Whose Side Are You On?

As politics has moved to the centre (in this country and others), ideologies seems to have grown a bit muddy. The political ideologies of "left" and "right" are both seeking to answer the question of how to land on the most economically productive use of society's rescources. the division of ideologies used to be quite clean cut:

On the right, you believed that markets were very good at solving problems and should be left to their own devices.

On the left, you believe that governments should intervene to improve areas where markets aren't very efficient.

Ideologically, the right believes in low taxes and low government sending to incentivise individuals to strive to obtain the things they want. The left believes that sometimes people end up in difficult situations through no fault of their own and that public services can be used to avoid these inequalities from becoming entrenched. Neither side is right or wrong; they're just different ways of looking at the world and at people. For my own part I find I switch between them in different situations.

As far as political parties go, the problem with having distinctions like this is that it can shut down good political ideas that don't conform to the party ideology. The advantage, though, is that you know what you're voting for when you go to the polls.

Over the last couple of years, we've had a Labor government pushing for an emissions trading scheme, while across the floor the Liberal opposition was pushing to introduce a carbon tax instead. For those expecting their Liberals to behave like it, this has been a particularly weird situation. We now have the Liberal shadow treasurer trying to out-do a Labor government on bank regulation.

Stranger still, however, is Tony Abbott's new "flat tax" proposal. Tony has suggested that a more equitable tax scheme than the current tiered system would be to have a tax free threshold for all households earning less than $25,000 per year, then a flat tax rate of 35% for incomes between $25,000 and $180,000. For income earners on above $180,000 both schemes propose a tax rate of 45%.

Here's what the proposal looks like:

What this shows is low income households (less than $46,000pa) paying a lot less tax, middle income households ($46,000 to $165,000) paying a lot more and high income households being largely unaffected. To summarise:

- the majority of people pay more tax;

- middle income earners subsidise low income earners (relative to their current levels); and

- the fastest way to increase the proportion of tax you pay is to to earn about an average income and get a raise.

There's nothing wrong with this, per se, it would just make more sense if it was coming from the other side of politics. if it was, I'm sure the Liberal would be talking about another "Great Big New Tax".

Sharing

A new fad appears to have emerged; in line with our new post-consumerist society apparently people now want to share stuff.

There is now a bike share scheme in Melbourne (at a ridiculous cost taxpayers, but that's a topic for another post) and several commercial car-share schemes that I occasionally hear people raving about in the papers, but I don't know anyone who actually uses them.

The thing is, I don't know if I want to share. I don't think that I'm overly selfish or overly precious about things - I wish that I could be swept away in the hysteria of all of this sharing. I wish that I could trade in my bike and car and just keep the money to spend on other luxury consumables - then save even more by learning to share those, too. The thing is, sharing just isn't stacking up for me.

1. People Wreck Things
Train stations are made of concrete and the only furniture is made of metal and bolted down. However, in my lounge room, there's carpet and a couch. I am hardly a neat-freak, but I take care of my stuff and I like it to be in good condition. Whether malicious or negligent, hire car schemes fill me with dread about showing up to my allocated car to find a pool of vomit in the passenger seat.

2. Quality
I can live on pasta and avoid eating out. I can restrict my clothing purchases to things that are already discounted and sell old clothes on eBay, if I must. However, I do own a very nice carbon fibre road bike and a fixie in cute colours with wheels expensive enough to be given their own bike lock. I am also, in my old age, getting a bit picky about cars.

Share schemes seem to trend towards to mean - they don't seem to acknowledge that in most respects I tend to be either a complete tight-ass or an elitist snob.

3. Where are these things?
Car share schemes are like petrol stations. Apparently they're all over the place, but when you start looking for one they mysteriously all vanish.

4. Demand
These schemes, like anything in infrastructure, are about balancing supply and capacity. If you buy enough cars/bikes to meet demand during the highest peak periods, most of your fleet will be idle the rest of the time. If you buy enough to get a good level of utilisation then there's nothing available during peak periods.

So, if you join one of these things then observe that there "never seems to be a car/bike available when I need it" you can reassure yourself that it's designed to work like that. If there is one available, you can rest assured that either there won't be once more people join up, or you're paying too much in fees.

Onwards and Upwards!

