TheChek News Flow

Energy groups must learn to live with $50 crude or risk extinction

he big international oil companies are among the most enduring institutions of western capitalism. Royal Dutch Shell grew out of a trading business set up in 1833. ExxonMobil and Chevron have their roots in Standard Oil, incorporated in 1870. BP’s ancestor company was founded in 1909.

Threats have come and gone, and Big Oil has kept its central role in the world economy. Now, however, they are facing what is arguably the greatest challenge in their history.

The real danger is not the collapse in oil prices over the past couple of years — that is just a symptom of the upheavals in global energy markets that are putting the international oil companies’ business model at risk. If they are to last another hundred years, they will need a fundamental rethink of their operations and their strategy.

Throughout their history, big oil companies thrived because of two competitive advantages. They supplied the fuels that dominated transport, and they had superior access to the crude oil used to make those fuels. Today, both are at risk.

On the supply side, large companies are no longer in privileged positions as producers of crude oil. The US shale boom was led by small and midsized businesses that learned faster and were more agile than their larger rivals. Their shale reserves are highly competitive against the mega-projects that are the big oil companies’ forte, such as developments in deep water or in Canada’s oil sands.

On the demand side, the pledges made by governments at the Paris climate talks to curb carbon dioxide emissions will impede the growth of fossil fuels, including oil.

Advances in battery technology mean that by the mid-2020s electric vehicles could have a noticeable impact on oil demand. The comforting assumption in oil company boardrooms that economic development will inevitably mean steadily rising use of their products could be misplaced.

It is quite possible that at some point crude prices will rise back above $100 per barrel. The world’s reliance on supplies from the Middle East means that disruption caused by conflict is always a risk. But a strategy that works only in that event is a road to ruin.

Large oil companies have been working hard to live in a world of $50 crude, cutting thousands of jobs, and slashing their investment budgets. It is still an open question, though, whether they will be able to fund the new projects they need to keep themselves from gradually withering away.

One answer is to seize the opportunity in climate policy. Big oil companies are as much gas companies, and there is still enormous potential for cutting carbon dioxide emissions by shifting power generation from coal to gas.

Another escape route could be investing more in renewable energy, although the record of diversification by oil companies is generally dire.

The other answer could be for big oil companies to become larger shale producers themselves, taking advantage of the crippling burden of debt that encumbers their smaller US rivals. Already Exxon and Chevron are the most active drillers in the Permian basin of west Texas.

Here too, though, the record of large slow-moving multinationals trying to compete with agile, focused independents has been mostly unimpressive.

Big Oil has proved adaptable in the past, surviving challenges such as the break-up of Standard Oil in 1911 and the wave of nationalisations by Opec members in the 1970s. Investors need to be convinced that the present generation of executives is facing up to the even greater test they face today.

Centralway looks to take on UK banks with app for all accounts

A fintech start-up backed by hedge fund mogul Alan Howard is to target UK banks’ hold on mobile banking with an app that allows users to view all their accounts in one portal and apply for loans.

Centralway Numbrs, a two-year-old Swiss company, is already being used to manage more than 1m German bank accounts, according to Severin Ruegger, its chief financial officer.

Mr Ruegger said the company, which has 100 staff, will expand into the UK in the middle of this year. It has applied for a UK licence that would allow it to offer loans and other financial products via the app from a range of banks and providers.

Banks have spent years developing their own apps. Aggregation — allowing multiple accounts to be managed together — is seen as the next frontier. Some banks are also working on aggregation apps.

“It’s about first-mover advantage,” said a person at one large lender, adding that banks have a head start because they have well-known brands.

Raman Bhatia, HSBC’s head of digital, said: “Helping customers take control of their finances is important in helping them manage their money and enabling them to see multiple bank accounts in one place is a good move, but making sure customer data is secure and fully protected is paramount.”

Centralway Numbrs has some heavy-hitting investors. As well as Mr Howard, its 33 backers include Marcel Ospel, former chief executive of UBS, Sir Ronald Cohen, co-founder of Apax Partners, Swiss private bank Lombard Odier and the Mirabaud family, which controls the private bank that bears its name.

The investors have put SFr70m into Centralway Numbrs, though it has yet to earn any revenue as the app will only make money once it begins selling products for banks.

Mr Ruegger said Centralway wanted to sign up a critical mass of users before approaching banks but was in discussions with Postbank, a subsidiary of Deutsche Bank, and a deal is expected by mid-2016.

Postbank declined to comment on Centralway but said it was “involved in a permanent exchange with several providers/suppliers to expand our leading market position with the help of innovative solutions”.

Centralway Numbrs would receive a 25-30 per cent cut of the revenue generated by sales from its portal. Mr Ruegger said on “conservative” estimates, it should be making a “comfortable” profit by 2017.

