The sustainable side of oil

“Having large reserves of oil and gas presents an economy with considerable opportunities over the short- and long-term”, read a government-sponsored proposal for a Scottish oil fund. This was a statement that came in the lead-up to last year’s in/out referendum and one that saw the Scottish Government roll out plans to establish two oil funds and make good on any surplus tax receipts derived from North Sea oil and gas.

The first of the two funds would offset any sudden price swings and stabilise what could otherwise prove a potentially volatile revenue stream, according to the Fiscal Commission Working Group. This stabilisation fund, “into which higher than forecast oil and gas revenues are deposited, would minimise North Sea revenue volatility from changes in oil prices”, according to the Scottish Government Finance Secretary John Swinney.

The second, however, is more akin to a long-term savings fund, and would come into play only when borrowing is slow or debt high. Whether investment in the fund would come when the country ran a net fiscal surplus, a current budget surplus, or instead as a fixed proportion of North Sea revenues, the model offers a lifeline for when times turn sour.

With such widespread corruption tied to it, populations often see oil as the enemy where the resource is in
plentiful supply

The oil fund idea, though novel, is not new, and proponents of the Scottish scheme cited the success of Norway’s own Government Pension Fund Global in selling the idea to the public that North Sea oil exploits – or any fossil fuel for that matter – could bring sustainable growth.

Resource curse
Too often, the rewards tied to the exploitation of oil escape the everyman and leave countless individuals with little-to-no understanding of how the proceeds could benefit the country at large. This failure on the part of oil economies to spread the wealth more evenly is perhaps best illustrated by the ‘resource curse’ hypothesis.

Referring to the all-too-common instance whereby a plentiful supply of natural resources can bring corruption, stagnation or even economic contraction for the host nation, oil often poses more problems than it does solutions. “Managing natural resource wealth is fraught with difficulties – some economic, many political – and if not done well, can adversely impact macroeconomic performance in the short and long runs”, according to one IMF report entitled Boom, Bust, or Prosperity? Managing Sub-Saharan Africa’s (SSA) Natural Resource Wealth.

The issue of managing oil-derived revenues is clearly not the simple task many assume it is, and ensuring that the wealth is distributed to those apart from the highest few officials is a rare thing amongst those blessed with an abundance of natural resources. There are numerous examples of countries that boast a plentiful supply of natural resources though likewise rank low down on Transparency International’s Corruption Perceptions Index, having thrown away countless opportunities to boost economic and social development.

With such widespread corruption tied to it, populations often see oil as the enemy where the resource is in plentiful supply. However, Norway and a select few other countries have bucked the trend inasmuch as the governments there have recognised that any proceeds tied to oil, if managed sensibly, can set the economy on the path to sustainable prosperity. “An important factor behind the resource curse is excessive spending of the resource revenues. A sovereign wealth fund that is used to save most of the revenues for future generations, will dampen the risk of excessive spending”, says Steinar Holden, Professor of the Department of Economics at the University of Oslo.

“By putting the resource revenues into a fund, it might be easier to safeguard the money, away from politicians. Hopefully, one can also obtain a fair return on the capital in the fund. However, a fund must be combined with a prudent spending rule. One must avoid too large and/or pro-cyclical spending, for example, avoid that the spending of the resource income increases when the economy is booming.”

Established in 1990 in the hope of turning non-renewable riches into a sustainable financial instrument, the aim of the Government Pension Fund Global was and still is “to have a diversified investment mix that will give the highest possible risk-adjusted return within the guidelines set by the ministry [see Fig. 1].” Put another way, the world’s biggest sovereign wealth fund is essentially a rainy day fund for when times are hard for one of Europe’s strongest economies. Originally called the Petroleum Fund, the oil fund was renamed in 2006 and has succeeded largely in freeing space for fiscal manoeuvring in times of economic contraction, not to mention license to offset any oil price reductions.

At the beginning of last year the fund made each of the country’s five million inhabitants a theoretical millionaire, albeit in krone, when the fund’s market value crossed the five trillion mark – equivalent to over $820bn. At NOK 6,950bn, as of March, the size of the fund is equivalent to over $170,000 for each inhabitant, and lays claim over approximately one percent of all the stocks and bonds in the world.

What’s more, the pace at which the fund has grown means that the government is able to spend more ‘oil cash’ from the fund and shrink tax rates, in order to tackle an economic slowdown. The guideline however, remains that no more than four percent of the surplus is spent on public projects.

Also, in keeping with the government’s distinctly sustainable approach to spending, Chief Executive of the fund Yngve Slyngstad revealed earlier this year that the Government Pension Fund Global had divested from no less than 114 companies over the past three years on the grounds of sustainability. Acting on the recommendations set out in board meetings, the fund is fast making a name for itself as a responsible investor, and underlined this focus in February when it released its first Responsible Investment report. In it, Slyngstad said: “We recognise that there is still much to be done, and that we will encounter a number of challenges in the years ahead. Our role is to think long-term and protect value for future generations.”

David Spegel, an emerging market analyst at BNP Paribas, calculates that oil-based sovereign wealth funds like Denmark’s hold more than $5trn in assets worldwide, and are fast becoming a major force to be reckoned with. The UAE and Kuwait, for example, whose funds are valued at $800bn and $400bn respectively, have created sovereign wealth funds of their own, though the approach does not necessarily guarantee a steady stream of income without a consistency that stretches the political gamut. “There must be a broad agreement that most of the money should be saved, or, for some countries, used on socially efficient public investments”, says Holden.

Fig 1

No guarantees
The Canadian province of Alberta took a step in the right direction in 1976 when it pledged to stash a percentage of oil royalties in its own Heritage Savings Trust Fund. However, a reluctance to pay-out the requisite amount from 1987 onwards whether it be 30 or 15 percent, along with a tendency to dip into the savings severely handicapped the fund’s earning capacity, meaning that its value sits around the $18bn mark in a time when Norway’s own is fast approaching $1trn. Add to that debts of over $10bn and an expected budget deficit of $500m come the end of the year, and the province is proof enough that inconsistent government policy can cripple the best of intentions.

The Alaska Permanent Fund, meanwhile, created in 1976, ensures that “at least 25 percent of all mineral lease rentals, royalties, royalty sales proceeds, federal mineral revenue-sharing payments and bonuses received by the state be placed in a permanent fund, the principal of which may only be used for income-producing investments.” What differentiates the fund from others like it is that a yearly dividend is distributed directly to Alaskan citizens to supplement their earnings.

The same can also be said of Bolivia, which in 1997 set up the Renta Dignidad programme and began distributing revenue derived from oil and gas to those of 60 years and older. Looking at Alaska, the hand out last year came to $1,884 and lifted the total sum paid out over the fund’s lifetime to over $37,000 per Alaskan.

True, the idea is unlikely to catch on in any global sense, it represents a tried and tested means of transforming diminishing oil riches into a sustainable financial asset.

In this sense, both Norway and Alaska share a certain likeness, in that the fund model employed by either nation and many more like them, means that the population can hold the government more accountable for spending decisions. And by demonstrating that a sovereign wealth fund can overturn the resource curse, the pressure will build on oil economies to do the same as they seek a tried and tested means of exorcising the resource curse.

Climate change and its stormy relationship with the insurance sector

Assuming that the findings from last year’s Intergovernmental Panel on Climate Change (IPCC) are accurate, the financial ramifications of rising temperatures could number in the trillions of dollars if the circumstances are allowed to go on unchallenged. “We live in an era of manmade climate change”, said Vicente Barros, Co-Chair of the group responsible for the report. “In many cases, we are not prepared for the climate-related risks that we already face. Investments in better preparation can pay dividends both for the present and for the future.” And in an age when global warming is exasperating extreme weather conditions and inflicting major pains on affected communities, the contribution of the insurance industry should not be underestimated.

In developing countries, where the dangers are most acute, the annual price tag attached to climate change-induced damages could soon tip the $100bn mark, as rising seas lay waste to coastal communities and other such areas without the requisite defences. True, the risks are well documented and the costs of inaction clear, yet under-threat areas and industries – not least insurance – have been slow to stem the losses, for want of a better understanding about where exactly their focus should lie.

False assumptions
Businesses can no longer assume that their day-to-day operations will perform uninterrupted, and the increased risk of climate shocks, described at length in the IPCC report, means that affected parties must make certain concessions or risk collapse. Of the industries exposed to climate change, few can match the seriousness of the situation facing insurance, and the circumstances here have prompted key names to make often-fundamental changes to their strategies and operating models, if only to survive the coming storm.

In developing countries, where the dangers are most acute, the annual price tag attached to climate change-induced damages could soon tip the $100bn mark

“Climate change represents one of the greatest long-term risks of change for the insurance industry”, says Ernst Rauch, Head of Munich Re’s Corporate Climate Centre. “There is uncertainty about the dynamics of these changes and where they will occur. To adapt and manage to these profound changes of the risk landscape, detailed data and deep expert knowledge is key as well as the development and application of risk modelling tools, reflecting changing patterns of weather catastrophes.”

However, although the changes made so far are noticeable, they stop short of the necessary transformation. “While the insurance industry is concerned about climate change, we have noticed that our clients, mainly insurers and reinsurers, have become more concerned about the continued upward trend in losses that largely results from exposure growth”, says Jayanta Guin, Executive Vice President of the risk modelling software and consulting services company AIR Worldwide. “Because most insurance policies are written for a short term (often one year), they are in some sense more concerned about the view of risk in the next few years, and less concerned over climate change that will occur over the next several decades.”

Without first recognising that climate change warrants attention on a global scale, or acknowledging that the industry has an important part to play in informing policy on climate change, insurers will fall flat. True, climate change may have found a way into risk modelling, yet the relationship is worth little if not explicitly stated and acted upon.

Learning by example
Hurricane Katrina, for example, illustrates just how much damage so-called extreme weather events can inflict on the industry, and shines a light on what inaction and oversight can bring. Although almost half of the affected population had no flood insurance, the $25bn in claims for those who did still managed to bankrupt the federal flood insurance programme. The programme, which was born of a desire to bail homeowners out of a crisis and protect taxpayers from shelling out additional funds, failed on both fronts, to the point where the government was forced to cough up an added $15bn to meet the costs. The shortfall still represents only a fraction of the overall costs tied to the catastrophe, and Swiss Re figures show that Hurricane Katrina was responsible for the loss of 1,836 lives and $71bn in insured losses. Statistics cited by the Insurance Information Institute also tell a story of how the hurricane then generated the largest single loss in the industry’s history, with over 1.7 million claims totalling $41.1bn and stretching six states. The takeaway from the disaster, however, is not necessarily that natural disasters can wreak havoc on any given location, but that climate change is something that warrants action if insurers are to survive the not-too-distant future.

“Because the very concept of climate change is that the past will not fully predict the future, the insurance industry has been, and must continue to be flexible to make operational changes as needed”, says Lindene Patton, Global Head of Hazard Product Development for CoreLogic Insurance and Spatial Solutions. “The operational fundamentals remain the same – using underwriting, actuarial science and natural catastrophe modelling. But the marketing, regulatory negotiations and consumer environment interaction must change. To date, those changes remain elusive.”

Though 2005 caught the eye, it was 2011 that really set the world alight, with insured losses relating to natural catastrophes costing upwards of $127bn (see Fig. 1). Unfortunately, the record-breaking year served only to highlight just how slow the industry had been to react to what remains a priority concern. One Ceres report released in 2013 showed that in the year after only 23 of 284 companies surveyed had a strategy for action on climate change. “Every segment of the insurance industry faces climate risks, yet the industry’s response has been highly uneven”, said Mindy Lubber, Ceres President in the report foreword. “The implications of this are profound because the insurance sector is a key driver of the economy. If climate change undermines the future availability of insurance products and risk management services in major markets throughout the US, it threatens the economy and taxpayers as well.”

With temperatures rising, developing and developed countries alike run the risk of increased floods and drought, and World Bank findings show that large coastal cities could face combined annual losses of $1trn by 2050 as a result. True, major names are funnelling more money towards finding creative solutions and defences are much improved on generations passed; yet the threats facing insurance are huge. Whereas weather-related losses averaged at some $50bn annually in the 1980s, the same amount today is close to $200bn. What’s important for the industry today, therefore, is that major names hone their focus on risk modelling and recognise climate change as a priority.

Natural disaster insured losses

Catastrophe modelling
“Given the prevalence of catastrophe models in insurance and the rising cost of extreme weather events, the accuracy of modelled outputs is a key interest for insurers”, according to a recent Lloyd’s report, entitled Catastrophe Modelling and Climate Change. “The potential for climate change to drive changes in the severity and likelihood of extreme weather events could have implications for the accuracy of natural catastrophe models.”

Once a standalone spreadsheet, catastrophe modelling has evolved to the point where it today resembles an all-encompassing risk management approach. Rather than taking a very limited standpoint on the issue of climate change, the strategy looks to big data and scientific analysis for answers, and by opening up these platforms, the industry has been able to more easily share and strengthen data on the subject.

