basis that this is a context the bulk of watchers and readers will understand and digest.

In fact, by the late afternoon of the day after the siege I was listening to Radio National, and an interviewer was still asking if, given what was known about the gunman, it was possible in hindsight to foresee that he might become a lone wolf terrorist.

If we take the gunman’s religious affiliations out of the equation it appears he was really a very disturbed and violent man with a persecution complex whose actions were largely unplanned and random. 

But that was not a narrative the general public would find pleasing, hence the alternatives that were provided.  As stated in other Updates, humans love cause and effect; cause – Islamic extremism and disaffection with western nations, effect – hostage siege at a Sydney CBD café.

Have a look at Alain De Botton’s book “The News”, where the UK philosopher dissects the place and role of the media in today’s society.  It is in many respects our modern day religion, where we go to pray at the altar of facts each morning and evening, and accept the words of our trusty talking heads as truth.

But is it?

A recent study focussing on the veracity of various news outlets in the US found less than half of all statements made on Fox News were true...and Fox News is owned by the same organisation that owns The Australian, The Sunday Times and

Now onto this week.

I want to begin (for a second time) by putting a scenario to all readers: times are tough for The Wife and I and cash flow isn’t as good as we would like.  I have been working on a few potential solutions and I think I have it!

I am going to get in touch with the ATO (yes, that’s the Australian Taxation Office) and ask them to defer our taxes.  The best strategy might be to ask for the cancellation or waiving of this year’s taxes, knowing that I would be happy to accept a deferral.

How do you like my chances?  I feel confident as, after all, the health of my local economy depends on the funds I pump into the local IGA, BP, Coles and corner store.

Of course I have zero chance, and fortunately for the sales staff at the Saba Department of David Jones, Perth, our cash flow is actually OK.

Then why the hypothetical?  Because that’s exactly what the junior iron ore miners have asked for and received from the WA State Government, with an agreement to defer royalties payable on shipments of iron ore until the iron ore price recovers.

Quickly, the junior iron ore miners are BC Iron, Mount Gibson Iron Ore, Atlas Iron and Mineral Resources.

Am I the only person who thinks that is mad???  What happened to the question of “moral hazard” that has been asked so many times since 2008?  Why are these companies so important?

And why am I so outraged?  Well, maybe it’s because the two blokes who own MinRes bought Bondy’s old place and Angela Bennett’s old place for a combined $90 Million a few years ago.  It’s not like the executives need the tax break.

Or, a better question.  Didn’t the executives in charge of these companies plan for a day when the iron ore price might fall to a more sustainable level?

No, of course not.  An entire economy has sprung up around iron ore, and that level of vested interest makes any discussion of a sharp drop in the iron ore price difficult.  You get called a pessimist at best, and beaten up at worst, as you are effectively pulling down the edifice that people’s whole lives are built on.

This situation represents the concurrent occurrence of a couple of interesting psychological phenomena (once again spoken about in depth by my boys Taleb, Kahneman, Tversky et al).

First, we adopt this higher price and the economy it creates as our “new normal”, and any potential drop in price becomes an improbable event; one that we would view as being random and unexpected.

This is perverse as the reverse is the case; the current high price is the improbable event.

Our behaviour changes on the basis of this new wealth and we become vulnerable to such a drop.

Second, our view of wealth adjusts to see the new, higher wealth levels as our “new normal”.  Kahneman found that changes in wealth are not experienced in absolute but relative terms.  The new higher wealth levels become our reference point, and any drop is seen as painful as humans are loss averse.

We experience losses of wealth as being twice as painful as increases, and as a result substantial action will be taken to preserve the higher status quo.

Such as large tax breaks being granted…and no-one caring.

It doesn’t matter that we know the demand for iron ore is cyclical, and that a similar spike in prices occurred during the last boom in the early 1970s.  We look backward using our animal, or limbic brain, and a scattered and inaccurate memory of both relevant and irrelevant events and craft a pleasing story that is based on the central theme of “this time is different”.

A character from a past Update, The Professor, put me onto a good book by Carmen Reinhart and Ken Rogoff titled (you guessed it) “This Time Is Different”, which details 800 years of economic booms and busts.  The past 200 years have been particularly rich in events across all continents.

Here is a graph of the iron ore price over the longer term.  I have included this before in Updates, but I think it’s worthwhile displaying it again.

Iron Ore Monthly Price - US Dollars Per Metric Ton

Iron Ore Monthly Price - US Dollars Per Metric Ton

So, I doubt whether this time will be different…and the signs are all there.

All the smaller iron ore producers have higher costs to produce and ship than BHP and Rio, so they are reliant on a higher price to stay afloat.

Another friend whom we will call The Inventor, sent me a very handy piece of data that showed the current iron ore price per metric tonne in USD plus 90 day forward order book prices for all global iron ore, together with the country and port of origin.

ALL global iron ore spot (current) prices were at least $10 per metric tonne higher than the forward order book prices.

This means the market is pricing in a further drop of $10 per tonne over the coming 90 days.