He said the app would offer clients “tailored products that really do suit their needs” based on account activity. “Banks have a shotgun kind of approach to shoot whatever products they have to their clients,” he said. “We will be a fair, transparent middleman ensuring retail clients are put first.”

UK banks did not want to comment on Centralway Numbrs specifically. Lloyds Banking Group said it welcomed new competitors and was investing £1bn in its own digital capabilities.

As well as the UK, Centralway Numbrs is planning to enter two other European markets this year but declined to give details. The app will also try to add credit cards such as American Express.

Britain’s fund managers have begun talks with the Financial Conduct Authority over better disclosure of their charges and transaction costs, just five months after angrily ousting the head of the trade body who pushed for such a move.

The Investment Association, which jettisoned Daniel Godfrey for his “narrow and aggressive” reform agenda, said it would develop a common framework with regulators and insurers to “ensure customers get a consistent and meaningful set of information” about the costs of investing.

Currently, pension fund charges are subject to both UK and EU regulatory requirements, but millions of pension investors do have not a clear idea of what their costs are.

“What we want from an industry perspective is to proactively join the UK and EU regulatory requirements together as far as we can,” said Jonathan Lipkin, director of policy at the IA.

”We can see a way to build an underlying system, a common template, that will provide data tailored in a way that is suitable to both retail and institutional investors.”

Mr Lipkin said the IA wants to launch a consultation on its draft disclosure code for pension fund charges towards the end of this year.

“We are seeking people’s views,” he added. “It is not a question of our industry building and designing without consulting those who are going to use it.”

The development comes five months after Mr Godfrey, former chief executive of the IA, was ousted after pushing for greater transparency on fees and charges borne by investors.

“This is a project that I initiated back in 2014 when it became clear that I wasn’t going to get my way in forcing disclosure of the split between research and execution costs bundled into dealing commissions,” said Mr Godfrey.

“The objective (now) should be complete accountability for every penny spent and for the friction incurred by spreads as a consequence of portfolio turnover.”

The move comes ahead of the publication of a study this week which concluded that fund managers could move faster to bring hidden pension charges into view.

The study, commissioned by the Financial Services Consumer Panel, an independent advisory body to the FCA, found there was little justification for fund mangers in not handing over charge information.

“There is information that is readily available to fund managers now that could be reported to pension scheme managers,” said Teresa Fritz, a member of the FSCP.

“Pension trustees and independent governance committees need this information to meet their duty to assess value for money for members.”

Ms Fritz said the research had shown that a standard format for data collection of pension charges could be “implemented quite quickly”.

”This is about getting fund mangers to surface all of the available costs in a format that would let trustees have a better grasp of what they are paying for,” said Ms Fritz. “If the format was mandatory, it would be something that trustees could rely on.” The FCA declined to comment.

Saudi Arabia has drawn up a new strategy to convince US companies to invest in the kingdom, as it struggles to deal with the impact of sharply lower oil prices.

Officials have been contacting a host of US corporations as Riyadh looks to increase foreign investment in its stuttering economy and boost employment, according to people familiar with the matter.

“The point is to attract inflows of cash and create jobs, which is why there is a focus on retail and healthcare, which are both labour intensive sectors,” said one Saudi banker briefed on the plans.

Mohammed bin Salman Al Saud, Saudi’s deputy crown prince, met a number of American chief executives when he and his father, King Salman, visited the US in September. Saudi officials have also been in contact with leading private equity firms to ask whether Riyadh can do business with their portfolio companies, one financier said.

The investment push is part of Saudi Arabia’s drive to lessen reliance on oil prices, which have fallen from about $115 a barrel in the summer of 2014 to $36.

One official leading the drive, Khalid Al Falih, health minister and chairman of Saudi Aramco, the state-owned oil company, last month said the economy had grown at an “incredible pace” of 5 per cent per annum over the past half-century, adding that he had every “reason to believe the next 50 years is going to exceed that rate”.

He insisted growth in technology, healthcare, tourism and transport would turn “challenges into opportunity” as the kingdom shifted from commodities exports to manufacturing.

At a high profile conference in Riyadh last month, ministers expanded on their plans for more privatisations and foreign investment opportunities in an economy that is heavily state reliant. The government is also set to extend public-private partnerships to build infrastructure while keeping spending off its own balance sheet.

The education ministry wants to increase private school capacity to 25 per cent of school places from the current 14 per cent, while the health ministry is halting new facilities to allow the private sector to deliver and operate hospitals and clinics

The potential that Saudi Aramco could float some of its holding company — or, more likely, bundling downstream assets together for a listing — has also sparked intense interest.

But some foreign investors and local bankers are also concerned that the pace of change will move too fast for the kingdom’s bureaucracy.