3 June 2007 was a milestone for carbon pricing in Australia: this was the date when putting a price on carbon finally became a bipartisan policy objective. Environmental types may harp about how Australian coal generators and energy companies "should have seen this coming for decades" but the fact is that as recently as four years ago the notion that a national carbon price (through a cap and trade scheme or a tax) was somehow 'inevitable' was by no means a foregone conclusion.

This point is by no means irrelevant to the current debate.

No material infrastructure investment decision in Australia will get past an Investment Committee process without a detailed financial model based on the well-founded principle of discounting cash flows (DCF). This is equally the case for investments by corporates, super funds and private equity (perhaps with the occasional exception in the more risk-loving mining states). For those not familiar with the logic behind DCF, here's a quick run-down:

- The only reason you invest money is because you expect to get money back at some time in the future. It is assumed that by making a series of well-reasoned assumptions about future performance, you can make a reasonably reliable estimate of how much money you will receive in each future time period.

- Not only do you expect to get your money back, you expect to get a bit more to compensate you for risking it in the first place. The more risk, the more you expect to get back. The return is usually expressed as a percentage return on your investment and by working back from the future date to the present and reducing each of your expected future cash flows each year, you can figure out how much you should be willing to spend on something now to receive the forecast payment in each future year.

- Adding up all of these "present value" numbers gives you a target price - if you can undertake the investment for less than this, you should do so, otherwise you shouldn't.

The DCF method of valuation is ubiquitous. The problem is that it's only as effective as the values that you plug into it and it implicitly relies on being able to make a relatively reliable forecast of future earnings.

When guys like Marius Kloppers (CEO of BHP) come out in support of a carbon trading scheme on the basis of "reducing uncertainty for business" they are not talking about a vague, qualitative type of uncertainty. Not knowing whether a project is going to have a substantial new cost tacked onto it means not being able to predict future cash flows and not knowing what annual percentage return you should expect to earn.

Companies can respond to this in several ways:

- Use a 'worst case scenario': in this case, many good projects that should be undertaken, won't be.

- Delay: given that the uncertainty will be removed once the political decision is made, many companies may simply delay the investment decision in the hope the policy is resolved quickly.

- Consider a range of policy outcomes and come up with a probability weighted outcome: this will reduce the level of underinvestment by consider both the best-case and worst-case scenarios. However, while there is an option to delay, delaying would generally be more favourable.

There has been no substantial new electricity generation infrastructure built for a very long time now. The impact of delaying and under investing in projects is that supply is constrained, which forces up the prices paid to existing electricity generators and eventually this rise in prices must be passed on to consumers.

So, at this stage, it appears we're faced with a bit of a Morton's fork:

1. Bring in a carbon price and energy prices will go up because of the added cost of carbon.
2. Don't bring in a carbon price and energy prices will go up because of a supply shortage.

It could be argued that there's the option to take a firm policy stance against any sort of carbon pricing but I would suggest that since 3 January 2007 this suggestion would be less than credible.

For those who took issue with coal generators receiving substantial compensation under the Rudd Government CPRS proposal, consider this: under the CPRS the proportion of compensation to generators was a minor portion of the total expected cost of a CPRS (perhaps around 25-30% for the first five years) and came from a much larger pool of revenues being delivered to Government. That Government revenue could be redistributed through welfare payments to those most dramatically impacted. While carbon pricing is being delayed, higher prices from underinvestment means that existing coal generators will be getting a bonanza - and they won't be sharing any of it.

The Shit Sandwich

I like analogies that neatly sum up life's dilemmas and if they involve swearing, all the better. One that I seem to be using a lot lately is the analogy of the shit sandwich. It goes something like this:

"Sooner or later, you're going to be forced to eat a shit sandwich. When this happens, some people will whinge about it, some people will just make the best of it and some people will pretend it tastes delicious."

I derive a great deal of satisfaction from using this analogy when accused of being a little too "constructive" about things. Yes, I may have a bit of a tendency whinge about things when I should just swallow a great draught of stoicism and get over it. However, if I'm going to overshoot the mark, I'd rather be a bit of a whinger sometimes than one of those overly optimistic people who are so busy trying to channel the power of positive energy that they neglect to notice they're getting screwed.

Cynical, much?