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UK oil and gas producers on Thursday warned Rishi Sunak, the chancellor, that his new windfall tax on their profits could force the cancellation of projects as well as prompt investors to deploy their capital elsewhere.
At a meeting with Sunak in Aberdeen, about 20 executives from companies with UK North Sea operations — including Equinor, Harbour Energy, Ithaca Energy and Shell — highlighted negative consequences from the chancellor’s 25 per cent “energy profits levy”.
The windfall tax, unveiled by Sunak in May, is meant to partly fund a £15bn support package for UK households struggling with soaring energy bills.
Simon Roddy, senior vice-president for Shell’s UK upstream oil and gas business, told Sunak the levy sent a “negative signal” that was undermining investment in British waters, according to people at the meeting. It raises the headline tax rate paid by North Sea oil and gas producers to 65 per cent.
An executive from Norwegian state-backed energy company Equinor suggested to Sunak it was questioning whether the UK was a sensible place to invest, said several people at the meeting.
Equinor is leading on one of the most eagerly anticipated investments in the UK North Sea, the £4.5bn Rosebank oil and gasfield 130km north-west of the Shetland islands. Equinor said later it was committed to delivering Rosebank and planned to take a final investment decision in the spring of 2023.
An executive from London-listed Serica Energy told Sunak the windfall tax would disproportionately harm smaller oil and gas producers compared to their larger rivals, which have big global portfolios of assets.
Executives asked for several key commitments from Sunak, including a review of the windfall tax every six months. The levy has a so-called sunset clause that would remove it at the end of 2025.
The industry also wants greater clarity on what the trigger might be for the removal of the windfall tax.
When Sunak announced the energy profits levy, the Treasury described it as “temporary” and said it would “be phased out when oil and gas prices return to historically more normal levels”.
This month he indicated that a retreat in prices to a range of $60-$70 a barrel may be the trigger for the levy’s repeal. Brent crude was trading at $111 a barrel on Thursday.
Executives would also like carbon capture and storage projects to be eligible for a new investment allowance that Sunak announced alongside the levy. The allowance is meant to provide incentives for companies to press ahead with schemes to boost UK oil and gas production.
But one executive at the meeting with Sunak in Aberdeen said the chancellor “was lacking in answers to the main questions the industry had”.
Another person with knowledge of the meeting with the chancellor said: “He found himself on the receiving end of some rather robust feedback.
“The relationship between the Treasury and the oil and gas industry might be characterised as several layers of frost.”
Deirdre Michie, chief executive of the North Sea trade body Offshore Energies UK, described the meeting with Sunak as “candid” and warned the windfall tax would undermine attempts to attract investment to Britain.
Shell, Serica Energy and Harbour Energy declined to comment.
A government spokesperson said its energy security strategy had set out how “North Sea oil and gas are going to be crucial to the UK’s domestic energy supply and security for the foreseeable future — so it is right we continue to encourage investment there”.
The spokesperson added that the levy’s investment allowance “means businesses will overall get a 91p tax saving for every £1 they invest — this nearly doubles the tax relief available”.
The Biden administration has placed five Chinese companies on an export blacklist for violating sanctions by allegedly providing support to Russia’s military and defence companies before and during the invasion of Ukraine.
The commerce department put the Chinese firms on the “entity list”, which effectively bars US companies from exporting to them. The companies, which are not globally recognised names, are Connec Electronic, King Pai Technology, Sinno Electronics, Winninc Electronic, and World Jetta (HK) Logistics.
“Today’s action sends a powerful message to entities and individuals across the globe that if they seek to support Russia, the US will cut them off,” said Alan Estevez, under-secretary of commerce.
The blacklisting was announced as the US grows increasingly worried about strengthening ties between Beijing and Moscow, particularly after Xi Jinping and Vladimir Putin in February signed a statement that described the China-Russia partnership as having “no limits”.
The Financial Times reported in March that China had signalled a willingness to provide military assistance to Russia, which set off alarm bells in Washington.
Over the past two months, Jake Sullivan, US national security adviser, and Lloyd Austin, secretary of defence, have warned their Chinese counterparts that Washington would take strong action if China gave Russia any military equipment or assistance. US officials said there was no evidence that China has provided military assistance.
The commerce department did not accuse the Chinese government or military on Tuesday of supplying equipment to the Russian army. “We have not seen China provide Russia with military equipment or systematic evasion of sanctions,” said a White House official.
But the decision to place the companies on the entity list emphasised the broader concern about ties between China and Russia. It also marked the first time that President Joe Biden’s administration has penalised Chinese entities for helping the Russian military since Putin launched the invasion of Ukraine in February.
Chinese and Russian nuclear bombers flew over the Sea of Japan last month while Joe Biden was in Tokyo, further stoking US anxieties. Experts said the exercise highlighted how Beijing was co-operating with Moscow even as Russian forces waged their assault on Ukraine.