“We believe that, even today, climate change in many regions is already having a definite impact on weather related losses”, says Rauch. “We therefore have to factor these changing loss patterns into pricing models in our industry. Since the influence of climate change increases with time, the insurance industry must recognise, quantify and make allowance for these developments in good time in the form of risk-capital and risk-price adjustments.” And by taking a proactive approach to mapping the financial risks posed by climate change, the industry can more easily understand and so resolve the risks knocking at their doors.

“The framework of catastrophe models lend itself nicely to incorporating and quantifying uncertainties associated with climate change”, says Guin. “Our clients are increasingly being asked by regulators and rating agencies to explain what they are doing to manage climate risk and, in turn, our clients are looking to us to keep them apprised of the current state of the science and to educate the regulators and rating agencies on what the catastrophe models currently capture.”

In fact, the industry’s contribution to climate change mapping has been so great that many have labelled insurance perhaps the most important link in tying together the many facets of a low carbon economy. Broken down into its simplest parts, insurance is a risk management tool, and if the industry can arrive at a working set of solutions for mapping climate change, all businesses in all nations can operate with more assurances about the future.

“The modelling data and analytic solution set is available to address the risk of climate change and is being applied by the industry, but it’s not merely a question of access”, says Patton. “Additional steps are needed to underscore the importance of investing in risk management to the customer base through an appropriate means of addressing the question of ‘who should pay?”

One Acre Fund empowers Africa’s farmers

If the world is really serious about ending poverty in Africa, then it needs to create market-based solutions. Simply increasing aid to the continent year-on-year is not enough. There is an answer, however, and it lies with Africa’s farmers. By supporting them to improve their harvests, they can pull themselves and their communities out of poverty with dignity.

The One Acre Fund, which represents Africa’s largest network of smallholder farmers, helps provide the necessary tools and financing they need to grow their way out of hunger and poverty. World Finance spoke to Eric Pohlman, the organisation’s country director in Rwanda, to learn how he and his team are better serving local farmers, so that they can create long-term solutions for escaping poverty for good.

What motivated you to become a senior partner in the One Acre Fund?
Having lots of opportunities growing up, I felt an obligation to give back. Originally, I thought I would do that through public service in the US, but, by chance, I ended up studying abroad in Senegal and that changed my worldview. Spending a semester at the Cheikh Anta Diop University in Dakar. I saw a lot of opportunity in Africa, there is certainly an entrepreneurial buzz.

Senegal itself has an amazing culture and it captivated my interest. So I shifted my studies at university and started looking at traditional development studies. Eventually I gravitated towards more business-based approaches. After school, I spent two years in the Peace Corps in Cameroon in the Extreme North province and then joined One Acre Fund immediately after that, which was back in 2007, and I have been with the programme since.

One Acre Fund sustainability: Total Farmer Loan Repayments, USD

1.5m

2010

5m

2011

13.7m

2012

14.4m

2013

22.8m

2014

Source: One Acre Fund

What does One Acre Fund do?
Our fundamental goal is to make farmers more prosperous. We serve smallholder farmers in East Africa as they face a number of common problems – mainly basic market failures in the region. Many farmers do not have access to information or training, and often impactful technologies do not reach rural areas. This includes everything from seeds and fertilisers to solar lamps. But even when farmers do know about these products or have received training through public extension, they often do not have the money needed at the start of the season to invest.

So what we do at One Acre Fund is develop a basic market bundle that offers a complete package tailored for the smallholder farmer in East Africa, which aims to address these shortfalls. It all starts with training through a field officer who is based in the community. We then develop a delivery system to get impactful products like seeds and fertiliser out to farmers before planting. We provide these services on credit, so farmers can pay back slowly over six to nine months, which better fits the household revenue flows. And then, finally, we have some post-harvest solutions that help farmers store their harvest at the end of the season.

In order to keep the One Acre Fund supporting farmers, how do you make the business profitable?
In order to serve more farmers, we are really focused on being as efficient as possible. So right now, farmers fund 70 percent of our core programme operations. The other 30 percent is coming from donors and over the years as we scale up, we will benefit from some efficiencies in delivery. We hope to see our subsidy go down over time, with the ultimate goal to be entirely farmer funded. But we are in new markets, we are in riskier places, so it is appropriate as a young start-up we are not financially sustainable at this point.

What are some of One Acre Fund’s greatest achievements so far?
Just a few weeks ago in the programme, we delivered farm inputs to our 100,000th customer, which is a big milestone for the programme here. Right now, we are serving 280,000 customers across East Africa, so it is a big farming population. We have lit over 100,000 households with solar lamps, which is really exciting. Most of our clients that we serve are off grid, so when the sun goes down their homes are dark or lit by kerosene.

Another big accomplishment of the programme is that we have started to demonstrate that farmers have a strong willingness to pay for good services. We’ve lent over $20m, and to date we have a 98 percent repayment rate, which is pretty impressive, considering the context that we are working in. We hope that we can act as an example for other micro-finance institutions and other businesses to start treating farmers not as beneficiaries, but as customers. These are all great accomplishments for the organisation, but really, I think our greatest victories are found in the individual stories of the farmers we serve.

One of our clients is a mother of six and, like many of our clients, she had never used improved farm inputs [seeds and fertiliser] before we started offering services in her village. But in her first harvest using improved farm inputs, she saw a huge increase. She then invested that surplus in buying a new cow. That was three years ago, and today, that cow has given birth to two other cows and upon visiting her recently you can see the pride in her face that she has started to become prosperous and self-sufficient.

People discuss farming options in Rwanda. Many working in agriculture   have become more self-sufficient with improved farm materials
People discuss farming options in Rwanda. Many working in agriculture have become more self-sufficient with improved farm materials

On average, the programme that we offer creates about $120 of new income for farmers per year. That may not sound like a lot of money, but it is often the difference between whether you choose to educate your kids or not; whether you decide to go to the hospital or not; and whether you decide to invest in another productive asset. That really is the difference between subsistence farming and wealth creation. It’s those farmers’ stories where we see our biggest accomplishments.

How does the work at One Acre Fund provide a better solution to the problem of poverty?
I think that a lot of food aid follows a giver-recipient model. This kind of model puts all the power in the giver’s hands and none in the recipients. This model is only appropriate in crisis scenarios, like in the event of a massive natural disaster or huge population displacement caused by a violent conflict in the region.

In those scenarios, the decision is very clear; people need support and they need it fast. It works in the short-term. But the giver-recipient model cannot handle any type of complexity or development or market creation. It is a brain-dead approach. It makes one person the decision-maker and the millions of recipients turn off their agency over themselves, losing their voice in the process.

What we need is market-based solutions, where you basically turn the giver-recipient model on its head. You empower the recipient by turning them into a customer, so they’re the ones making decisions. The giver then becomes an innovator. They have to figure out what works and what doesn’t. Together that combination is powerful. It is where long-term solutions come from.

What is your opinion of farming subsidies?
I can understand a government’s desire to support farmers. Farmers are the most important profession in any given community. They create the food we eat, and food is the single largest determinate of health. Farmers have the ability to grow surplus, and surplus is what originates a market economy. It is what allows, in the initial stages, for a vibrant economy to develop.

On one hand, I get where governments are coming from. Rwanda has a farm subsidy for its farmers and in less than seven years it has helped shift the country from a net food importer to a net food exporter. There is now food security here for the first time. That is an example of an effective farm subsidy. On the other hand, there are a lot of farm subsidies that are not farmer first. If you look at a number of farm subsidies in the US like maize or soy for example, these deflate global prices and put farmers in parts of the world at a competitive disadvantage. They pervert the economy.

Agriculture in African countries

Is there any way to balance the concerns of maligned farmers in both developed and developing nations?
I think that we need to reorient [farm subsidies] in developed countries. In these countries, one percent of the population work as farmers, so a subsidy that artificially deflates the price of food is probably good for the economy. But we live in a globalised world and that artificial cost to produce maize or soy for example, negatively impacts most of the African continent, where 90 percent of the population is engaged in farming.

How do we balance that? Well, I think it is unlikely that farm subsidies, given their political history, will change. But I do think that reorienting subsidies in developed countries, so that we re-incentivise farmers to plant a more diverse crop base and to serve local and regional communities’ food needs would build a much stronger society, as well as having the secondary benefit of making communities in developed countries healthier.

What other challenges need to be confronted in order to reduce poverty in Africa?
One, we need a lot more investment in the region. I would focus first on agriculture (see Fig. 1), because I believe it is the foundation for any vibrant economy. I read recently that 33 percent of Africans expect within the next one or two years to start their own business. There is a lot of entrepreneurial drive there. If we can match that with appropriate investment, then I think we will start to see many more innovative market-based solutions.

We also need good governance and better infrastructure. Those help to create the environment necessary for a vibrant economy. It is hard for that to happen without both of those. There are a number of bright spots across the continent where things are working. Rwanda is one of the best case studies, where good governance and really smart investments in infrastructure have made it one of the fastest growing corners of the world right now.

What are some of the more common misconceptions about poverty that are most harmful?
I think the biggest is that farmers are not capable or unwilling to pay for services and products that are going to make their lives better. That misconception perpetuates the giver-recipient model. It makes micro-finance institutions scared to work in rural areas or increase their agriculture-lending portfolio. Micro-finance has largely focused on urban areas where they have higher population densities. You see very few banks out in rural areas where it is more expensive to serve customers.

So I think that misconception is pretty harmful and we have a lot of evidence to the contrary. In the past eight years, we have seen over a 98 percent repayment rate, with hundreds of thousands of farmers. The difference is, farmers are willing to pay for stuff that works, so it is on the plate of every company or social enterprise to figure out what works for their customers and provide services they want to buy.

What does the future have in store for you and the farmers that you serve?
I intend to serve farmers well into the future. Rwanda is my home. It is one of the most exciting places in the world right now, so I want to keep doing what I am doing. For One Acre Fund, as a whole, we are going to keep growing our impact and keep innovating new ways to better serve farmers. And for the farmers we serve, their future will hopefully be full of big harvests, healthy children, and educated families. These farmers are the keystones to building prosperous communities across Africa.

China-Russia relationship intensifies

On May 8, Russia and China signed various new deals for finance, trade, transportation and energy, with the purpose of strengthening their economic partnership. A cooperation decree has also been signed to bring the recently-formed Eurasian Economic Union into the fold.

“The integration of the Eurasian Economic Union and ‘Silk Road projects’ means reaching a new level of partnership and actually implies a common economic space on the continent,” Russian president Vladimir Putin is reported as saying after a meeting with Chinese Premier Xi Jinping.

China has pledged to invest $5.8bn into the project, which is estimated to cost over $20bn

One of the schemes agreed for collaboration is the 800km long Moscow-Kazan High Speed Railway that will connect the two countries though Kazakhstan. According to The Moscow Times, a top speed of 400km per hour can be reached on the new line, which will cut the current 14-hour journey time by over 10 hours. China has pledged to invest $5.8bn into the project, which is estimated to cost over $20bn.

An energy contract was also signed between the largest gas suppliers of the two nations – China National Petroleum Corporation and Gazprom. The state-owned companies have agreed upon the provision of 30bcm of gas to China per annum, via what is known as the Western route – the Altai. Once the project is complete, China will become Russia’s biggest customer for gas, considerably outstripping the 40bcm it currently supplies to Germany each year.

Since its annexation of Crimea in 2014, Russia has actively sought closer political and trade relations in Asia, as well as with neighbouring states. Similarly, China is also making moves to consolidate its influence in the region, including the formation of a closer alliance with Pakistan and laying the foundations for the Asian Infrastructure Investment Bank – the region’s first development bank that is independent from the World Bank and IMF – explicitly, the first of its kind that is free from Western control. With both powerful states now moulding a landscape in the East that is economically integrated and autonomous from the West, it would seem that the international arena soon faces a rebalance of power that is gradually tipping away from the current status quo.

Thaioil: how to navigate plunging oil prices

Back in May 2014 Brent crude was being sold for around $110 per barrel, but that soon changed, with the price sitting at nearly half its previous value at just $56 per barrel, as of March 2015. A number of factors played a part in the commodity’s decline: one is a reduction in global demand spurred by Europe and China. Another is the US’ energy independence, something made possible through the controversial process of fracking, which permits the extraction of large shale oil and gas reserves deposited deep underground. Finally, there has been a distinct lack of noise coming from the world’s largest oil cartel, OPEC. Many thought that it, or one of the states that comprises it, would have stepped in and cut back on supply in order to push up the price of oil. But nothing happened. Instead, OPEC seems happy to engage in a price war with US shale oil producers.

