Friday, August 29, 2008

Three Infrastructure News Stories

These infrastructure stocks continue to be out of favor on an "institutional money rotation away from global growth stories", but in the big picture I continue to believe the story is very interesting. Below is a series of stories entailing some of the opportunities and challenges we've discussed many times in the blog.

First, as we always say - America; the land of not addressing a problem until it's an emergency. And we have an emergency brewing in our infrastructure. The positive is, addressing this emergency can create many good, solid jobs for Americans. (these will be tough to offshore) The negative is we're plain broke and we'll have to call the Chinese or Middle Easterners to help us pay for the coming tsunami of upgrades. Or back to the printing press (strong dollar everyone - strong dollar) Even worse - many of these solutions will relay not on states (who actually seem to get some things done in America) but on that pathetic body called Congress, due to the need to cross state lines. Here we have a story from the NYTimes about the challenges of wind power vis a vie our national grid. A few ideas to address this angle are (conservative) [Aug 10: Quanta Services (PWR) - Looking to Break Out] or General Cable (BGC) [series of articles here] or (speculative) American Superconductor (AMSC) [Jun 12: Starting a Beachhead in American Superconductor (AMSC)]
  • When the builders of the Maple Ridge Wind farm spent $320 million to put nearly 200 wind turbines in upstate New York, the idea was to get paid for producing electricity. But at times, regional electric lines have been so congested that Maple Ridge has been forced to shut down even with a brisk wind blowing.
  • That is a symptom of a broad national problem. Expansive dreams about renewable energy, like Al Gore’s hope of replacing all fossil fuels in a decade, are bumping up against the reality of a power grid that cannot handle the new demands.
  • The dirty secret of clean energy is that while generating it is getting easier, moving it to market is not. The grid today, according to experts, is a system conceived 100 years ago to let utilities prop each other up, reducing blackouts and sharing power in small regions. It resembles a network of streets, avenues and country roads. “We need an interstate transmission superhighway system,” said Suedeen G. Kelly, a member of the Federal Energy Regulatory Commission.
  • While the United States today gets barely 1 percent of its electricity from wind turbines, many experts are starting to think that figure could hit 20 percent. Achieving that would require moving large amounts of power over long distances, from the windy, lightly populated plains in the middle of the country to the coasts where many people live. Builders are also contemplating immense solar-power stations in the nation’s deserts that would pose the same transmission problems.
  • Wind advocates say that just two of the windiest states, North Dakota and South Dakota, could in principle generate half the nation’s electricity from turbines. But the way the national grid is configured, half the country would have to move to the Dakotas in order to use the power.
  • The grid’s limitations are putting a damper on such projects already. Gabriel Alonso, chief development officer of Horizon Wind Energy, the company that operates Maple Ridge, said that in parts of Wyoming, a turbine could make 50 percent more electricity than the identical model built in New York or Texas. The basic problem is that many transmission lines, and the connections between them, are simply too small for the amount of power companies would like to squeeze through them. The difficulty is most acute for long-distance transmission, but shows up at times even over distances of a few hundred miles.
  • The power grid is balkanized, with about 200,000 miles of power lines divided among 500 owners. Big transmission upgrades often involve multiple companies, many state governments and numerous permits. Every addition to the grid provokes fights with property owners. (that's a problem)
  • In a 2005 energy law, Congress gave the Energy Department the authority to step in to approve transmission if states refused to act. The department designated two areas, one in the Middle Atlantic States and one in the Southwest, as national priorities where it might do so; 14 United States senators then signed a letter saying the department was being too aggressive. ("they" are an even bigger problem)
  • Without a clear way of recovering the costs and earning a profit, and with little leadership on the issue from the federal government, no company or organization has offered to fight the political battles necessary to get such a transmission backbone built. (welcome to America - if you don't have a lobbyist to fight your fight, nothing gets done)
  • We still have a third-world grid,” Mr. Richardson said, repeating a comment he has made several times. “With the federal government not investing, not setting good regulatory mechanisms, and basically taking a back seat on everything except drilling and fossil fuels, the grid has not been modernized, especially for wind energy.” (beat and puff out chest: "But we're America - we're the best at everything! Take that as a solution to your "facts"")
Onward - we've talked about the weakness in state budgets, that will only get worse next year. [Jul 25: States Slammed by Budget Shortfalls] [Apr 25: Shoes Beginning to Fall in the States] [Dec 16: California in a State of Emergency - Coming to a Theater Near You]

