“According to the Mercer Pension Health Index, the decline in longterm interest rates over the past six months has brought the funded status of Canadian pension funds near the all-time low reached in 2008 (Chart 20). This index declined from 71 per cent in the second quarter of 2011 to 64 per cent at the end of October, indicating that a representative pension plan faces a higher risk of being unable to fully meet its financial obligations.”
2. 1
Can you spare a moment for the real economy? Despite the
undoubted, but cheap, appeal of adding to the chatter about
which country is thought to be going bankrupt this week or which
government believes it can prevent this outcome by the expedient
of effectively adding zeroes to amount of its currency in circulation,
I thought instead I would try to conduct some analysis of a few
trends in the productive economy. Sadly, trying to forecast the next
12 months, or even the next month for that matter, in large part has
become a game of guessing how the markets are going to react
to political announcements in the land of sovereign debt. How, as
people attempting to make rational economic decisions, can we
possibly predict the day-to-day actions of markets dominated by
non-profit maximizing government and central bankers?
It follows that this may be one of those times when long-term
trends are easier to discern than short-term and so today’s
discussion revolves around some long-term issues in the areas of
pensions and energy. I also want to examine another important
trend in water resources which I will do in my next briefing.
Pensions (see also Agcapita briefings - Pension Funds and
Hobson’s Choice & Demographics are Destiny): Pension plans are
heading into a challenging period for their ability to pay promised
benefits and perhaps for some even for their solvency. At its
core, the issue arises because a significant number of pensions
assume annual returns in the range of 8% when they are planning
how to meet their obligations - at the same time as they are being
faced with the Zero Interest Rate Policies (“ZIRP”) and boomer
demographics. As Ron Chernow points out people are beginning
to worry that this might not be a workable investment model “There
is a kind of fear, approaching a panic, that’s spreading through the
Baby Boom Generation, which has suddenly discovered that it will
have to provide for its own retirement.”
Demographics: It is no secret that the developed world is facing
a wave of retirements as boomers move to the end of their
productive careers. Just how big is this transition? In 2000, the
ratio of Americans between 15 and 59 years old to those over
Agcapita Update
3. 2
Agcapita Update (continued)
60 was four to one, according to a United Nations
report. In 2050, the ratio will be only two to one.
The boomers will need to liquidate assets to fund
retirement. However, we can’t all cash out at once
- pensions are already facing solvency issues and
when the boomers start to liquidate this issue will
grow in magnitude with poor equity returns as the
transmission mechanism. If you don’t believe me,
here is the bad news straight from the horse’s mouth
- the US Federal Reserve - an organization which
is much more likely to err on the side of optimism
than full disclosure: “Historical data indicate a strong
relationship between the age distribution of the U.S.
population and stock market performance. A key
demographic trend is the aging of the baby boom
generation. As they reach retirement age, they are
likely to shift from buying stocks to selling their equity
holdings to finance retirement. .... P/E* should decline
persistently from about 15 in 2010 to about 8.4 in
2025, before recovering to 9.14 in 2030... Moreover,
the demographic changes related to the retirement
of the baby boom generation are well known. This
suggests that market participants may anticipate
that equities will perform poorly in the future, an
expectation that can potentially depress current
stock prices. In that sense, these demographic shifts
may present headwinds today for the stock market’s
recovery from the financial crisis.” Poor equity returns
indeed!
ZIRP: How does ZIRP also affect my pension you
may ask? A large portion of pension portfolios
are in fixed income securities that are now yielding
a fraction of the returns required to maintain plan
benefits. The longer ZIRP continues the worse the
problem will become. Ultimately, the combination of
demographics and ZIRP is going to mean benefits
will have to be reduced and/or large amounts of
additional capital in the form of higher contributions
will have to be collected. A recent report from the
Bank of Canada supports this conclusion. According
to the BOC December 2011 Financial System
Review “The aggregate solvency of defined-benefit
pension funds in Canada is close to an all-time low”
(emphasis mine) and further that “According to the
Mercer Pension Health Index, the decline in long-
term interest rates over the past six months has
brought the funded status of Canadian pension funds
near the all-time low reached in 2008 (Chart 20).
This index declined from 71 per cent in the second
quarter of 2011 to 64 per cent at the end of October,
indicating that a representative pension plan faces a
higher risk of being unable to fully meet its financial
obligations.” No mention of course that it is exactly
the ZIRP policies followed by the BOC that in part are
responsible for this problem.