This is all great news for net importers of the commodity; as consumers in those countries can enjoy a reprieve when they go to fill up their cars at the pump. The opposite is true for net exporters like Russia, whose economy relies heavily on its energy exports, and now, combined with the economic sanctions imposed on it by the US and EU, sees its economy teetering on the brink of collapse. But managing oil’s fall from on high has been a bit of a mixed bag for some. Thailand still relies heavily on imports in order to sustain its rising fuel demand (see Fig. 1), and, therefore, the plummeting price of oil is seen as a bit of a double-edged sword.

30%

Fall in the number of US oil rigs since peak level in October 2014

Price plunge
As a result of oil prices plunging by over 50 percent since mid-2014 amid unprecedented supply from both non-OPEC and OPEC producers, domestic refinery Thaioil, a company recognised globally as having one of the best track records for sustainability, has seen its business affected in two major ways.

First of all, its gross refinery margin (GRM) has become much healthier compared with previous years, which enhances Thaioil’s competitiveness against imported petroleum products. The underlying rationale being, that the dramatic drop in the outright price of Dubai crude has boosted its GRM, which serves as the key input or cost of production of the refined petroleum products. In fact, the cost of crude oil accounts for 70 percent of the total cost of oil production.

“As a result, the cost of production is becoming much lower for the business and subsequently enhances refining profitability”, says Atikom Terbsiri, CEO and President of Thaioil. “Additionally, refinery margins had also been bolstered by the fact that the petroleum product spreads had not fallen as rapidly as crude prices. Nevertheless, there is also a downside effect to Thaioil’s profitability in terms of the stock loss of crude reserves.”

This is due to the fact that it is legally mandatory for refinery businesses in Thailand to reserve crude inventory as a tool to enhance energy security for the nation. The current proportion of legal reserves is six percent. If the event arises that will impact oil supply such as unrests in oil producing countries or obstacles of transporting oil to Thailand; the reserves ensure that the country will still have some tucked away, which can be exploited for approximately 43 days.

“It is, therefore, inevitable to confront such a stock loss as we had to initially reserve the crude oil at high prices last year”, says Terbsiri. “But despite this, we are certain that Thaioil’s profitability can be partly cushioned by the remarkable GRM. Not to mention the fact that low oil prices stimulate domestic demand by elevating consumers’ purchasing power, so even in the middle of such difficulties there lies opportunity. The company also has the added benefit of over THB 40bn [$1.22bn] to cushion the business amid any sudden crisis.”

Crude surplus
The surplus of crude oil worldwide – around nearly two million barrels – persistently pressures oil prices. The IEA recently published its medium-term outlook for the oil market by forecasting that the US will remain the main contributor of non-OPEC supply growth up until 2020. The IMF has also revised its GDP growth forecast for January 2015 to just 3.5 percent (down from its earlier figure of 3.8 percent). On the back of such bearish forecasts, the price of oil is unlikely to soar above $100 per barrel any time soon.

There is, however, a notable harbinger that low oil prices start to adversely affect the oil drilling and investment plans. Major international oil companies (BP, Chevron, Conoco Phillips, Royal Dutch Shell, Apache and Total) have begun scaling back investment by reducing capex on oil production projects. As a result, US oilrig counts have fallen by over 30 percent, compared with the peak level in October 2014 (1,019 rigs as of 20 Feb 2015). However, the impact is lagged since it takes some time for the decline to register and have an impact on actual oil production.

Oil trade balance in Asia

“With the expectations of continual deceleration of non-OPEC production growth, we may be able to see the slight recovery of oil prices in the second half of 2015”, says Terbsiri. But despite his optimism he admits that there are real challenges ahead – the main being oil’s price volatility. “Even though there is an initial rise of oil prices in 2015, along with global markets on optimism over eurozone crisis, prices continue to be volatile and could soften due to the worry of crude markets oversupplied, especially in the US, where inventories are at record highs”, says Terbsiri. “Even though Thaioil Group has strong net cash margin, due to strong gross integrated margin (GIM) from our integrated refinery, aromatics and lube base oil configuration together with relatively low cash operating cost, there are a number of new large and complex refining capacities that would be pressure GIM in the coming years.”

The real challenge for oil producers, however, is the constant advancement of technology. While the breakthrough in shale gas and oil production processes may have a positive impact in term of crude availability, and create a higher oil demand from oil prices remaining low, advancement in alternative and renewable energy such as solar and liquid hydrogen may lead to a downward trend of petroleum demand for transportation, especially gasoline. In addition, alternative and renewable energy promotion from governments around the world may cause structural change in future domestic petroleum products demand.

To mitigate the effects of the markets volatility and overcome the challenges it faces from alternative energy sources, Thaioil has chosen to embark on a strategy of organic growth, with projects to improve efficiency. Such projects include the Emission Improvement Project, HVU-2 revamp and CDU-3 energy efficiency improvement. The company is also planning to strengthen its value chain integration through Sriracha terminal, LAB project (LAB stands for Linear Alkyl Benzene, a surfactant product categorised in downstream fine chemical and a major ingredient in fabric and homecare business) and SPPs projects, which are expected to be completed over the next 1.5 years. Thaioil also plan to strengthen its value chain through logistics capability, building higher value products and extension of products and services toward end customers.

“Thaioil is aiming towards international business expansion, focusing on three key countries, Indonesia, Vietnam and Myanmar, and leveraging on our core competency, which is refining skills and capability”, says Terbsiri. “For [the] long term, in light of more competitive new refining capacity, we will need to consider upgrading investment for its main refining and petrochemical business, enhancing competitiveness through our ability to upgrade low value to higher value products and flexibility to process diverse crude types. In addition, with the changing trend of energy consumption, we have set up an innovation and R&D team to study and develop new energy business opportunities. These strategies would support Thaioil to cope with challenges we are facing.”

Net winner
Despite the challenge the dramatic price drop of oil poses for producers like Thaioil, the country as a whole stands to benefit from the 50 percent dip. The lower cost of fuel is great news for consumers, who can take advantage of cheaper gasoline. Due to rising domestic demand, Thailand has had to spend much of its foreign exchange reserves buying oil, but because of the recent drop in price, the government can now funnel that money elsewhere, at least for the time being.

Experts believe that while the oil’s price will remain depressed for at least the next two quarters, such prices are simply unsustainable. In the meantime, consumers in net importing countries can enjoy a moments respite from inflated prices, while producers will not have to wait too long until they see profits return.

US Senate to consider contentious trade agreement

The TPP will be one of the largest trade agreements in history, covering 40 percent of global GDP and encompassing potentially 11 other countries. The other nations proposed for inclusion are Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam.

There have been some efforts from within President Obama’s own party to derail the initiative

The bill will need 60 votes of approval in the Senate and 218 in the House of Representatives to pass. There have been some efforts from within President Obama’s own party to derail the initiative, with Democratic Senator Bob Menendez attempting to add a provision which would block any trade agreements with countries that the State Department’s Human Trafficking Report has classified as Tier 3, of which potential TPP partner Malaysia is classified.

In a boost to Obama’s efforts, footwear manufacturer Nike has said, reports the Financial Times, that it will expand “advanced footwear manufacturing” in the US, creating 10,000 jobs, if Congress gives the president the authority to fast track negotiations with other TPP partners.

For TPP to go ahead, Japan’s dairy and rice protectionist policies must be addressed, as well as Canada’s protection of its dairy industry. There have also been concerns over human rights in Mexico and Malaysia.

According to Obama, the US must take the initiative in creating this free trade agreement. “We have to make sure America writes the rules of the global economy and we should do it today while our economy is in a position of global strength,” the FT reports Obama saying. “If we don’t write the rules for trade around the world, guess what, China will. And they’ll write those rules in a way that gives Chinese workers and Chinese businesses the upper hand.”

Start-ups fail to help women start up

In February, 800 female entrepreneurs gathered at the Female Founders conference hosted by Y Combinator. That’s certainly a promising sign, but the very existence of a separate entity dedicated to women is a stark reminder that men remain the overwhelming majority in the start-up scene.

The numbers speak for themselves; just 1.3 percent of privately held startups had a female founder in 2012, according to the Women at the Wheel: Do Female Executives Drive Start-Up Success? Dow Jones report. And out of 395 early-stage start-ups surveyed, 83 percent had no females on board.

The report found that the more developed the start-ups were, the higher the likelihood they had women on board – suggesting companies tend to add female executives as they go. But adding a plaster to patch up a wound doesn’t deal with the problem itself. To establish real, rooted gender parity, it must be there from the beginning. Quotas and other attempts at creating equality do little more than give the appearance of it.

Stereotypes and brogrammers
Perhaps the most notable factor holding women back from entrepreneurship is the fact the tech sphere – the area offering the most opportunity for start-up creation and growth – is still so glaringly male-dominated; according to a report by the data centre Telecity Group, only nine percent of chief information officers in the US were female in 2012. And according to Venture Lab, female tech start-up CEOs are outnumbered 20 to one.

17%

of computer science graduates in the US are female

That fuels the misguided perception of the tech world as first-and-foremost the province of men, forming a vicious circle that’s tough to break. Patricia Greene, Professor of Entrepreneurship at Babson College, agrees. “The culture and role models [in the tech sphere] are highly male based”, she says.

That’s ironic given that women, at least in the US, use social media sites more than men. According to Pew Internet, they dominate the user-base of big sites like Facebook, Twitter, Zynga and Pinterest – but they don’t found them. All four, like most of the other success stories – Snapchat, Instagram, WhatsApp, Tumblr and Spotify to name but a few – were created by men. Given the importance of social factors in influencing career choices, perceptions of the tech world need to change if more women are to enter it.

Cults like ‘brogramming’ don’t help; the concept, intended to give programming a cooler image by associating it with ‘bros’ and frat boys, is fuelling an already prevalent perception of coding as largely male-oriented. That hasn’t always been the case; according to historian Nathan Ensmenger, up until the 1960s programming was largely seen as ‘women’s work’. Now only 17 percent of computer science graduates in the US are women, according to Fast Company.

Encouraging more women to delve into tech at the education stage is of course central to achieving greater representation in the wider field. According to Greene, fewer females than males study in tech “because young women don’t see themselves spending their days the way they imagine they would if they were to work in tech companies”. A study by Penn Schoen and Berland (PSB) found that two thirds of teenagers had never thought about engineering as a career – and 74 percent of those that did had made the decision after learning about its economic benefits and how they could influence the world.

That suggests the importance of eschewing stereotypes and helping all young people understand the importance of tech skills, as Lydia Thomas, former CEO of Noblis and Co-Chair of the National Academy of Sciences, argues. “We have to capture women at a very young age”, she said in a Forbes report. “Women are not getting the emphasis in school. We need to encourage parents to encourage their daughters.”

Obstacles inside and out
It’s not just an apparent lack of interest in tech that’s holding some women back from launching successful start-ups. A Global Entrepreneurship Monitor (GEM) survey found that women were more likely to doubt their ability to start a business than men (especially in developed Asian economies such as Japan, where just five percent believed themselves capable). Women were also more likely to be held back by fear of failure, according to the report.

Dr Luz Cristal Glangchai, founder and CEO of VentureLab, which teaches entrepreneurship to young people, tells World Finance that confidence can be an issue. “As a college professor, I remember trying to encourage young women to go into technology and entrepreneurship”, she says. “But the girls in my classes felt intimidated. They would look to male classmates for answers even when their own experiences were superior.”

Glangchai believes this is rooted in early childhood experiences, and that role models can help combat the apparent trend. “We have noticed that many successful women CEOs and leaders in technology have all had some sort of ‘spark’ or mentor which gave them the confidence to believe they could accomplish anything”, she says. The GEM study suggests a similar concept; in Sub-Saharan Africa, four out of five women surveyed believed they had the skills to launch an enterprise – and half knew other female entrepreneurs.

But, as the GEM report recognises, even when it’s not a question of will, confidence or other inner hindrances, external barriers can block women entrepreneurs from attaining the same level of success as their male counterparts. Among the more subtle obstacles is the issue of funding; studies have shown female founders have a harder time getting venture capital (VC) backing than men, and it’s little surprise given the stark gender imbalance among VCs; in the US, women accounted for less than 10 percent of high-level VCs in 2012, according to the Kaufman Foundation.

That’s an unfortunate truth given that networks are of the utmost importance in obtaining funding and so achieving growth, at least according to Greene. “For [start-up growth], the factors are generally seen as money and network, with network actually being one of the major blockades for raising capital”, she says, adding that this is even more true for tech companies. “Tech businesses most likely need equity capital as opposed from other sources, and that’s where the network really comes into play.” While men continue to rule over the VC sphere, then, it seems they’ll simultaneously continue to dominate the entrepreneurial one.

As a female entrepreneur, Glangchai has said in the past that she experienced first-hand the prejudices that can greet female entrepreneurs in the science and tech sphere when she pitched the idea for her first company, NanoTaxi. “There were no women to pitch to… I tried not to show my femininity”, she told Women & Tech Project. “So I didn’t feel like I had to be more aggressive, but I did feel like I had to dress more like a man.”

