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?

The Price of Vigilance

I have a caffiene addiction. It's addiction just as surely as if I were laying in the gutter in a pool of vomit. Except that I'm a blithering, slurring drone who can't walk straight when I haven't had a coffee, rather than after I've had a few.

Being both an addict and a bit of a snob (which is to say, instant coffee makes me feel like my gut is rotting, so I only use it for emergencies), coffee forms an important part of my budget. To date I have managed to avoid the need to break into any houses or mug any little old ladies to feed the habit, but all of these articles in the Age suggests I might need to reconsider my position on that.

So, what's going on with coffee prices? Well, judging by the following graph of arabica prices (arabica is the standard cafe bean) prices are indeed heading north.

Check out that positive gradient! Looking at this chart, the price of beans has increased by over a third in the past two years. If I take a cursory look at this chart and combine it with the broad media coverage, I would be starting to think that I was going to have to commence drastic austerity measures to keep up my consumption (in my world, this might mean ironing my own shirts).

However, there is more to think about here. Consider that the pointy end of this chart is suggesting a coffee price of around US$4.665 per kilogram of coffee. If you assume, generously, that each cup has 15g of coffee, this means the price per cup of coffee has soared from around 4.5c per cup to a whopping 7c per cup. Even assuming that wholesaler costs add 100% to this price, we're talking an increase in the price per cup of 5c.

When I moved from Perth to Melborne around 10 years ago, the difference in coffee prices was remarkable. In Perth, a coffee costing up to around $4 was reasonable. $3.80 was about the benchmark for a standard coffee from a standard coffee shop. In Melbourne, anything over $3 was expensive.

The difference between Perth and Melbourne wasn't driven by input costs, like a 5c differential in coffee prices. It was driven by greater levels of competition. Coffee shops in Melbourne had to take a hit to margins to get people through the door - I suspect that some Melbournce cafes sell at very low margins just to get customers in to buy high-margin items (eg, muffins). In Perth, lower competition meant that consumers would pay a bit more. This little allegory points to the fact that prices aren't always driven by input costs - sometimes they're driven by customers' sensitivity to price movements (ie, their elasticity).

However, the story about a West Australians moving to Melbourne 10 years ago perhaps points to the bigger issues here. A sandgroper (West Australian) can still show up in Melbourne and be surprised by getting a coffee for $3 when they have to pay about $4 back home. Over a period where inflation has pushed average prices up by more than a third, coffee prices have moved by only around 5%. Perhaps the level of competition has pushed margins down so far that everyone is feeling the squeeze more than they'd like to, but cafes are too worried about losing market share if they increase prices.

Price fixing and collusion are illegal. Sending a signal out through the media that "we should all lift our prices now while we can blame it one the commodity price" may not be.

Now, if only I could get my salary to keep pace with inflation, I might be able to afford it.

Allen and Gloger

I recently discovered an interesting little biological byline. I take a certainly delight in the rare occasions where trash talk forms a logical nexus with 'respectable' scientific theory. This little observation fell so neatly into that category that it had to get a mention, irrespective of the fears that it might impede the high-brow tone of this publication (*cough*).

It turns out that way back in 1877 a biologist named Joel Asaph Allen posited that endotherms in colder climates should have shorter appendages than equivalent animals from warmer climates. It became known as "Allen's rule".

The initial theory was framed in terms of the hypothesis that figures with more contrast between their dimensions have a greater surface area than figures with the same volume but closely comparable dimensions. That is, a rectangle with dimensions 4x1x2 has a greater surface area (28) than a cube with the same volume (a 2x2x2 cube has surface are of 24). More surface area means more heat loss, which is an advantage in hot climates, but a disadvantage in cold climates.

Examples of this include things like polar bears having short legs and recent studies suggesting that the hotter the climate, the larger the beaks on local birds.

There is another rule called "Gloger's rule" that states that within a species of endotherms, more pigmented forms tend to be found in regions closer to the equator.

I'm sure you can see where all of this biology is headed. All I'm saying is that that if you're walking past the science labs and you hear a girl in a lab coat tell her mate that she "went on a date with a gentleman of equatorial ancestry conforming to Gloger's rule" and subsequently "discovered he was a classic illustration of Allen's rule", you should get what those crazy science chicks are on about.

A New Visa Scheme

Here's a thought.