The Chinese embassy in the US said Beijing was playing a “constructive role” in promoting peace talks and had not provided military assistance to Russia.
“China and Russia maintain normal energy and trade co-operation, and the legitimate interests of Chinese companies should not be harmed,” said an embassy spokesperson, who criticised Washington for imposing unilateral sanctions under its “long-arm jurisdiction”.
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Good morning. Ugly day for stocks yesterday. The blame was pinned on a bad reading on the Conference Board’s consumer confidence index. Feels more like a market looking for an excuse to sell, though. And for good or bad, the market half-life of economic data is measured in hours at this point. Email us with measured, sensible, long-term views: firstname.lastname@example.org and email@example.com.
Working on yesterday’s letter about long-maturity corporate credit, I chatted with Jim Sarni, a principal at Payden & Rygel, a good friend of Unhedged. He pounded the table a bit, saying that I had things backwards: the real opportunity was in the short to middle bit of the curve.
“It’s appealing from the simple standpoint of, where the hell do I put my money right now, whether as an institution or a private investor,” Jim says. “And it can appeal no matter what view a person has — that we are facing Armageddon, or we are going to be fine.”
The argument goes like this. A portfolio of investment-grade corporates with an average duration around 2.5 years provides a yield of up to 4 to 4.5 per cent. “Doing the math on the back of a napkin,” Sarni says, “that means Treasury yields can move up another 180 basis points or so before total return to the investor turns negative.”
The two-year Treasury, roughly mirroring the expected peak for the fed funds rate, is yielding 3.1 per cent. Suppose that does move up to, say, 4.6 per cent. Now your basket of mid-duration corporates are barely at break even. But under those circumstances, equities and longer-duration bonds will probably be doing a lot worse than break even. Losing only a little money might have you feeling pretty good. And if rates fall (or spreads tighten), there will be bonus returns along the way.
CPI, of course, is running at 8 per cent or so, which makes a yield of half a lot less enticing. Sarni is undeterred: “You’ve gotta be somewhere. Eight per cent is not a long-term number. It’s 8 per cent coming down. Over the duration of this portfolio inflation won’t be close to 8 per cent — north of 3, south of 4, maybe?” Sarni thinks that, given the palpable slowing in the economy when the Fed is only halfway to its anticipated destination, the bet is tilted towards lower inflation and rates. And if the Fed pushes the economy into a hard landing, you could do worse than owning the debt of companies “that are going to weather the storm just fine”.
For a proxy of the kind of portfolio that Sarni is talking about, you can look at, for example, the Ice BofA 1-5 year corporate ex-144a index (yield to worst 4.25 per cent, average duration 2.7 years); or the Bloomberg US corporate bond 1-5 year index (yield 4.33 per cent, duration three years). Here is the price and spread of the latter over the past year:
Keen to hear from our readers in the bond business whether they also see value in this bit of the curve.
We’ve been asking around these parts what the next 60/40 portfolio — 60 per cent stocks for growth, 40 per cent bonds for stability — should look like if we are moving into a world of persistently higher inflation. In such a world, the glorious negative correlation of bonds and stocks of the last 30 years or so may be nothing but a memory.
We call this replacement, affectionately, the dumb portfolio. It has to generate decent returns over a long horizon, require little active oversight and can’t be too complex. There also have to be enough assets for a broad swath of investors to pile in. Inflation-linked I-bonds, for example, have less than $60bn in circulation. They don’t fit.
We noted last time that commodities looked better as an inflation hedge than as a way to grow capital. A few readers pointed out that we used an index that understates how well commodities have done by focusing only on raw price performance. They rightly suggested we try a total return index instead, which includes the extra yield earned by the collateral, usually Treasury bills, that must be held against commodity futures. The difference is noticeable:
Still, this is not a resounding growth story. The latest rally puts us back to early 2000s levels. The last sustained period of appreciation before that, from the early 1980s to early 2000s, saw commodities grow 531 per cent, versus over 2,000 per cent for the S&P 500. Unless you believe a commodity supercycle is coming (lots of people do!), expect a growth trade-off for the diversification benefit.
Another possibility is publicly listed infrastructure projects. Tim Robson, spooked by inflation a year ago, wrote that he cut out his 35 per cent bond allocation to add infrastructure and has liked the results:
This construct has performed as I hoped with significant gains and yield from this infra allocation offsetting my equity losses since the turn of the year.
In the UK this shift was relatively easy to achieve by buying a selection of UK listed infrastructure investment trusts.
Several readers suggested getting exposure to factors such as value or momentum. Here’s Caleb Johnson, formerly at AQR and now at Harbor Macro Strategies:
Investors don’t just need exposure to more asset classes, like commodities, they need exposure to factor and style premia. Yes, this has typically been available mainly through private investments . . . but they are also available through “liquid alts” in the form of mutual funds and [exchange traded funds] that non-accredited investors can access as well.