Glangchai added that women in her field often have fewer opportunities to progress than men, not least because their ideas are sometimes shunned in preference for male-voiced ones. “There is some sort of weird, subconscious thing where the guys in the room, they don’t kind of notice you’re there”, she said. According to her, such discrimination can drive women out of tech and leadership positions.

Overhauling the model
It seems that in order to destroy these apparent prejudices, we need to go back to the beginning and challenge male-oriented business models. One way of doing that is by providing female entrepreneurs with greater access to resources – something a number of programmes (such as Astia, which has over 5,000 investors on board) are already helping to do. That marks a useful start in questioning the existing models, but there’s still a long way to go before they’re completely overhauled.

The efforts are clearly having some impact; the number of women in VC-backed companies is on the increase, and the likes of Hopscotch – a female-founded start-up that teaches children how to code – provide positive examples for others to follow. But such examples remain exceptions to the rule.

It’s evident that both men and women would benefit from having more women involved in the tech start-up scene; according to the Dow Jones report, venture-backed tech firms with a higher number of women executives have a higher chance of succeeding. For start-ups with five or more women on board, 61 percent succeeded. Given that some estimates put the average rate for Silicon Valley start-ups at just 10 percent, that’s significant.

It suggests that if the obstacles – whether interior barriers or exterior, cultural factors – can be overcome and the existing models upturned, a far higher number of female-founded start-ups could enjoy the types of colossal growth achieved by the likes of Facebook, Instagram, Spotify and fellow giants.

But those obstacles are ample, and more needs to be done to help knock them down and build new models that see real gender equality established from the start. Only then can men and women be seen as individuals in their own right rather than polarised, binary categories, and the future business world be characterised by true parity, from the roots up.

South Africa’s retirement industry strengthens

Despite its growth in recent years, South Africa’s retirement sector faces various challenges – both old and new. By understanding the changing culture of employment and financial discipline, industry leaders, such as Johannesburg-based Sentinel Retirement Fund, are responding to the growing need to educate citizens on the importance of saving, which is more vital than ever before. World Finance had the opportunity to speak with the CEO of Sentinel Retirement Fund, Eric Visser, to discuss the evolving retirement industry in South Africa and how private firms and the government are working together to overcome shortfalls in the sector.

The retirement industry in South Africa has thrived in recent years and is now worth an estimated ZAR 2.74trn ($231.92bn). Yet, there is still a great deal of the market that remains untapped as many citizens do not have access to retirement funds. According to the September 2014 quarterly employment statistics published by Statistics South Africa, of the 35.6 million citizens of working age, 4.9 million are unemployed and 15.4 million are either unavailable to work or not seeking employment. For those without a formal pension plan in place, the government’s social security system provides a State Old Age Grant from the age of 60 onwards; but at ZAR 1,350 ($115) per month, it scarcely covers basic living costs for the three million South Africans that rely solely on this income.

There are several processes that can rectify existing shortfalls, such as educating the population on financial discipline and the importance of saving from a young age

Job-hopping generation
“Towards the end of the 20th century, the majority of pension and provident funds in the private sector converted from Defined Benefit (DB), wherein compulsory annuitisation at retirement applies, to Defined Contribution (DC) arrangements, whereby employers in the private sector contribute to the pension funds of their employees”, says Visser. “Although many valid reasons supported this move, employment in the country has gradually changed from stable and lengthy careers at the same employer to ‘job hopping’. DB structures were seen as old fashioned and punitive to the new generation employees as they did not sufficiently promote portability of accumulated savings.”

Moreover, members of retirement funds are increasingly engaged in irresponsible financial behaviour, such as making premature withdrawals from their retirement savings and largely ignoring the preservation of capital. “Even at retirement, cash withdrawals are made and either squandered or inappropriately invested, rather than being annuitised to provide a life-long sustainable post retirement income”, says Visser. South Africa’s National Treasury (NT) initiated a retirement reform programme in 2012 in order to address such shortfalls in the current system. The process started well, with a number of proposals being legislated in 2014, but has since hit a roadblock as actual implementation has been postponed for at least one to two years.

Challenges and solutions
South Africa’s retirement industry soars ahead of its neighbours, which face even greater obstacles, such as underdeveloped financial markets, poor literacy levels, ineffective administration and low per capita income. Cumulatively, these factors have resulted in a large majority of citizens being forced to find alternative ways of saving for retirement. Furthermore, the growing trend of young Africans migrating in search of better living conditions has weakened traditional family social security structures, thereby impacting the socioeconomic conditions of the elderly – particularly those living in the rural areas.

That being said, most African countries have some form of official social security arrangement through which employed citizens are encouraged to save pro-actively and the elderly are supported. These systems have been largely inherited from colonial times or adapted from foreign designs, and as such do not meet the population’s requirements. Even in South Africa, where the retirement industry is relatively well-structured and operates effectively, citizens who have the opportunity to save often do not do so sufficiently for their retirement. “With this mindset, citizens impoverish themselves and place themselves in a position where they erode security in old age, undermine the alleviation of chronic poverty, and increase reliability on others”, says Visser.

A high level of unemployment is an ongoing issue for South Africa’s retirement industry (see Fig. 1), while the rising occurrence of shorter working careers presents a new challenge for the sector. Additionally, people nowadays have a greater inclination to access their pension funds when in-between jobs, which is part of a wider issue of the increasing ineptitude for personal financial discipline. Furthermore, as Visser explains, “Increased longevity places a strain on the sustainability of post-retirement income provision. The retirement savings horizon of South Africans are shortened, rather than extended, and remains around age 60.”

In order to combat such issues, the NT has proposed schemes aimed at improving the country’s culture of low savings, starting with the compulsory preservation of retirement savings – particularly in the early years of a pension plan. Better incentives for saving and compulsory annuitisation during retirement have also been earmarked as key areas. Moreover, the NT is trying to improve post-retirement income products and the fees charged in the industry. “The Social Security System is also part of this reform initiative, and to this end a compulsory contributory system is envisaged that will produce core benefits to all citizens”, says Visser.

At present, most retirees in South Africa are without the means to maintain their current lifestyle, which is largely attributed to intervals during the savings period or early withdrawals as a result of unemployment. The reluctance to annuitise at retirement and tendency to squander cash withdrawals or make bad investments are largely to blame for this growing dilemma. “Inappropriate retirement products are sold to retirees who do not have the means, knowledge or wisdom to manage these properly. In general, these products are also relatively expensive”, says Visser. While the only alternative, the state’s social security system, does not provide a sufficient safety net for individuals when they reach retirement age.

There are several processes that can rectify existing shortfalls, such as educating the population on financial discipline and the importance of saving from a young age. This can be achieved through traditional education settings or via online platforms. Additionally, advising those enrolled in retirement plans on important life changes and decision-making can be valuable in ensuring more effective saving in the long term. Aside from the changes that can be made on an individual level, amendments to South Africa’s legislative framework are also required, such as implementing some level of compulsory preservation and annuitisation. While on the part of retirement firms, providing appropriate and cost-effective products can cater for the changing needs of a wider spectrum of customers.

Unemployment in South Africa

An example of better educating individuals and offering client advice is now being implemented through Sentinel’s communication strategy, which includes personal interaction and one-to-one consultations with qualified financial advisors. The programme also gives members access to their personal information through a secured web interphase, thereby making the fund easier to use, while also acting as a platform for formal updates. By providing flexible and dynamic fund products, Sentinel allows its members to choose the most suited system to meet their individual needs, while also providing default systems that are preferable for those who prefer not to manage their own affairs. “This concept is further supported by Sentinel’s fund through a seamless and costless transition of a retiree from contributing member to pensioner”, says Visser.

In order to allow individuals to save sufficiently for their golden years, Sentinel aims at an investment strategy that can generate a post-retirement income replacement of at least 75 percent of one’s final salary. While for pensioners, the strategy is geared to maintain the purchasing power of pensions on a level of at least 80 percent of the Consumer Price Index (CPI). “Actual experience shows that a level in excess of 100 percent of CPI has been maintained and, in addition, annual bonuses of around 10 percent of annual pension have been awarded over the last 10 years to pensioners,” says Visser.

Social responsibility
Due to the nature of the industry, pension schemes are heavily regulated by government authorities, namely the Registrar of Pension Funds and South African Revenue Service. As such it is essential for firms to create a foundation of trust with authorities and the general population. Furthermore, as retirement funds help to stimulate the economy through investment and by establishing a means for citizens to become financially self-sufficient when they reach retirement, it is crucial for the industry to be sustainable in order to ensure its continuing viability.

As a means of supporting societal development, Sentinel has a social responsible investment policy that allocates capital to relevant investment opportunities. For example, its participation in an emerging black investment manager incubation programme is designed to give black investment managers the support and experience needed in order to gain exposure in the mainstream asset management industry. Furthermore, Visser explains, “Sentinel subscribes to the Code of Responsible Investment in South Africa and has incorporated economic, social and governance factors into its investment process.”

In 2013, Sentinel broadened its focus on corporate employers from the mining sector to include participation by all industries. Further plans for expanding its reach are on the horizon. “Sentinel is currently in the process of creating a provident fund that it envisages to run alongside the pension fund, with the view of attracting new participating employers. This extended platform will open the fund for participation to a far broader membership base, allowing more individuals the opportunity to maximise their retirement savings”, says Visser. Given the potential for South Africa’s retirement sector when various shortfalls are overcome through schemes that are employed by industry leaders and the government, further growth can be expected in the coming years.

Battling with the too-big-to-fail banks

Banking

Headlines about banks’ risks to the financial system continue to dominate the financial news. Bank of America performed poorly on the US Federal Reserve’s financial stress tests, and regulators criticised Goldman Sachs’ and JPMorgan Chase’s financing plans, leading both to lower their planned dividends and share buybacks. What was also of interest was Citibank’s hefty build up of its financial trading business that raises doubts about whether it is controlling risk properly.

These results suggest that some of the biggest banks remain at risk. And yet bankers are insisting that the post-crisis task of strengthening regulation and building a safer financial system has nearly been completed, with some citing recent studies of bank safety to support this argument. So which is it: are banks still at risk? Or has post-crisis regulatory reform done its job?

Bankers are insisting that the post-crisis task of strengthening regulation and building a safer financial system has nearly been completed

The 2008 financial crisis highlighted two dangerous features of today’s financial system. First, governments will bail out the largest banks rather than let them collapse and damage the economy. Second, and worse, being too big to fail helps large banks grow even larger, as creditors and trading partners prefer to work with banks that have an implicit government guarantee.

Balancing the figures
Too-big-to-fail banks enjoy lower interest rates on debt than their mid-size counterparts, because lenders know that the bonds or trading contracts that such banks issue will be paid, even if the bank itself fails. Before, during, and just after the 2007-2008 financial crisis, this provided an advantage equivalent to more than one third of the largest US banks’ equity value.

Bailouts of too-big-to-fail banks are unpopular among economists, policy makers, and taxpayers, who resent special deals for financial bigwigs. Public anger gave regulators in the US and elsewhere widespread support after the financial crisis to set higher capital and other safety requirements.

And more regulatory changes are in the works. New studies, including important ones from the IMF and the US Government Accountability Office, do indeed show that the long-term boost afforded to too-big-to-fail banks like Citigroup, JPMorgan Chase, and Bank of America is declining from its pre-crisis high. This is good news.

The bad news is that US bank representatives cite these studies when claiming, in the financial media and presumably to their favourite members of Congress, that the too-big-to-fail phenomenon has been contained and that the time has come for regulators to back off.

This is a dangerous idea, for several reasons. For starters, the IMF’s research and similar studies show that the likelihood of a bailout over the life of the bonds already issued by banks is indeed now lower. But the studies do not specify why. Lower bailout risk could reflect the perception that the regulation already in place is appropriate and complete. Or bond-market participants may expect that new regulations, like the stress tests, will finish the job. The studies could be telling us that investors believe that regulators are on the case and have enough political support to implement further safeguards. Or they could think that the economy is currently strong enough that the banks will not fail before the bonds are paid off in a few years.

The bigger picture
The second reason why such studies should not deter regulators from continued intelligent action is that the research focuses on long-term debt. But that is not the right place to look nowadays, because regulators are positioning long-term debt to take the hit in a meltdown, while making banks’ extremely profitable – and far more volatile – short-term debt and trading operations more certain to be paid in full.

As a result, traders choose too-big-to-fail banks, rather than mid-size institutions, as counter-parties for their short-term trades, causing the large banks’ trading books – and, hence, their profits – to surge. Measuring the boost to short-term debt is not easy. But it is most likely quite large.

The major banks’ recent effort, led by Citigroup, to convince the US Congress to repeal a key provision of the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act that would have pushed much of their short-term trading to distant affiliates (which are not too big to fail) reinforces this interpretation. The banks know that they will receive more business if they run their trading desks from the part of their corporate group that has the strongest government backing.