The government, led on economic affairs by Mohammed bin Salman, has pushed through a significant reform of energy subsidies that raised the price of petrol, electricity and industrial feedstocks.

But one veteran banker said: “My concern is that there is so much on the agenda, and there are so many discussions, that not much output is going to result from it all.”

Mohammed bin Salman’s powerful economic committee is working alongside the Saudi Arabian General Investment Authority (Sagia), the promotion and licensing body for foreign investment, to boost domestic competitiveness and channel investment.

“We are figuring out ways to attract global companies to invest over the long term,” Prince Saud bin Khalid Al Saud, Sagia’s deputy governor, said last month. “The type of investment we are targeting are those that add value to country.”

But Sagia has a reputation for overly officious regulation, say investors and western officials, particularly for small businesses. Bankers and investors looking at opportunities in other areas, such as King Abdullah Economic City, have also had to content with excessive bureaucracy.

“Sagia has become a bureaucratic organisation, rather than being there to help the cause of foreign investors,” said one investor. “We pay them and count on their assistance, but their services are not commensurate with the charges.”

Prince Saud countered that Sagia has had to crackdown on some investors misusing their licenses to carry out retail operations.

Macro :

- U.S.’s Lew Agrees on Debt Relief for Greece ‘In Timely Manner’

- G-20 Strengthens Words on Competitive Devaluations: Dijsselbloem

- Brazil Convinced China to Avoid Competitive Devaluation: Barbosa

- Weidmann Says ECB Should ‘Look Through’ Energy-Price Slump

- U.S.’s Lew Says China Committed Not to Devalue to Boost Exports

- Moscovici says China Policymakers Were Reassuring at G-20

- ECB’s Villeroy Says Deflation, Not Inflation Is Main Risk: FAS

Keep an eye on :

- A2A IM : A2A Working to Conclude LGH Transaction: CEO Tells Il Sole

- AAL LN : Anglo American Hires Banks to Sell Brazil Nickel Mines: Times

- AZN LN : AstraZeneca May Clash With Investors Over Bonus Plans: Telegraph

- BIFF LN : Chinese Buyer Eyeing U.K. Waste Disposal Firm Biffa: S. Times

- BBRY US : WhatsApp to Stop BlackBerry, Older OS Support by End-2016 (Fri.)

- EN FP : Martin Bouygues to Nominate Son, Nephew to Bouygues Board: JDD

- BING GY : Boehringer Ingelheim, Abbvie Said in Cancer Partnership Talks

- BMW GY : Germany Shouldn’t Subsidize Electric Cars, Kauder Tells Focus

- DAI GY : EPA Contacts Daimler Over U.S. Diesel-Emission Suit: Handelsbatt, Daimler Says It’s Cooperating With Authorities

- EDF FP : France’s Royal Says She’s Ready to Extend Life of Nuclear Plants

- EDF FP : EDF Approval for Hinkley Point Could Be Delayed a Year: FT

- FERR IM : Ferrero to Reorganize Italian Business Structure, Sole Says

- FCA IM : FCA’s Altavilla Says European Car Mkt May Rise 3%: Corriere

- FRA GY : Fraport Ebitda May Exceed EU1 Billion, CFO Zieschang Tells BZ

- GSK LN : Glaxo Hires Headhunter to Find Replacement for CEO Witty: Times

- LSCC US : Lattice Semiconductor Mulls Sale Amid Chinese Interest: Reuters

- M5z GY : Shanghai Electric to Buy Up to 92.9m Euros Stake in Manz AG

- NG/ LN : Global Infrastructure May Bid for U.K. Gas Network: Telegraph

- NESN VX : Nespresso App Machine to Go on Sale in Switzerland: Blick

- SAN FP : Sanofi Open to Deals ‘Up to Size of Genzyme,’ Meeker Tells FT

- SUN SW : Renova Rejects NZZ Report of Possible Sulzer Sale, Merger

- SUN SW : Sulzer CEO Says W. Europe to Be Affected by Savings Program: SZ

- SYNN VX : ChemChina Said to Seek $30b Loan for Syngenta Deal: WSJ

- UNA NA : Unilever CEO Expects Europe Business to Stay Difficult: NZZamS

- UTX US : UTX Adds Goldman Sachs as Adviser Against Honeywell Bid: CNBC

- VOW3 GY : VW’s Seat Can Be Profitable: Unit Chairman De Meo to Expansion

- WEIR LN : Weir Group shares gain on talk of possible interest from Flowserve 

- YOOX IM : Yoox Net-A-Porter Seeks to Boost Mobile Internet Sales: Il Sole

Share Buybacks: The Bill Is Coming Due

U.S. companies borrowed heavily in recent years, but often bought back stock rather than investing in their business

Low rates alone aren’t enough to make it easy to pay off a loan. Many companies may find that out the hard way, especially as high-yield debt markets show signs of strain lately.