EROEI (see also Agcapita briefing - Start Thinking
About EROEI): I have touched on the matter of EROEI
on and off over the last year. Put simply, it requires
energy to produce energy and the relationship is as
Energy Return On Energy Invested. I’d like to take a
short-cut and quote from my 2011 EROEI briefing:
Why is EROEI important? Because we are in the
process of transitioning from high EROEI hydrocarbon
sources of energy to low EROEI sources - think Saudi
Arabia versus the oil sands. Even if you don’t believe
that peak oil is an immediate issue, I would argue
that EROEI decay is most certainly. Discoveries of
conventional oil total roughly 2 trillion barrels, of which
1 trillion have been extracted so far, with another
trillion barrels to go. However the first trillion barrels
was the oil found on shore or near to shore; close
to the surface and concentrated in large reservoirs;
in politically stable regions - the “easy oil”. The
4. 3
Agcapita Update (continued)
remaining oil is far offshore or deep underground;
smaller, harder-to-find reservoirs; in politically unstable
locations- the “difficult” oil.
I believe an increasingly reliance on “difficult oil” has
some serious consequences for the global economy.
The first is that deliverability - the amount produced
per year for a given quantity of reserves - will fall,
making it harder to increase total production even if
reserves remain relatively abundant. The second is
that the real cost of extracting the remaining reserves
will escalate in terms of the energy inputs required.
Current production is around 86 million BOPD.
However an 86 million BOPD oil production profile
of high EROEI sources is very different from 86
million BOPD of low EROEI sources. Effectively the
net energy left over to drive economic growth is
significantly lower in the latter scenario. Here are
some very approximate EROEI ratios for various
energy sources:
– 1970s oil & gas discoveries - 30 to 1
– Current conventional oil & gas discoveries -
20 to 1
– Oil Sands - 5 to 1
– Nuclear - 5 to 1
– Photovoltaics - 3 to 1
– Biofuels - 2 to 1
Assuming 86 million BOPD composed of 1970s oil
& gas - there is around 83 million BOPD net to fuel
growth. Assuming 10% 1970s oil & gas, 45% current
oil & gas and 45% oil sands then this drops to 76
million BOPD - an 8% reduction. So as we transition
to lower EROEI sources of energy - it seems logical
that production has to increase faster and faster to
generate the same rate of economic growth.
Water: An examination of water resources as they
relate to agricultural and industrial output and some
practical consequences of water constraints for
emerging economies - particularly China and India -
will be included in part 2 of this briefing. In the interim
I will leave you with some quick agricultural facts you
may find interesting:
– In the United States, approximately 3,000
acres of farmland are taken out of production
every day and used for non-agricultural
purposes.
– In the United States, 44% of all farmland
is owned by individuals who do not farm
the land themselves - they lease it back to
farmers. In Canada this percent is significantly
lower as financial investors are still relatively
new to the market.
– Saskatchewan has approximately 40%
of Canada’s farmland - Alberta and
Saskatchewan together have approximately
70% making the two provinces the
cornerstone of Canadian agriculture.
– China, with 20% of the world population, has
only 7% of the world’s arable land.
– China has lost 20 million acres over the last
10 years, much of this due to construction
– Wheat demand is projected to increase to
775 million tons by 2020 with 2/3 of this
increase coming from emerging economies
that will double their imports.
5. #205, 120 Country Hills Landing NW
Calgary, AB T3K 5P3
Canada
DISCLAIMER:
The information, opinions, estimates, projections and other materials
contained herein are provided as of the date hereof and are subject to
change without notice. Some of the information, opinions, estimates,
projections and other materials contained herein have been obtained from
numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates
make every effort to ensure that the contents hereof have been compiled or
derived from sources believed to be reliable and to contain information and
opinions which are accurate and complete. However, neither AGCAPITA
nor its affiliates have independently verified or make any representation or
warranty, express or implied, in respect thereof, take no responsibility for
any errors and omissions which maybe contained herein or accept any
liability whatsoever for any loss arising from any use of or reliance on the
information, opinions, estimates, projections and other materials contained
herein whether relied upon by the recipient or user or any other third
party (including, without limitation, any customer of the recipient or user).
Information may be available to AGCAPITA and/or its affiliates that is not
reflected herein. The information, opinions, estimates, projections and other
materials contained herein are not to be construed as an offer to sell, a
solicitation for or an offer to buy, any products or services referenced herein
(including, without limitation, any commodities, securities or other financial
instruments), nor shall such information, opinions, estimates, projections and
other materials be considered as investment advice or as a recommendation
to enter into any transaction. Additional information is available by contacting
AGCAPITA or its relevant affiliate directly.
Tel: +1.403.608.1256
Fax: +1.403.648.2776
www.agcapita.com