The third reason to be wary of bankers’ confidence that the regulatory job is complete is that once they believe it, they will behave accordingly – less frightened of failure and thus willing to take on more risk. That seems to have been the case before the financial crisis, and there is no business or psychological reason to think that it will not happen again.

Regulators must not be deterred by bank lobbying or studies that measure neither the short-term boost afforded by a bank’s too-big-to-fail status, nor how much of the perception of increased safety can be attributed to the regulations in place and the expectation of additional good regulation. In the absence of such studies, regulators must use their own judgment and intelligence. If ‘too big to fail’ also means ‘too big to regulate’, the perception of increased safety will not last long.

Mark Roe is a professor at Harvard Law School. He has written a series of articles on banking reforms for Project Syndicate, the FT and The Wall Street Journal.

© Project Syndicate, 2015

Global arms industry struggles for sales

The Sipri annual report published last December revealed that the global arms industry had declined for the third year in a row. There has been progressively slowing demand for weaponry following the end of the Cold War, and that demand has dropped further as a result of NATO’s shrinking world budget since the onset of the 2008 financial crisis. Amid this disappointing backdrop, one market stands out in terms of achieving revenue growth in recent years: Russia.

The defence budget
The US is the most prolific in terms of weapons manufacturing and sales, with a defence budget that is bigger than 15 countries combined (see Fig. 1) – an incredible ranking for any industry. While the US will continue to dictate the global industry by means of its sheer size (see Fig. 2), this formidable market is now under pressure. “The decline in arms sales in the US, in our analysis, is mostly due to the decrease in the operations budget, so that directly affects the industry because these budgets also buy weapons and services”, says Dr Aude Fleurant, Programme Director at Sipri, a research centre specialising in arms and the military. Namely, the 2011 Budget Control Act that was introduced in order to reduce the budget deficit of $2.1trn by 2021 has had a detrimental impact on arms sales in the US.

While revenue in the US has fallen, Russia’s arms industry is doing increasingly well. But despite its increase of the global market share, Russian producers now face a possible hindrance as a result of the country’s recent economic woes. Currently, the state budget is experiencing considerable pressure due to Western sanctions and the drastic fall of the rouble. The implications for the arms industry are yet to be seen, but perhaps they will not even come about. “There might be ring fencing of the defence investment in order to pursue the effort in modernising the Russian defence industry, because the Russian objective is to upgrade and update the defence industry so that it can become more competitive on the international stage and more efficient – but they have not actually met these objectives yet”, explains Dr Fleurant. Tensions with Ukraine and last year’s annexation of Crimea give further validation for Moscow to maintain its current defence strategy and continue to bolster its capabilities, in spite of the state’s fiscal crisis.

A number of countries prefer to purchase Russian or Chinese equipment over US counterparts, not only due to much lower prices, but also because of traditional alliances

Sales in Western Europe, on the other hand, have been mixed, largely as a result of the varying defence programmes and budgets of each state. Furthermore, unlike the collaborative efforts made towards economic integration, the same has not been achieved for security. The UK, the world’s second largest producer – like the US – has experienced a drop in sales. While French firms Dassault and DCNS, have climbed the ranks of Sipri’s top 100 arms-producing companies report for 2013.

Further reflecting the heterogeneous nature of the European market are Spain’s Navantia and Italy’s Finmeccanica, which have both fallen in Sipri’s rankings. The performance of Navantia and Finmeccanica correlates with the mounting fiscal debt inflicting their respective states and indicates the vulnerability of a country’s defence industry to national economic pressures.

Domestic demand
The US Department of Defence has enforced a number of changes that have considerably reduced domestic demand. First, it has implemented a policy of upgrading weaponry as opposed to frequent replacements. In addition, according to the Performance of the Defence Acquisition System 2014 Annual Report, the Pentagon is attempting to administer more sophisticated and individually tailored contracts, as the traditional format is known for encouraging overspending.

Furthermore, the withdrawal from Iraq and Afghanistan has also reduced the weaponry requirements of the US Government drastically. Public outrage and global pressures have influenced this radical change in foreign policy, thereby highlighting the susceptibility of the industry to the political paradigm. As demonstrated in this case, foreign policies can change suddenly and drastically; the direct impact on arms manufacturers is immediate. As such, US producers must now await another ‘peace-keeping excursion’ in order to significantly bolster their sales again.

Despite the general downturn in the global weapons market largely resulting from economic pressures, Russia’s gains are the result of an investment strategy that was administered in the 2000s. Funding was furthered when the State Armaments Programme was implemented in 2008 and instigated the radical renovation of the Russian Ministry of Defence. The transformation began with the reorganisation of the military’s structure from divisions to brigades, and was then followed by the armament of the newly-formed contingents.

Countries with the highest military spending

Reflecting this change in policy is the state’s three most prolific firms that have had a combined revenue growth of 172 percent in 2013 from the previous year. What is striking about the recent success of Russian arms producers is the timescale required to turn investment into profit, a standard protocol for the industry. In order to advance revenue growth, heavy investment and a long-term strategy is required, both of which can be interrupted if domestic or global political circumstances interfere; making the nature of this industry more precarious and protracted than most.

Japan is another market in which domestic demand is on the rise as its defence policy – which has been notoriously subdued for decades – begins to change. Threats from ISIS insurgents, including the recent beheading of two Japanese citizens, has brought into focus the country’s legal obstruction of deploying troops abroad. In addition, verbal clashes with China regarding territorial waters and provocation by North Korea as it tests rockets near the Japanese border have given Prime Minister Abe a strong pretext to drastically shift this aspect of the country’s foreign policy.

As a result, Japan augmented its defence budget to a record JPY 4.98trn ($4.3bn) in January, according to Bloomberg – in spite of the economic challenges currently facing the state. Not only will increased power overseas bring Japan in closer alignment with the security strategy of other nations, it will also have a positive impact for the country’s arms industry.

Exporting weaponry
There are further hopes of bolstering the revenue of Japanese products through the overseas market. Since 1967, the state’s ban on the export of almost all weaponry had restricted its arms industry to domestic sales. In another bold move made by Abe, the once strict regulations were eased last year. Mitsubishi Heavy Industries was the first to be awarded with an arms export licence, and has signed agreements to sell its sensors for US missiles and propulsion technology for Australian submarines.

Opening up Japanese producers to foreign markets can allow economies of scale to be achieved, a significant factor when considering that for the past five decades the customer base has consisted of just one patron. Despite a great deal of anticipation from Japanese manufacturers, a significant increase of exports is doubtful due to the nature of the global arms industry. International competition is greater than ever, therefore the gap available in the market for expensive Japanese products may only be marginal.

There is also a group of newcomers to the industry that have begun to increase their respective sales and attract attention: India, Brazil and Turkey. South Korea is a notable case as a rising player on the international scene, with sales of fighter jets to the Philippines, Indonesia and Iraq.

Despite relative success of emerging producers in recent years, their profit growth is capped by the fierce level of competition for exports. In addition, achieving long-term projects is an extremely complex and costly business and so presents another limitation to emerging economies. Furthermore, Dr Fleurant argues that the success of these new suppliers has been overstated: “In truly quantitative terms, their place as arms producers is not that important, but they attract a lot of attention from traditional suppliers”.

There is another new challenge facing the saturated market: competition from the ever-growing and increasingly influential tech industry. As a by-product of greater investment and research capabilities, tech companies are currently exploring the field of innovative weaponry, such as robotics and exoskeletons. There has been considerable media attention about this overlap of the two spheres, most likely because it appears to be a logical convergence of the two industries.

US defence budget breakdowns

Yet, the reality of this trend is yet to transpire as there are a series of inhibitive factors that prevent the tech industry from supplying weaponry. The extremely long lead times for development and commercialisation in the defence industry are a far cry from those in the tech sector. This is largely due to military standards and export controls, which are far more rigorous and demanding than those required for commercial products. The drastically different nature of the two markets raises further doubts; with the civilian consumer base being so much wider, varied and more profitable, the hurdles affiliated with the defence industry may make the much-talked-about endeavours of tech companies un-viable.

Unlike other industries, the arms market is impossible to forecast. As customers are governments, and defence budgets are determined both by a state’s economic success and the geopolitical climate – industry experts cannot predict how markets will evolve in the coming years. With that being said, it is likely that the fierce competition prevalent in the export market will continue. Global economic growth continues at a slow rate, thereby constricting defence spending in general. Furthermore, sales are tied into the long-standing relations between states that make it extremely difficult for a new supplier to make headway into an established buyer-seller relationship, particularly as politics are principally at play. For example, a number of countries prefer to purchase Russian or Chinese equipment over US counterparts, not only due to much lower prices, but also because of traditional alliances.

Sluggish GDP growth means that a state’s defence budget is a popular target for cuts, particularly in light of growing social and political pressures. Therefore, in consideration of such a restrictive client base and flagging domestic demand, it is increasingly necessary for arms manufacturers to evolve. Their strategy and product line are in much need of diversification in order to reverse the current trend of falling profits and vast job cuts.

Although some firms are reluctant to expand into the civilian sphere, the scope for modifying products exists, and has potential; examples include vehicle components and hi-tech systems. Of course, there are challenges inherent to this kind of adaptation for any industry, in addition to those attached specifically to weapon manufacturers, which include public disapproval and reluctance from potential business partners. Yet even for those who are against the industry as whole, this is a logical step, and one that should be encouraged both internally and externally.

The deflation/inflation balancing act

the-price-paradox

In 1923, John Maynard Keynes addressed a fundamental economic question that remains valid today. “Inflation is unjust and deflation is inexpedient”, he wrote. “Of the two perhaps deflation is… the worse; because it is worse… to provoke unemployment than to disappoint the rentier. But it is not necessary that we should weigh one evil against the other.”

The logic of the argument seems irrefutable. Because many contracts are ‘sticky’ (that is, not easily revised) in monetary terms, inflation and deflation would both inflict damage on the economy. Rising prices reduce the value of savings and pensions, while falling prices reduce profit expectations, encourage hoarding, and increase the real burden of debt.

The post-crisis experience of quantitative easing has highlighted monetary policy’s relative powerlessness to offset the global deflationary trend

Keynes’ dictum has become the ruling wisdom of monetary policy (one of his few to survive). Governments, according to the conventional wisdom, should aim for stable prices, with a slight bias toward inflation to stimulate the ‘animal spirits’ of businessmen and shoppers.

Failing to meet expectations
In the 10 years prior to the 2008 financial crisis, independent central banks set an inflation target of about two percent, in order to provide economies with a price-stability ‘anchor’. There should be no expectation that prices would be allowed to deviate, except temporarily, from the target. Uncertainty relating to the future course of prices would be eliminated from business calculations.

Since 2008, the Federal Reserve Board and the ECB have failed to meet the two percent inflation target in any year; the Bank of England (BoE) has been on target in only one year out of seven. Moreover, in 2015, prices in the US, the eurozone, and the UK are set to fall. So what is left of the inflation anchor? And what do falling prices mean for economic recovery?

The first thing to bear in mind is that the ‘anchor’ was always as flimsy as the monetary theory on which it was based. The price level at any time is the result of many factors, of which monetary policy is perhaps the least important. Today, the collapse in the price of crude oil is probably the most significant factor driving inflation below target, just as in 2011 it was the rise in oil prices that drove it above target.

As British economist Roger Bootle pointed out in his 1996 book The Death of Inflation, the price-cutting effects of globalisation have been a much more important influence on the price level than the anti-inflation policies of central banks. Indeed, the post-crisis experience of quantitative easing has highlighted monetary policy’s relative powerlessness to offset the global deflationary trend. From 2009 to 2011, the BoE pumped $578bn into the British economy ‘to bring inflation back to target.’ The Fed injected $3trn over a slightly longer period. The most that can be claimed for this vast monetary expansion is that it produced a temporary ‘spike’ in inflation.

The old adage applies: “You can lead a horse to water, but you can’t make it drink.” People cannot be forced to spend money if they have good reasons for not doing so. If business prospects are weak, companies are unlikely to invest; if households are drowning in debt, they are unlikely to go on a spending spree. The ECB is about to discover the truth of this as it starts on its own €1trn programme of monetary expansion in an effort to stimulate the stagnant eurozone economy.

So what happens to the recovery if we fall into what is euphemistically called ‘negative inflation’? Until now, the consensus view has been that this would be bad for output and employment. Keynes gave the reason in 1923: “The fact of falling prices”, he wrote, “injures entrepreneurs; consequently the fear of falling prices causes them to protect themselves by curtailing their operations.”

The cost of bad deflation
But many commentators have been cheered by the prospect of falling prices. They distinguish between ‘benign disinflation’ and ‘bad deflation’. Benign disinflation means rising real incomes for lenders, pensioners, and workers, and falling energy prices for industry. All sectors of the economy will spend more, pushing up output and employment – and sustaining the price level, too.