U.S. companies went on a borrowing binge in recent years. Nonfinancial corporations owed $8 trillion in debt in last year’s third quarter, according to the Federal Reserve, up from $6.6 trillion three years earlier. As a share of gross value added—a proxy for companies’ combined output—corporate debt is approaching levels hit in the financial crisis’s aftermath.

Most of the debt increase came from bond issuance, as nonfinancial companies took advantage of the lowest rates on corporate bonds since the mid-1960s. That is a plus as companies in many cases extended the maturity of their debt and lowered borrowing costs.

The negative: Rather than investing the funds they raised back into their businesses, companies in many cases bought back stock instead. That was something that many investors welcomed, but it may have come with future costs that they didn’t fully appreciate.

In aggregate, nonfinancial companies’ cash flows over the past three years were enough to cover capital spending. That is unusual—typically, capital spending outstrips cash flows as companies invest for growth—and is reflective of how muted business investment has been since the financial crisis. Over the same period, the companies repurchased $1.3 trillion in shares.

Because those stock buybacks helped reduce companies’ total shares outstanding, earnings per share got a boost. Indeed, absent the past three years’ share-count reductions, S&P 500 earnings per share would have been 2% lower in the fourth quarter than what companies are reporting, according to S&P Dow Jones Indices.

The major reason companies plowed money into buybacks rather than capital spending was that, in a low-growth environment, the returns from investing in expansion didn’t seem as attractive as in the past. This is a big part of why companies were able to borrow cheaply: In a low-growth, low-inflation environment, investors were willing to accept lower returns on corporate bonds than if the economy was moving at a more rapid clip.

The sticking point is that in a low-growth environment, paying down debt also may be harder. Especially because companies weren’t putting the money they borrowed into capital investments, which provide cash flows to help service debt. The stock they bought back won’t do that for them.

Even if this doesn’t present an immediate problem for all companies given how they refinanced debt to longer maturities, it could be a long-term drag on earnings.

Of course, if necessary, companies could issue new equity to help meet debt payments. But existing investors would get diluted.

In many cases, companies have large cash reserves they could tap. This, too, has drawbacks. One is that, in cases where the cash is overseas, it might be subject to taxation before it could be used. Another is that companies’ cash holdings are reflected in their shares. If their cash is diminished, so is their share price.

Investors who cheered as companies bought stock with borrowed money could end up blanching when they see the bill.

By suggesting the richest 400 Americans have seen their effective tax rate drop by one-third and thus they should back a 30% minimum tax rate, Mr. Buffett is deflecting attention toward rates and away from itemized deduction and tax-avoidance regulations.

It is interesting to see Warren Buffett using selective data to steer the Hillary Clinton tax plan away from tax reform that would truly unhinge the superwealthy (“Clinton Tax Plan Backed by Buffett,” U.S. News, Dec. 17). By suggesting the richest 400 Americans have seen their effective tax rate drop by one-third and thus they should back a 30% minimum tax rate, Mr. Buffett is deflecting attention toward rates and away from itemized deduction and tax-avoidance regulations.

What Mr. Buffet doesn’t highlight is that for 2013 the millionaire club claimed tax deductions totaling $145 billion. Mrs. Clinton might be credible as a tax reformer if she proposed the elimination of itemized deductions for the millionaire club. She’d really be on the forefront if her plan eliminated Section 664 of the Revenue Code (Charitable Remainder Trusts), which allows Mr. Buffett and other millionaires who have highly appreciated stock to avoid paying tax on the gain while reducing their estate-tax liability. As Mrs. Clinton is also a member of the millionaires club, you can be sure that any tax plan she proposes will have minimal impact on her own fortune.

Ron Dudley

Sanibel, Fla.

Of course Warren Buffett is in favor of progressively higher taxes on the rich. Our progressive tax system guarantees the rich will get richer by stripping essential cash from people attempting to become rich and rewarding the already rich. If you make $10 million and pay a 50% tax, you still take home $5 million.

If two guys start a business and make $400,000, they have to pay a $100,000 tax, in cash. Because the startup’s cash is invested in inventory, receivables, payroll, assets, etc., the not-yet-rich have to borrow cash from the bank to pay taxes, further limiting their ability to grow.

Then the banks require the owners to grow retained earnings to support the loans, further limiting the enjoyment of their efforts. The solution for most of these companies is to sell to someone with deep pockets. In this example, if the two startup guys are bought for a typical five times earnings by a company that is valued at 15 times earnings, the startup gets $2 million for the company, which the owners split, pay the tax and net $600,000 each. The rich guy turns this into $6 million of market value and owes no tax.

The solution is a broad-based, first dollar proportionate (flat) tax and the elimination of all tax on the mere generation of income.