Consider a style factor like momentum. A commodities ETF treats an entire asset class like a monolith and is only going to give an investor passive exposure to it. But a factor-oriented fund is going to do more than offer long-only exposure, allowing investors to profit from exposure to individual markets across asset classes even when they are going down in price.
Along similar lines, Philip Seager at Capital Fund Management wrote that trend following, factor investing’s close cousin, looks promising:
Not only is it a diversifier (on average zero correlated with equities) but also has mechanical features that make it a hedge against long, drawn out, protracted moves down in equities (see the 2008 crisis for example). We have also shown recently that TF as applied to commodities provides an effective hedge against inflation (end 2021 and 2022 year-to-date demonstrate this). On top of all this because of its long term nature and exposure coming from very liquid futures contracts it also scales very well.
We don’t deny the proven power of trend following and factor investing (when done right) but wondered whether the underlying concept might be too complex, even if you can buy it in an ETF. In general, the point of the dumb portfolio is maximum returns given minimum trust in your fund manager. Factor investing asks for a lot of trust.
Paul O’Brien, a 60/40 optimist, suggested a simpler change:
The key premise of the 60/40 is not the negative correlation of stocks and bonds. It is the low covariance of stocks and bonds. Bonds are less volatile than stocks and so will diversify a stock portfolio (lower portfolio volatility) even if the correlation is [positive].
Rather than ditching the 60/40, investors may want to hold lower-duration bonds, or [Treasury inflation-protected securities].
Could building the inflation-proofed dumb portfolio be as easy as take 60/40, sprinkle in some Tips and small caps, and call it a day? (Ethan Wu)
Is the Fed tightening faster than it thinks?
The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy
The markets are evolving their minds about US economic prospects just as the Federal Reserve has been scrambling again to catch up to developments on the ground.
This risks yet another round of undue economic damage, financial volatility and greater inequality. It also increases the probability of a return to the “stop-go” policymaking of the 1970s and 1980s that exacerbates growth and inflation challenges rather than addressing them.
Good central bank policymaking calls for the Fed to lead markets rather than lag behind them, and for good reasons. A well-informed Fed with a credible vision for the future minimises the risk of disruptive financial market overshoots, strengthens the potency of forward guidance on policy and provides an anchor of stability that facilitates productive physical investment and improves the functioning of the real economy.
Coming into the second half of June, the Fed had already lagged behind markets twice in the past 12 months and in a consequential manner. First it stubbornly held on to its “transitory” mischaracterisation of inflation until the end of November, thereby enabling the drivers of inflation to broaden and become more embedded. Second, having belatedly course-corrected on the characterisation, it failed to act in a timely and decisive manner — so much so that it was still injecting exceptional liquidity into the economy in the week in March when the US printed a 7 per cent-plus inflation print.
These two missteps have resulted in persistently high inflation that, at 8.6 per cent in May, is hindering economic activity, imposing a particularly heavy burden on the most vulnerable segments of the population, and has contributed to significant market losses on both stocks and government bonds. Now a third mis-step may be in the making as indicated by developments last week.
Having rightly worried about the Fed both underestimating the threat of inflation and failing to evolve its policy stance in a timely manner, markets now feel that a late central bank scrambling to play catch-up risks sending the US economy into recession. This contributed to sharply lower yields on government bonds last week just as the Fed chair, Jay Powell, appeared in Congress with the newly-found conviction that the battle against inflation is “unconditional”.
The markets are right to worry about a higher risk of recession. While the US labour market remains strong, consumer sentiment has been falling. With indicators of business confidence also turning down there is growing doubt about the ability of the private sector to power the US economy through the major uncertainties caused by this phase of high inflation.
Other drivers of demand are also under threat. The fiscal policy impetus has shifted from an expansionary to contractionary stance and exports are battling a weakening global economy. With all this, it is not hard to see why so many worry about another Fed mis-step tipping the economy into a recession.
In addition to undermining socio-economic wellbeing and fuelling unsettling financial instability, such a mis-step would erode the institutional credibility that is so crucial for future policy effectiveness. And it is not as if Fed credibility has not been damaged already.
In addition to lagging behind economic developments, the central bank has been repeatedly criticised for its forecasts for both inflation and employment — the two components of its dual mandate. A recent illustration of this was the sceptical reaction to the Fed’s update on monetary policy released on June 15.
The scenario that worries the market — the Fed aggressively hiking rates only to be forced to reverse by the end of this year due to the threat of recession — is certainly a possibility, and it is not a comforting one.
There is another equally possible alternative, if not more likely and more damaging economically and socially: A multi-round flip-flopping Fed.
In this scenario, a Fed lacking credibility and sound forecasts would fall in the classic “stop-go” trap that haunted many western central banks in the 1970s and 1980s and remains a problem for some developing countries today lacking policy conviction and commitment. This is a world in which policy measures are whipsawed, seemingly alternating between targeting lower inflation and higher growth, but with little success on either. It is a world in which the US enters 2023 with both problems fuelling more disruption to economic prosperity and higher inequality.
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