By contrast, ‘bad deflation’ means an increase in the real burden of debt. A debtor contracts to pay a fixed sum in interest every year. If the value of money goes up (prices fall), the interest he pays will cost him more, in terms of goods and services he can buy, than if prices had stayed the same. In the reverse, inflationary case, the interest will cost him less. Thus, price deflation means debt inflation; and a higher debt burden means lower spending. Given the huge levels of outstanding private and public debt, bad deflation, as Bootle writes, “is a nightmare almost beyond imagining.”

But how can we stop benign disinflation from turning into bad deflation? Apostles of monetary expansion believe that all you have to do is speed up the printing press. But why should this be any more successful in the future than it has been in the last few years?

Avoiding deflation – and thus sustaining economic recovery – would seem to depend on one of two scenarios: either a rapid reversal in the fall of energy prices, or a deliberate policy to raise output and employment by means of public investment (which, as a by-product, would bring about a rise in prices). But this would mean reversing the priority given to deficit reduction.

No one can tell when the first will happen; and no governments are prepared to do the second. So the most likely outcome is more of the same: continued drift in a state of semi-stagnation.

Robert Skidelsky is Professor of Political Economy at Warwick University

© Project Syndicate, 2015

 

Investors navigate the risks of crowdfunding

Crowdfunding sites have revolutionised the way people invest and how international companies seek out capital, with the World Bank estimating that the industry is set to bring in more than $93bn worth of investment by 2025. Most people who have taken part in the practice get involved in what is known as reward-based crowdfunding, where start-ups and entrepreneurs use websites like Kickstarter and IndieGoGo to pre-sell a product or service.

There is usually a tiered system of donation, with the highest entry point allowing backers to obtain a copy of the product if the campaign can raise the necessary capital. But if backers cannot stretch to the top tier of investment, they can still help to get the project off the ground in exchange for incrementally smaller perks, depending on how much money they are willing to part with.

Then there is equity crowdfunding, with the key distinction being that, unlike the reward-based model, investors receive shares in a company in exchange for the capital they put in. With both types there are massive risks involved. Start-ups are notorious for failing fast, and failing often. But that does little to deter the millions of investors from logging on and paying out, all in the hope of getting involved in the next big thing. But while both backers and investors share an eagerness to support fledgling companies to take flight, there is a clear distinction in the decision-making behaviour of the two – one where emotion and objectivity are exercised in unequal measure.

Start-up failures: percentage of failures by year of operation

25%

Year 1

36%

Year 2

44%

Year 3

50%

Year 4

55%

Year 5

60%

Year 6

63%

Year 7

66%

Year 8

69%

Year 9

71%

Year 10

Source: Kickstarter. Notes: 2014 figures

Falling short
When the right product comes along it can send people into a bit of a frenzy, with happy backers showering crowdfunding campaigns with money in an attempt to see their dream device or service made a reality. This is exactly what is happening to the Sondors Electric Bike that launched its quest for capital on IndieGoGo. It is priced well under its competitors at just $649, and the bike boasts some impressive stats for such a small price, helping it to raise nearly $4m – far exceeding its modest goal of $75,000. But when something sounds too good to be true, it usually is. This is why, despite attracting a lot of funding, it has also caught the attention of others in the e-bike industry that question whether it can really deliver on all of its pre-sale promises.

In an interview with Yahoo! Tech, Robert Provost, CEO of Prodeco Technologies, a company that sells its own line of electric bikes, accused the makers of the Sondors Electric Bike of making hugely inaccurate and false claims in their IndieGoGo campaign. “What they are claiming is highly suspect”, says Provost. “We’re afraid a lot of people who think they got a great deal will be disappointed with the bike.”

Apart from its very low price tag, the e-bike claims some impressive stats: a powerful 350-Watt motor capable of generating a top speed of 20mph and a lithium ion battery that can be charged in just 90 minutes, with enough juice to keep it moving for 50 miles – all adding up to make it an attractive offering to the market. But industry insiders are not convinced.

“I do question some of the [bike’s] specs”, says Court Rye, owner of the Electric Bike Review website and YouTube channel. “The lightest fat-tire electric bike I’ve ever reviewed and weighed myself is the Felt Lebowski, a $5,800 performance model built with 6061 aluminium alloy — it weighs just 48 pounds. Steel is much heavier, in my experience.”

To answer some of their doubters the team behind the Sondors Electric Bike have planned a number of demonstration days in order to prove naysayers wrong and display to consumers that their bike can do what they claim: “There has been a lot of speculation about the bike over the past few days and we want to assure you that it is real, it exists and it is quality”, reads an update on their IndieGoGo page. “We feel the best way to address this is to invite our backers, potential future backers and those naysayers out there to test the bike for themselves.”

The bike will need to perform well if it is to lower many a raised eyebrow over claims made about the bike’s range and top speed. Critics contend that with a rider in tow the direct drive motor is simply not powerful enough to reach such speeds and that 10 to 15 miles is a much more realistic range for a battery of that size. Electric-FatBike.com even went as far to imply that the people behind it are “overselling their bike to the point of fraud” and highlighting the inconsistencies in the company’s marketing campaign.

“In the photos and video they show people riding bikes that are prototypes with foot-pegs instead of pedals and using much larger motors than a 380-Watt system”, writes the reviewer. “They also advertise it as Direct Drive, but in the pictures the motor is clearly a geared hub. They talk about hydraulic brakes, but then show pictures of cable brakes. There is little to no consistency in the description and the pictures and videos.”

Great expectations
But even with his expertise, this reviewer still hopes that the Sondors Electric Bike will deliver, even admitting at the end of the piece that he would “rather give [his] money to a beach bum surfer with big promises than a CEO of a big company any day”. Many people seem to get so blinded by the possibility of getting their hands on the product of their dreams that they are no longer capable of exercising any kind of objectivity.

This proclivity of people to allow themselves to get caught up in all the excitement, means that entrepreneurs may inadvertently over stretch or make promises that will fall short in an attempt to acquire the necessary attention and capital they require. This vicious cycle becomes even more disconcerting because these sites do not offer refunds if it all goes south. Nor are the creators contractually obligated to refund funders, so long as they supply them with something. Whether it lives up to its initial billing, however, is irrelevant.

Number of crowdfunded investing platforms

The world of videogames is a clear example of this vicious cycle in action. Peter Molyneux, a developer who once carried a lot of weight in the industry, has seen his reputation take a nosedive. After he successfully got his most recent offering, Project Godus, off the ground through Kickstarter back in 2012, the game is still yet to reach players’ PCs. This has naturally angered fans and led to him coming under huge criticism from the gaming community, as well as those who supported his campaign.

Adding to the irritation felt by supporters of the project, Molyneux recently announced that he will be shifting his attention onto a different project, leaving backers wondering if he has just decided to shelve the game for good. Molyneux is not the only developer to pull this type thing. Many consumers have had their excitement snuffed out by broken pre-release promises.

But to put all the blame on these entrepreneurs and would-be start-ups is simply not fair. The backers of these campaigns are just as much at fault for backing them in the first place. Both campaigns received well over their target amount. The sensible choice would be to wait and see, but the fact that people are unwilling to show restraint is indicative of their inclination to act on impulse. The criticisms aimed at developers like Molyneux taking too long and the likely complaints that will be levelled at the Sondors Electric Bike should it fall short, also provide evidence of the fact that many simply fail to comprehend the huge undertaking that is game development or the potential risks and manufacturing road humps that arise when bringing a prototype to the mass market.

Bigger stakes
Equity crowdfunding is a different story entirely. Users of sites like Crowdcube are not looking at the product or service in isolation – they are looking at the business as a whole. “Investors are looking for a strong idea that offers the opportunity to scale up, so there needs to be a really clearly defined market opportunity – a real problem that your business is solving”, says Luke Lang, Co-Founder of Crowdcube. “No matter who is investing, whether it is a crowd investor, an angel investor, or a VC. They’re all looking for the same thing: a strong team with decent levels of experience and a proven ability to exercise a successful business plan.”

Kickstarter’s successfully funded projects

1,798

Art

1,715

Design

998

Fashion

3,846

Film & Video

1,980

Games

4,009

Music

2,064

Publishing

1,124

Technology

Source: Kickstarter. Notes: 2014 figures

Looking at companies from this perspective alters the types of businesses that equity crowd funders are interested in. Enterprises that are already up and running and operating with a decent degree of success – which are looking for the next round of investment to really accelerate growth – are particularly popular. “It is not to say that we do not fund startup businesses, but it is slightly more challenging for the entrepreneur”, says Lang. “But they need to be even more convincing that their business or idea is highly transformational or that they have spotted a niche in the market that they believe they can plug.”

“It just makes the investment pitch that little bit harder. I guess that is why our investors tend to edge towards the early stage businesses, as it lowers the amount of risk that they expose themselves to.” Christine Lomax is a London-based business advisor who has invested in four companies through Crowdcube and recommends that before investing in any business or start-up to do some thorough research behind the scenes.

“It’s better to be cautious if you feel sales projections seem sky high or you just feel they’re getting a bit too crazy; make sure people aren’t pulling figures out of the air”, says Lomax. “They should have a very transparent business plan and cash flow, with a good attention to detail – the figures have got to stack up.” Backers on IndieGoGo, however, tend to look strictly at the product or service and usually from the perspective of a consumer, not an investor.

Although understandable, backers of campaigns on reward-based crowdfunding sites might be better off exercising a little more caution, especially if the project has already reached its goal. There is always the opportunity to buy the product once the business is fully operational, and at that point any kinks or manufacturing potholes are likely to be smoothed out.

Over-funding could also inadvertently put the start-up in bit of a bind, as manufacturing is notoriously hazardous, with delays and mistakes a plenty. Excessive orders, therefore, can be more trouble than the are worth for an inexperienced entrepreneur.

Even tech behemoths like Apple struggle to get products out in time, so assuming a small start-up with little or no experience to hit all its targets and live up to the huge expectations that are placed on it by backers is demanding a lot.

Agency loss can occur if the principal and the agent do not share common interests. So as long as both parties desire the same outcome then everyone is happy. In equity crowdfunding this parameter is adequately met, as both investors (principal) and management (agent) seek to maximise personal economic wealth and, therefore, agency loss is minimised.

But in reward-based crowdfunding there is a problem: the principal is not concerned with maximising economic wealth, but instead, the principal simply wants a good or service in return for their investment. The agent on the other hand is seeking to maximise economic wealth. This reduction in common ground leads to agency loss and negatively impacts the relationship between both parties.

As equity crowdfunding rewards investors for choosing companies that can achieve long-term success, there is a tendency for people to gravitate towards companies that offer more than an impressive-looking product. Investors are looking to be involved over the long haul, and investors and management bond over a desire to make money. But just because backers on sites like Kickstarter do not have equity in the company, it shouldn’t lead to short-term thinking.

Peter Molyneux, founder of the 22Cans games studio
Peter Molyneux, founder of the 22Cans games studio

Get ready: the cyber-criminals are coming, and they’re better than ever

The prolific Sony hack late last year sparked attention and debate across the world. But it was just one of the latest in a string of malicious cyber attacks doing untold damage to the reputations and revenue bases of the globe’s largest corporations – including its biggest banks. The threat is on the increase; a study by Radware last year found that 19 percent of companies in the UK claimed they were under constant cyber attack – up three times from 2013 – as hacks become easier to carry out, quicker to spread, and harder to detect.

Meanwhile, a study by PwC found that 81 percent of large UK businesses had fallen victim to at least one security breach in 2014, resulting in losses of between £600,000 ($903,000) and £1m ($1.5m). It’s no wonder that more than 70 percent of banking and capital market CEOs believe cyber risks are threatening their potential growth (according to PwC).

Political statements
The motives for these attacks vary; from selling personal data for financial gain to ‘hacktivists’ making geopolitical statements – which 34.4 percent of targeted companies said they’d experienced (see Fig. 1). Those politically motivated attacks pose a significant danger to corporations and wider economies, targeting financial institutions in their masses as an assault on government revenue.

Worryingly, they’re expected to rise. “All our intelligence tells Radware it will see more geopolitical campaigns and everyone will be a target, especially the banks, because of what they symbolise rather than what they control”, said the cyber-security consultancy. Last year, protests in Hong Kong and news that Latvia would be leading the EU both drove a rise in the number of cyber attacks on the respective countries, and Ukraine’s Central Election Commission found itself the victim of an attack ahead of the elections in May.

Cyber attacks are growing every day in strength across the globe

State-owned banks are particularly vulnerable, according to Adrian Crawley, Radware’s UK and Ireland regional director – as are those whose reputation may have been tainted in the public’s eye. “If the bank happened to have just declared that there was tax avoidance at certain branches in certain countries, which may have happened recently, they would also be liable to be attacked”, says Crawley.