Not only are the juniors getting tax relief, but they are getting rid of anything they can lay their hands on and declare as non-essential (in the case of one, tomato sauce, salt and coffee machines in staff kitchens).

Now, this is where we look at economic theory and ask if the behaviour of market participants is what it should be given the circumstances.

Answer:  NO.

In an environment of dropping prices as a result of contracting demand, suppliers should be restricting supply, right?

Rio and BHP are ramping up production, as is FMG, and Gina is trucking along with Roy Hill.


Well, Rio and BHP are clearly using their market position and lower cost base to drive out their competition.  Makes sense to use one’s competitive advantage and clear out your competitors.

But FMG and Roy Hill?  I can only suppose that now they are committed the only option is to push on, for better or worse.

As I said, this time won’t be different.

A quiet word on the manner in which this story is being covered by the media.  I’ll admit it; there was a story on a weekday West Australian front page a week or so ago, but other than that, this government gift, sorry subsidy, has almost escaped notice.

This weekend is was front page news…of The Weekend West Business Section.

From my perspective this story carries significant public interest, but I couldn’t locate it online at The West Australian, or The Australian.

But, then, it’s a story without a pleasing narrative. 

Now, while on the topic of demand and supply and financial crises, has anyone read about, thought about or hypothesised about the massive drop in the price of oil and the fact that Russia’s economy is coming apart at the seams?

Most readers would be aware that over the course of the past few months the price of oil has dropped a lot, right?  I thought a couple of graphs to display, first, the long term movement in oil prices:

Crude Oil Price History 1983-2014

A long term trend of around $30 - $60 per barrel, then a spike to $150 per barrel and a return to a “new normal” of between $80 and $110 per barrel.

And now the short term:

Crude Oil Prices December 2014

The two big units of measurement for the global oil price are the price of West Texas Intermediate (WTI) and Brent Sea Crude, and the prices of both, while not the same, are close and also closely follow each other.

Today (20/12/14) the prices per barrel in USD for each are as follows:

Brent Sea Crude:     $61

WTI:                         $57

So, what’s the question on everyone’s mind?  “Why is petrol still $1.30 a litre in Perth???” 

Of course that’s the question, and there are only two real answers: either it takes a long time for those drops in prices to flow through the supply chain, or we are all suckers being taken for a ride. 

But the question I want to talk about is, “Why is this happening and what is happening as a result?”  Or maybe, “So what?”, or “Why talk about this?”

Firstly, why talk about this? 

Number 1: Because the extraordinarily high oil prices caused investors to see quite weak economies as much stronger than they really were.  This is known as the halo effect; and

Number 2: Because the actions of oil producers to create this sharp drop are similar in motivation to those of Rio and BHP above.

A couple of weeks ago I mentioned the BRIC nations; Brazil, Russia India and China; emerging economies regarded as hotspots for investment.  Russia’s place amongst these nations was due to the very high oil price, as oil is Russia’s primary export and the pillar that supports its economy.

Russia was already at risk of a calamity due to the economic and financial sanctions imposed on it by other nations as a result of Russia’s actions in the Ukraine.  It wasn’t going to take much to push it over the edge.

And the push came when the US proudly told the world that the shale gas boom underway there for the past few years meant that they were approaching oil self-sufficiency.

Happy Days!!!

Never mind the diplomatic and military actions taken by the US globally over the past 50 years to protect its access to oil.  I am sure no one was upset with the US about that at all.

So, the 12 OPEC (Organisation of Oil Exporting Countries) nations, when asked a few months ago about the falling oil price, said they were unconcerned and didn’t plan to take any action to restrict supply.

Brief moment here.  Who is OPEC? Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya, The United Arab Emirates, Algeria, Nigeria, Ecuador and Angola.

That’s almost a hit list of countries least liked by the USA, isn’t it?  Back to supply and demand.

Restricting supply would, of course, mean the price would recover.


Since then, OPEC have actually increased supply, to drive the price down further.

Why? Because US shale gas is only profitable when oil, its main substitute, is at $75 - $80 per barrel.  At lower prices they stop producing shale gas and start buying oil again.

OPEC like having the US by the balls.  It’s been that dynamic that’s formed the basis of the relationship between the US and Saudi Arabia for 40 years.

So, OPEC accept lower profits, or even a short term loss, in order to drive a competitor out of the market.

Russia and its woes is just collateral damage in a price war between the US and OPEC.

Before I sign off I want to make a brief philosophical point I picked up watching a brilliant address given by comedian, writer, musician, Christchurch Old Boy and brother of a mate, Tim Minchin, where he correctly states it’s easy to be against stuff, and harder to be pro stuff.

And reflecting on my Updates, sometimes I think I tend to be overly anti stuff.

So, what am I for?

1.     New ideas, good or bad.

2.     Never taking yourself or anything too seriously.

3.     Constantly learning and improving your own mean skill level.

4.     Luck, good or bad.

5.     Human beings in general.

Food for thought….