Bernard Salt, the ubiquitous demographer, recently wrote this article in which he highlight that there's a 'shortage' of men in Australia. The issue is particularly worrisome for those women born in the 70s.

As an example, Salt notes that for the 169,000 women in Australia born in 1971 there are only 156,000 men in Australia born in 1969 (noting that a two year age gap is the norm for couples). This means we are short 13,000 men for that year alone - and that's before we factor in the higher incidences of homosexuality among men, or the fact that many of those men may be cloistered away digging dirt out of some Western Australian hole.

Now, as we all know from the well-worn generalisations dragged through the media, those 13,000 women are all sitting at home with their cats eating ice cream direct from the tub and lamenting that they can't "get a man". They all want to get married and have babies and for many of them time is running out.

Urgent action is required. If we don't get these women married there is likely to be catastrophic social consequences, probably in the form of a feline-borne plague.

So, here's what I propose. We should start up a visa system that will allow men (and men only) to enter into the country - but only on the proviso that a woman in her 30s wants to marry them. If they get divorced at any point in the first five years of the relationship, they will automatically be deported.

This departs markedly from the current visa system - mainly because there are no work or educational requirements and the couple don't have to know each other before the man arrives.

The details could be worked out, but the idea is that the man has to pay his own way to get here. The visa may grant a stay of three months, but during that time the man has to either be in a committed relationship with long term prospects, or have secured at least five dates per week with single women in the target age bracket. Failure to meet the requirements means deportation.

"But what if," I hear you ask "these women are not in relationships because they haven't made relationships a priority in their lives? Or what if some if them are unattractive, or emotionally manipulative or if they're not very nice people?"

All of these points are moot. Sure, the law would be stupid and is that blatantly exploitative of the men involved, but these women have needs and we as a society have to acknowledge that whether we like it or not, these needs have to be met. Besides, immigration is the "world's oldest travel".

If this post sounds logically flawed, inconsistent with our existing legal framework and blatantly sexist, please note it's just a reframing of the stupid arguments used to justify legalising prostitution.

Long White Cloud

Plastic Lines has been silent for the last couple of weeks. Last week it was because the one contributing author was living it up in the NZ snow. Prior to that it was all about meeting the deadlines that had been brought forward a week. I am assuring myself that I will try harder, because I like writing in my blog more than I like deadlines.

New Zealand is awesome. Having been raised in WA, I have a strong aversion to the cold. To my mind, cold weather is completely inexcusable unless accompanied by hills with snow on them. The South Island of New Zealand may be moderately colder than Victoria, but with snow fields in abundance, it's justified.

We stayed in a pretty crappy hostel for most of the trip, which was populated by snow-bogans in their early 20s. We overheard a whole lot of conversations because we were separated from our neighbours by locked internal door, rather than a (more conventional) wall but I don't think we heard anyone discuss any topic other than the possibility of laid. One night, one of the dodgy heaters blew up in the next unit, which shorted out all our power such that we woke up freezing at 3am and couldn't do anything about it until the next morning. My point is that IT WAS STILL AWESOME.

To top off a week of awesome snow, bruises to prove how tough I am and cheap alcohol, we spent the last night at a wildlife park where I got to pat a dear, an eel and the ugliest pig I've ever seen and let a Kea nibble my finger.

The Kune Kune Pig - awesomely ugly

One of the great sources of entertainment for the week was cruising between the two local TV channels. We were completely astounded by how nice the cops were on their local reality-TV cop show ("I'll hold off processing this fine for not having your rego in order for 24 hours to give you a chance to pay it") and learned about the perils of giving people drivers' licences at 15 (I loved it when they noted that the drunk 16 year old driver asleep in the stolen car on the side of the freeway "already had a suspended licence").

Dodgy TV moment of the week, however, has to go to the racist guy hosting the morning TV program and his bitch co-host. The most cringe-worthy moments included:

- Him complaining about how "Asians just don't integrate" (literally, using that language);
- Him reading out a letter saying that "maybe there wouldn't be so many Maori people in jail if they just stopped committing so many crimes" then staring down the barrel of the camera and saying "couldn't have said it better myself".
- Her interviewing Ms New Zealand and nodding sincerely as they discussed how she didn't get through to the final 15 because the judges were all corrupt and the New Zealand government wouldn't give her enough money to take an entourage to Las Vegas.