Under attack
The damage geopolitical cybercrime can cause was made all too clear when the Izz Ad-Din Al Qassam Cyber Fighters (QCF) launched its seven-month Operation Ababil in 2012, targeting some of the largest financial institutions in the US – including the New York Stock Exchange, Bank of America and JP Morgan Chase. The attack sent 15 bank sites down for a total of 249 hours – equivalent to an average of 2.7 hours a week for each institution. Its financial impact, including the consequences of the downtime, was huge; although the exact figures have never been revealed, Crawley estimates the campaign caused multi-million dollar losses.

That’s not the only prolonged attack the US has suffered over recent years; between 2005 and 2012, a number of American businesses, including Dow Jones, Visa Jordon, JC Penney and 7-Eleven, fell prey to a series of vicious attacks that saw over 800,000 bank accounts targeted and more than 160 million credit and debit card numbers stolen. Global Payment Systems suffered losses of almost $93m, and Heartland Payment Systems – one of the biggest credit and debit card-processing firms in the world – saw losses amounting to around $200m, after the numbers were used to create and sell counterfeit cards, according to federal prosecutors.

Target, eBay and Home Depot have all hit the headlines for prolific hacks, but it’s arguably the JP Morgan Chase attack in 2014 that has provoked the most concern. Hackers reached the accounts of 76 million customers and seven million small businesses, making it one of the largest bank hacks in history and prompting chairman and CEO Jamie Dimon to warn of the rising dangers in his yearly letter to stakeholders: “Cyber attacks are growing every day in strength across the globe”, he wrote, adding that the fight will be “continual and likely never-ending”.

As those hacks suggest, the financial implications for targeted corporations can be substantial; in 2008, McAfee surveyed 800 firms and found they’d racked up combined losses of $4.6bn in intellectual property, while incurring costs of around $600m in repairs.

And the potential losses are even greater for banks, where every minute of down time deals million-dollar blows to the revenue base through lost trade. It can also have serious implications on the retail side, with consumers unable to access accounts and thereby make necessary payments – which in turn may pose legal issues, according to Crawley. “The legal side of not being able to adhere to your policies is critical”, he says.

Fig 1 Motives behind cyber attacks

Holes in Obama’s plans
It’s little surprise, then, that governments are stepping up efforts to fight cybercrime. In February, Obama held a summit to detail plans to increase digital security; namely by encouraging the sharing of information between public and private tech companies via Information Sharing and Analysis Organisations (ISAOs). “We have to work together like never before”, he declared. Under the plans, a transatlantic ‘cyber cell’ is being created to bolster collaboration between the US and the UK, and cyber war games between the two nation’s banks are set to kick off later in 2015 as they test each other’s resilience. The UK is meanwhile dedicating £700m ($1.03bn) a year to step up the cybercrime fight.

But there’s only so much the government can do, and that’s limited further by the fact Obama has failed to get a number of the major Silicon Valley tech names on side – including Google, Facebook and Yahoo!, whose executives declined to attend the summit.

And there are counter-arguments to America’s plans. According to Lillian Ablon and Martin Libicki, cybercrime researchers at global policy thinktank RAND, Obama’s strategy could restrict WhiteHat security and see other all-important areas (such as vulnerability research) neglected. In a RAND testimony against the plans, Libicki also argued that ISAOs could mean excluding small- and medium-sized enterprises (SMEs) unable to afford the expensive ISAO fees – thereby dealing a blow to the very businesses already struggling to put adequate cyber-security measures in place.

Crawley is similarly sceptical of Obama’s plans: “Whatever is identified during this process will be very constructive, but the negative side is, attackers have already gone beyond that”, he says. “Whilst it’s great [on] one hand, I don’t believe it’s going to be the answer that everyone’s expecting.” He believes the power to prevent cyber attacks lies more with individual institutions – and specifically how they run and audit their security systems. Ian Whiting, CEO of cyber-security firm Titania, argues the planned collaboration is a positive move that could help identify “where weaknesses lie with our own country’s critical infrastructure”. But even he recognises its limits, arguing that it’s ultimately down to organisations to decide what level of risk they’re willing to take – and act accordingly.

Not so secure
It therefore seems clear a more comprehensive approach is needed to tackle threats from the cyber world. Libicki suggests governments should implement measures that cater for smaller as well as larger companies – such as helping them to seek out potential weak areas, and to analyse (and so learn from) past cyber attacks.

But the companies themselves must do more to tackle cyber threats if they’re to protect themselves and the wider economy. Although many are already taking action – major banks are collaborating, and 52 percent (see Fig. 2) surveyed by Radware said they were ramping up their cyber-security processes and protocols – some are falling behind.

A substantial number of companies aren’t being transparent enough; PwC found that 70 percent of them have kept their biggest breaches secret. That makes sharing information, and developing suitable systems and responses accordingly, somewhat of a challenge. And according to security company Venafi, over half of the Forbes Global 2,000 list have servers that aren’t fully protected against breaches. “[Some companies] feel maybe that they’re not so exposed”, says Crawley. “But what we’ve identified over the past five years with our emergency response team is that no-one is outside of the vulnerability here, everyone is at risk.”

That’s something the Bank of England is recognising, encouraging financial institutions to up their protection levels on the back of a growing threat from politically motivated attacks. Director Andrew Gracie said at a security conference that banks should reach “a level of resilience that goes beyond basic cyber hygiene”, and that firms should be “in a position to manage advanced persistent threats that are the hallmark of some state-sponsored attackers”. He added that protocols should seep through into the c-suite rather than resting solely with IT staff.

How have organisations responded to cyber threats

Shared responsibility
Relying on IT experts alone is indeed insufficient; according to a study by McAfee, misunderstandings and misinterpretation reside among a worryingly large number of security experts responsible for preventing advanced evasion attacks (AETs) – concealed attacks which bypass security controls. According to the report, 75 percent of those surveyed used vendors that didn’t include technology to prevent this form of security evasion. A further 39 percent of IT decision makers, meanwhile, admitted they didn’t have adequate measures in place to spot and track AETs.

According to nearly two thirds of the McAfee respondents, the biggest obstacle to preventing that form of attack was convincing the board AETs were a genuine danger; it’s thus clear that, as Gracie has argued, getting executives on board should be a priority. So long as cyber-security is considered the preserve of cyber-experts alone, the threat will remain. Training the entire workforce so as to avoid potential attacks is essential – and it’s a strategy that, unlike ISAOs, both SMEs and larger organisations can get involved with.

But RAND’s Ablon believes efforts should go yet further beyond workforce training to ensure that cyber-security is embedded from an early stage. She believes that teaching secure coding in school, and making it an obligation for those developing technology, should be priorities. “We currently only focus on the [functionality and convenience], and then ‘patch and pray’ that security will also happen”, she says, arguing that far more needs to be done if the very serious risks are to be, at least in part, mitigated.

Ablon certainly has a point. And as the Internet of Things takes on an increasingly important role, the potential damage cybercrime can cause is only going to grow – especially if it seeps into other areas, notably health. Crawley gives an example: “Your pacemaker could be linked to the internet, and if someone could hack into that system they could hack a device that’s protecting people.”

If not controlled properly, cybercrime could pose a very real and serious threat to both economies and the institutions and people in them. Although the digital revolution has made complete security impossible – as Crawley puts it, “the only way you’re going to be 100 percent secure is if you cut all links to online and you become an industry of the 1900s” – improving training, raising awareness through education and increasing transparency are actions that need to be taken urgently if we’re to halt the threat before it’s too late.

US President Barack Obama speaks at the White House Summit on Cybersecurity and Consumer Protection
US President Barack Obama speaks at the White House Summit on Cybersecurity and Consumer Protection

Forget price slumps. Oil’s days have always been numbered

The dramatic collapse in the price of oil over the last 12 months has caused panic around a world so reliant on the fossil fuel. Oil has become the dominant resource of the world’s energy mix over the last century, meaning that the bigger consumers of it would likely welcome a rapid reduction in cost. However, what it has really done is bring into focus the prospect of a world where stocks of oil are scant and energy is provided by alternative sources.

While the end of oil has been long predicted, the last 12 months of increasing production – led largely by the Organisation of the Petroleum Exporting Countries’ (OPEC) Saudi Arabia – has shaken up the oil markets, closing many prospective wells elsewhere and leading to people starting to think again about newer sources of energy. The day when oil is no longer the go-to fuel might just be getting closer than many had imagined.

As discussed in the last issue of World Finance, there has been a concerted effort to phase out fossil fuel use in recent years, but it has so far failed to bring about a meaningful shift towards renewable energy. However, the falling price of oil and the subsequent closure of many unprofitable wells mean that there could now be a proper shift away from polluting energy sources in favour of cleaner sources.

US shale industry productivity

Oil barrels per day:

308,700

March 2011

372,757

March 2012

817,428

March 2013

1,004,803

March 2014

Natural gas, mn cubic feet per day:

360,497

March 2011

626,262

March 2012

876,497

March 2013

1,112,944

March 2014

Indeed, many people – including the World Bank’s Jim Yong Kim and the IMF’s Christine Lagarde – have called for nations collectively to wean the world off fossil fuels by cutting subsidies. The oil, gas and coal industries have all enjoyed extremely generous government subsidies around the world for many years. In 2009, a meeting of G20 leaders led to a commitment to axe many subsidies, but six years later little has happened. This has been in part because of the financial crisis, but also because of the sudden boom in shale oil and gas discoveries.

The shale revolution
The global energy landscape has changed considerably over the last few years thanks in large part to the shale revolution in the US. It has taken away the reliance on foreign oil and gas in the US and Canada, creating a booming North American industry in the process. It has led to panic among nations like Saudi Arabia that have enjoyed a huge amount of demand for their plentiful crude oil resources, as they no longer hold as much sway over energy markets.

However, the plunging price of oil has dealt a blow to the industry, with many projects relying on high prices to justify exploration and the relatively high cost of production has meant that a falling oil price has led to many projects no longer being deemed financially viable.

At the same time, the continued blocking of the long-proposed Keystone XL pipeline by President Obama has meant the oil industry won’t be able to tap into all the resources it had hoped for in the future. Despite this, some in the industry believe that the cost of drilling for shale oil and gas will continue to fall, meaning that many of the projects will be viable soon enough.

The fall in the price of oil, however, is likely to be long term. Regardless of the shale revolution, many commentators think that oil’s days have been numbered for some time, and the normal safety net of the past is no longer willing to sustain stable prices. OPEC, the group of countries that have held a sway over the global price of oil, has faced the most difficulty from the last year, yet is also largely responsible for the fall.

Dominated by Saudi Arabia, OPEC has traditionally prevented prices from dropping too low, maintaining a semblance of stability in an industry that so many are reliant upon. However, instead of propping prices that were falling as a result of increased supply from the US shale boom, Saudi Arabia has driven up production levels as a way of crushing this new competition.

The reasons for this ramping up of production have caused much debate, with many saying it is Saudi Arabia’s way of stopping the US shale revolution, while also applying further pressure to the struggling economies of its’ oil producing rivals Russia and Iran. However, it seems more likely that the country has realised that its vast deposits of oil may not be so in demand in the not too distant future.

In fact, some within the regime have predicted the decline of oil for many years. In 2000, former Saudi oil minister Sheikh Yamani told The Daily Telegraph that new technologies would mean far less demand by 2030. “Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”

Yamani also correctly predicted that discoveries of oil would continue to remain high over the medium-term, but that eventually newer technologies would lead to oil’s downfall. “On the supply side it is easy to find oil and produce it, and on the demand side there are so many new technologies, especially when it comes to automobiles.”

He was also correct in predicting a major crash in the price of oil. “I have no illusion – I am positive there will be some time in the future a crash in the price of oil. I can tell you with a degree of confidence that after five years there will be a sharp drop in the price of oil.”

Fast-forward to last year, and the predicted crash finally began to materialise. Whereas in previous times of price instability Saudi Arabia has led OPEC towards slashing production, this time it refused. Because of its cheaper production costs compared to rivals Russia and the US, Saudi Arabia has been able to take a hit on profits that others could not justify.

According to a January article by Elias Hinckley for Energy Trends Insider, the Saudis might be looking at the long-term implications of a world no longer reliant on oil. “Saudi Arabia has embarked on an absolute quest for dominant market share in the global oil market. The near-term cost of grabbing that market share is immense, with the Saudis sacrificing potentially hundreds of billions of dollars if low prices persist.

“In a world of endless consumption, this risk would be hard to justify merely in exchange for a temporary expansion of global market share – the current lost revenue would take years to recover with a marginally higher share of global supply. But in a world where a producer sees the end of its market on the horizon, then every barrel sold at a profit is more valuable than a barrel that will never be sold.”

Saudi Arabia’s declining oil empire

Saudi Arabia, the world’s biggest crude exporter, shipped

5.7%

Less oil overseas in 2014 than it did in 2013

Shipments averaged

7.11m

barrels a day; down from an 11-year high of

7.54m

barrels a day in 2013

In December 2014 exports dropped

5%

from November to

6.9m

barrels a day

Sustainable alternatives
As oil sees a sharp decline, other technologies are finally beginning to show their potential. Many countries have long dodged climate change regulations, but there have been signs recently that countries are beginning to take the issue seriously. Both the US and China have signed up to relatively strict carbon emissions targets in recent months, while US companies increased their investment in clean energy technologies last year to $52bn. China followed suit, with an investment last year of $89bn in clean energy technologies, a huge increase of $19bn on 2013’s figure (see Fig. 1).

Although governments enthusiastically backed many renewable energy technologies with generous subsidies at the turn of the century, a number of leading companies failed to turn their clean energy operations into profitable businesses. These included solar panel maker Solyndra, which severely damaged the reputation of the industry when it was declared bankrupt in 2011, despite a series of government loans.

However, the solar energy industry has certainly bounced back from a number of setbacks a few years ago. Prices of solar panels have fallen sharply over the last five years, and a number of observers are predicting that the industry will surpass more polluting fuels over the course of the next decade.

The IEA released a report last year that suggested by 2050 the world’s electricity supply would be provided largely by solar power. According to the report, two solar technologies – solar photovoltaic (PV) systems and solar thermal electricity (STE) – could result in a 27 percent of the world’s energy supply, meaning it would be the dominant form of power generation. This would also result in the prevention of six billion tonnes of carbon dioxide emissions, which represents more than all of the US’ current energy-related carbon dioxide emissions.

The IEA’s Executive Director Maria van der Hoeven said, “The rapid cost decrease of photovoltaic modules and systems in the last few years has opened new perspectives for using solar energy as a major source of electricity in the coming years and decades.” Despite this potential, she added that upfront capital costs are still relatively high. “However, both technologies are very capital intensive: almost all expenditures are made upfront. Lowering the cost of capital is thus of primary importance for achieving the vision in these roadmaps.”

Fig 1 New Investment in clean energy by region

According to a study conducted by independent German think tank Agora Energiewende in February, solar power is emerging as the cheapest power source for many parts of the world. The study also suggests that this has happened far quicker than many had predicted.

Dr Patrick Graichen, Director of the Agora Energiewende, said in the report, “The study shows that solar energy has become cheaper much more quickly than most experts had predicted, and will continue to do so. Plans for future power supply systems should therefore be revised worldwide. Until now, most of them only anticipate a small share of solar power in the mix. In view of the extremely favourable costs, solar power will on the contrary play a prominent role, together with wind energy – also, and most importantly, as a cheap way of contributing to international climate protection.”

A changed perspective
Another report that followed in March by Deutsche Bank suggested that solar power will generate as much as $5trn worth of revenue by 2030. This would represent 10 times the figure of today, driven by the dramatically falling cost of building solar plans. The bank’s report represents a significant endorsement from a major financial institution more concerned with profit than environmental causes.

Whereas solar previously represented a costly technology propped up by government subsidies, it is now seen as a financial viable investment, says Deutsche Bank. “…we think solar has now become an investable sector and over the next five to 10 years, we expect new business models to generate a significant amount of economic and shareholder value. Looking back eight to 10 years ago, the solar industry was in the primitive stages and mostly dependant on government subsidies. Most companies that came to the public market were manufacturing businesses earning above-average returns due to unsustainable government subsidies.”

The report adds that the financial crisis may have been what really spurred on the growth of the industry. “The global financial crisis that resulted in the demise of several solar companies was really a blessing in disguise. The financial crisis really acted as a catalyst that resulted in reduction of solar hardware costs. Emergence of innovative financing models by companies such as SolarCity and NRG really acted as the second catalyst for further reduction in solar financing costs.”

Deutsche Bank analyst Vishal Shah added, “Over the next 20 years, we expect nearly 10 percent of global electricity production to come from solar. Bottom line: we believe the solar industry is going through fundamental change and the opportunity is bigger than it has ever been before.”

While solar has had a resurgence, there has also been a concerted effort to get tidal energy contributing more to the world’s power generation mix. The UK has been particularly keen to harness the oceans surrounding it, with a series of projects being developed off the coast of Wales, Scotland and northern England.

In March, a 70km-squared tidal lagoon off the coast of Cardiff was announced that would be able to generate up to 2,800MW and power every home in Wales. In Japan, the country’s New Energy and Industrial Technology Development Organisation unveiled a $501m tidal energy project.

The scheme, in partnership with Toshiba and IHI Corp, will look at ways in which Japan can find alternative sources of sustainable power in the aftermath of the Fukushima nuclear catastrophe of 2011. It is the nuclear power industry that took such a serious hit in 2011 because of the reactor leak in Japan. The German Government was quick to announce a phasing out of the technology in the aftermath, with no more nuclear power to be used in the country by 2022.

Belgium and Spain unveiled similar plans to axe nuclear power from its energy sources, while France – traditionally a big supporter of the tech – has said it will scale back some of its own power plants. However, with dwindling resources of oil, nuclear power is certain to play a prominent part in the makeup of the world’s energy mix in the future. China has begun heavily investing in nuclear power plants after four years of no development, while Russia and India have plans to invest in their own projects.

Oil price per barrel

The shale revolution in the US – which many countries are themselves hoping to replicate – has delivered huge amounts of liquefied natural gas (LNG) to the market. LNG has become a hugely important part of the world’s energy mix. According to a report by Bloomberg, this year will see shale become the second most valuable commodity in the world after oil, with trade exceeding $120bn. By 2035 it is expected to be the second most used source of energy, according to Total, moving ahead of coal. The North American shale gas finds have proved a boon to the many providers there, while countries like Iran are eager to come in from the international wilderness and sell their huge deposits of LNG to the rest of the world.

Seize the day
The falling price of oil is not expected to be a freakish short-term blip for the market. Many observers expect oil prices to remain low for the foreseeable future, which could prove to be a problem for the global economy. With oil prices remaining low (see Fig. 2) and a rise not looking likely in the short-term, the prospects for the global economy seem quite stark.

ExxonMobil CEO Rex Tillerson told a conference in March that the price is unlikely to increase anytime soon, spelling bad news for the global economy. “People need to kind of settle in for a while. There’s a lot of supply out there. And I don’t see a particularly healthy world economy”, he said.

Some observers, however, feel that the decline in price of oil could be a huge opportunity for the world to embrace alternative methods of power. Ben Goldsmith, founder of leading European sustainable investment firm WHEB Group, told World Finance that the falling price of oil over the last 12 months has presented the world’s governments with an opportunity to invest in cleaner forms of energy production.

This, he says, can be achieved through slashing the generous subsidies that the oil industry has enjoyed for many decades, and instead diverting the money towards renewable technologies: “The recent sharp drop in the oil price presents governments around the world with a unique opportunity to cut back subsidies for both the production and consumption of oil. Such subsidies are unaffordable in many cases, unnecessary, and act as a drag on the development of clean, renewable alternatives. By cutting back the subsidies the playing field is levelled, and the clean energy revolution will move on even faster.”

Goldsmith says the attractiveness of clean energy is its stability compared to the highly volatile fossil fuels that have been traditionally used. “As we have seen, the prices of oil, gas, and coal move up and down like a yo-yo. Clean energy offers a completely non-volatile alternative to these unreliable, volatile and polluting forms of energy. This predictability is one of the key benefits of clean energy.” While the day when oil is no longer the dominant fuel has yet to come, the past 12 months could prove to be the turning point for how the world decides to power itself in the future.

Italy’s stale political system is what’s hampering its economy

Italy’s Prime Minister, Matteo Renzi, is close to performing a minor miracle that will play a crucial role in helping the country make the constitutional and economic reforms that it so desperately needs. In January his government passed a measure that, if accepted by the senate, will limit the size and, therefore, power of the upper house to block laws. The upshot being that his government, which holds a majority in the Chamber of Deputies, will possess the power to implement the prime minister’s extensive reform agenda, which aims to boost living standards and strengthen the overall economy.

Italy’s political system is notorious for its inefficiency and corruption, characteristics that its prime minister says must be shed if the country has any hope of climbing out of the economic abyss it finds itself in. It is why he is also attempting to pass a new electoral law in the lower house, with the purpose of producing a clear winner in the next general election.

Overall, the reforms are good news for a country in desperate need of jobs, but Italy is going to need to do a lot more to revive
its economy

Traditionally, the country has suffered because its numerous political parties have each struggled to garner enough votes to secure a significant mandate to govern. The new proposal, however, states that, if no party can win a majority (more than 40 percent of the vote), a run-off between the top two parties will be staged to assure the newly elected government commands the necessary authority to ensure the political cogs can keep moving – something that is essential if Italy is to meet the challenges it faces with any sense of conviction.

Labour rules
So far, real progress has been limited due to political gridlock. Even so, Renzi has managed to approve the key parts to his overhaul of labour market rules, which aims to boost job creation in a country haunted by high unemployment, especially among its young people, with the youth unemployment, as of January 2015 sitting at 41.2 percent – the lowest it has been for over a year, but still far too high (see Fig. 1). The Jobs Act also intends to boost women’s participation in the workforce by improving policy on parental leave and providing quality child care for mothers looking to enter work.

The new labour market rules, having eased firing restrictions for large private sector companies, have helped reduce the use of temporary contracts. It is estimated that more than 200,000 people will see their employment status switch from temporary to a new type of permanent contract, which will offer minor compensation in the event of dismissal with that amount increasing with seniority in an effort to meet employees and private sector employers somewhere in the middle.

The new labour rules already appear to have made an impact, with car manufacturers Fiat and Chrysler echoing similar sentiments to those of Telecom Italia, who recently unveiled plans to hire 4,000 people.

“We are again recruiting, after seven years”, Chief Executive Officer of Telecom Italia Marco Patuano said. “We need to strengthen our workforce by introducing new professional skills into the company, with young technicians and graduates between 20 and 30 years of age. We will be recruiting up to 4,000 people over three to four years, using the new regulatory tools the government is developing.”

“[Our] new industrial plan envisages around €10bn [$10.62bn] of investment in Italy in the next three years, over €1bn [$1.06bn] more than in the previous plan. Thanks to this significant increase in innovative investments”, added Patuano. “By 2017 we will reach 75 percent of the population with optic fibre and over 95 percent of the population with the 4G mobile network, positioning us as the leader in the infrastructure development of the country and thus getting closer to the targets of the Digital Agenda for 2020.”

An unprecedented path
Despite its apparent short-term success, Renzi’s Job Act has been met with criticism from those inside his party, as well as heads of trade unions, who contend that the reforms dismantle basic workers’ rights.

Youth unemployment in Italy

Overall, the reforms are good news for a country in desperate need of jobs, but Italy is going to need to do a lot more to revive its economy if it hopes to make a significant dent in unemployment figures over the long term. At least that is the view held by the Secretary-General of the OECD, Ángel Gurría, who said that the over-arching message of the 2015 OECD Economic Survey of Italy is a straightforward one: a lot done, a lot more to do.

“Italy is progressing on an unprecedented path of reform, that will not only boost growth and employment, but that, being a core country, will also bring confidence at the systemic, European level”, said Gurría. “Strong political courage has been necessary to advance this agenda. The Italian government should continue with this determination to complete the work. The reforms will also enable more resources to be directed to vital areas such as education, a fairer social safety net, improved support for job seekers and key infrastructure investment.”

Challenges ahead
The truth is, Italy is in bad shape. The financial crisis has helped devastate economies across the eurozone, but even before it hit, Italy’s economy had begun to stagnate, with growth in real GDP per capita averaging just 0.7 percent between 2000 and 2007, compared to the OECD average of 1.7 percent over the same period. In fact, since 2011, the economy has been shrinking, and was flat in the fourth quarter of 2014.

Italy’s poor economic performance is underpinned by substandard levels of investment in education that are necessary to provide its citizens with the skills they require to find work in today’s economy. The country also ranks far behind other OECD members when it comes to many quality indicators such as jobs, earnings and housing.

Renzi’s reforms, however, can boost average annual per capita GDP growth by six percent over the next 10 years, which may not sound like much, but considering that the Italian economy has only grown four percent since the euro was first implemented 16 years ago, a figure worse than Greece, it is a massive step in the right direction.

While the changes that Renzi and his administration have begun to implement are positive, as always, the main threat to the country’s economic recovery is its political system and the members comprising it. Silvio Berlusconi, a man whose reputation precedes him, has been a thorn in Italy’s side for some time, and now it seems he wishes to cause his fellow countrymen yet more problems. Il Caimano (The Caiman), as he is affectionately, or perhaps not so affectionately known, is eager to challenge Renzi in the senate, asking for the support of his party (Forza Italia) to block the prime minister’s constitutional reforms. But for the sake of Italy’s future, many will be hoping The Caiman has lost his teeth.