It was jaw dropping stuff. Unfortunately it seems like the downside to living in an agrarian paradise is a few insular attitudes.

Equity and Compulsory Voting: a Framework

I live in a safe ALP seat in inner Melbourne, which means that once every three years I am overwhelmed by the sense that nobody loves me and the world is unfair. Sort of. Here’s an attempt to qualify my sense of disenfranchisement:

The Framework:

Assume for a moment that wealth has a certain ‘natural’ utility. That is to say, assume that we live in a ‘perfect’ free market economy, where you get to keep everything you earn (ie, there are no taxes) and the market includes perfectly fair pricing for all goods and services (ie, perfect competition). We assume that the only value of wealth in this economy is the goods and services that wealth it can be used to purchase. In the first instance, we assume there is no inherent social or political advantage conferred to those who are wealthy that could act to increase their utility. The utility of wealth is only influenced by consumption. In this respect, we can say that the advantage of wealth is “politically neutral”, that is, in case (1):

Actual utility = politically neutral utility

Assume that there are three levels* of wealth within this society, called A B and C, where A has the least wealth and C has the most. The utility associated with each level is standardised; that is, the score reflects what portion of politically neutral utility A, B and C can each capture. In case (1) we assume that everyone has a utility score of 1. Graphically, this looks like this:
Now we can start to overlay political assumptions. We will assume that political power has no potential to create or destroy wealth, only power to redistribute it.

Assume that under the current system, everyone at level A cannot afford to eat, everyone at level B eats and owns a car and everyone at level C eats, owns a car and a big yacht. Most poeple would share the view that we can make this system ‘fairer’ by redistributing some of the utility of the Cs to the As. This forms Case (2): fair redistribution.
Note that this does not mean A has more actual wealth that C, just that A has more actual wealth than they would in the "politically neutral" world, and C has less.

The extent to which you think redistribution (ie, tax) should take place is likely to depend on your political persuasion. Some people would argue that C should own a small yacht instead of a big one in order to give A enough money to eat. Others may argue that C should give up the yacht altogether and give A enough money so that everyone has enough actual wealth to own a car. However, the principle that some level of redistribution is "fair" is broadly accepted.

I would argue that case (2) effectively represents what governments want to achieve; though their precise starting point, methods and the extent of the redistribution may vary.

The Equity:

So, what’s the beef with compulsory voting?

The problem is that of the 150 seats in Australia’s lower house of parliament, only 20-25% are really in for a contest. These are the “marginal” seats – generally defined as those that would require a swing of less than 6% of the vote to change the sitting member

Marginal electorate politics wouldn’t be such a problem if the group of 20-25% marginal seats were randomly distributed. The problem is that they’re not. Marginal seats form a biased cross-section of the population. A quick look at the current map of national electoral zones (http://www.aec.gov.au/profiles/maps/national/aec-boundary-map-june-2010.pdf) shows that the vast majority of marginal seats are in the outer suburbs of major cities – basically, the people deciding the outcome of the election all sit within level B in our model.

Marginal seat politics means that there’s an incentive for politicians to stray from a political model of “fair redistribution”. The result is that in order to get elected you need to pork‑barrel marginal electorates. Under the assumption that political decisions don’t create wealth, just redistribute it, this means a political subsidy for level B at the expense of A and C. Perhaps due to the fact that the political class and their supporters typically come from level C, the bulk of the burden will usually fall on level A. Hence, we have case (3): the pork-barrel:

Based on our model, we're saying level A can go without food so level B can keep there car and afford to pay for the occasional rental of a big yacht.

This is an issue that’s intrinsically caught up with having a compulsory voting system. If voting was optional, politicians would have to campaign in all seats or face the risk of voters (like me) becoming so disenfranchised that they don’t bother showing up to vote.

PS – the PLNC is dead. My brain couldn’t cope with any more Murdoch papers and I figured I would invariably descend into election dross, anyway.

*I avoid using the word “class” because, as Australians, it makes us uncomfortable. I can only assume this comes from a national tendency to associate social classes with classes of wool, where being of a higher class is necessarily better. This is distinctly opposed to the British understanding, where being middle class is normalised and anything else has the connotation that you come from a dysfunctional family and you don’t work for a living.