Remember these are are so very reliant on (a) income from home tax assessments as home prices fall (mostly) nationwide and (b) increased sales tax revenue while the national consumer is retrenching. So we know what the "fight the fire today, and kick the can down the road" mindset will be, correct? It's already happening (local example - debate in Detroit to sell off local zoo to raise funds for budget shortfalls) - now the question is just how far it will go. States and local municipalities will sell off assets for that 1x payment (get the "fix") and give up the annual annuity (income stream). I don't know if this is necessarily "good" or "bad" - one could make the argument that private enterprise would run things more efficiently... but I do believe the cost to consumers will be higher as private equity, hedge funds, and large financial institutions and hedge funds own our roads, bridges, and the like. Implications here are more and power moves from the masses (government) to the few elite. More concentration of wealth in fewer hands. You can debate amongst yourselves the merits - I'm just pointing out the long term trends coming your way. But it points again to a lack of planning, fiscal responsibility, and outright idioticy from government agencies with "our" money. Once again, the "sheep" do not realize what is going on, nor do they get involved, or kick these folks out - their decisions are costing us all, over and over. From the NYTimes: Cities Debate Privatizing Public Infrastructure.
  • Cleaning up road kill and maintaining runways may not sound like cutting-edge investments. But banks and funds with big money seem to think so. Reeling from more exotic investments that imploded during the credit crisis, Kohlberg Kravis Roberts, the Carlyle Group, Goldman Sachs, Morgan Stanley and Credit Suisse are among the investors who have amassed an estimated $250 billion war chest — much of it raised in the last two years — to finance a tidal wave of infrastructure projects in the United States and overseas.
  • Their strategy is gaining steam in the United States as federal, state and local governments previously wary of private funds struggle under mounting deficits that have curbed their ability to improve crumbling roads, bridges and even airports with taxpayer money.
  • This fall, Midway Airport of Chicago could become the first to pass into the hands of private investors. Just outside the nation’s capital, a $1.9 billion public-private partnership will finance new high-occupancy toll lanes around Washington. This week, Florida gave the green light to six groups that included JPMorgan, Lehman Brothers and the Carlyle Group to bid for a 50- to 75 -year lease on Alligator Alley, a toll road known for sightings of sleeping alligators that stretches 78 miles down I-75 in South Florida.
  • And then there is the odd romance between Americans and their roads: they do not want anyone other than the government owning them. The specter of investors reaping huge fees by financing assets like the Pennsylvania Turnpike also touches a raw nerve among taxpayers, who already feel they are paying top dollar for the government to maintain roads and bridges. And with good reason: Private investors recoup their money by maximizing revenue — either making the infrastructure better to allow for more cars, for example, or by raising tolls.
  • Mitch Daniels, the governor of Indiana, faced a severe backlash when he collected $3.8 billion for a 75- year lease of the Indiana Toll Road. A popular bumper sticker in Indiana reads “Keep the toll road, lease Mitch.”
  • Traditionally, the federal government played a major role in developing the nation’s transportation backbone. (but now the federal government is a paralyzed useless piece of... joy and wonderment) But since the early 1990s, the United States has had no comprehensive transportation development, and responsibilities were pushed off to states, municipalities and metropolitan planning organizations.
  • Look at the physical neglect — crumbling bridges, the issue of energy security, environmental concerns,” said Robert Puentes of the Brookings Institution. “It’s more relevant than ever and we have no vision.” (do you notice a theme that permeates through story after story of our national government? they sure do run $50M conventions well though!)
Some facts that should startle you as we sell off infrastructure stocks because (a) the world is ending and (b) its time to buy retail stocks and financials
  • The American Society of Civil Engineers estimates that the United States needs to invest at least $1.6 trillion over the next five years to maintain and expand its infrastructure. (cross the 4, carry the 1... umm... errr... $320 Billion a year? So you mean TWICE the stimulus check we just sent out EVERY year? Just to MAINTAIN what we have. Mr Paulson - it's time to get on the phone with our Chinese friends again. Oops nevermind - Goldman Sachs and friends just raised $250B - well that takes care of most of 1 year)
  • Last year, the Federal Highway Administration deemed 72,000 bridges, or more than 12 percent of the country’s total, “structurally deficient.” (so you are playing russian roulette as you drive, over 1 in 10 chance you are driving under a structurally deficient bridge)
  • But the funds to fix them are shrinking: by the end of this year, the Highway Trust Fund will have a several billion dollar deficit. (is there anything we don't have a deficit in, other than hot air and empty promises of all the things Obama/McCain are going to give to us once they arrive on their mighty horses into town January 09?)
  • We are facing an infrastructure crisis in this country that threatens our status as an economic superpower, and threatens the health and safety of the people we serve,” New York Mayor Michael R. Bloomberg told Congress this year. (one man with sense) Gov. Arnold Schwarzenegger of California warning of a national infrastructure crisis (two men with sense)
Back to the investing side
  • People are creating a new asset class,” said Anne Valentine Andrews, head of portfolio strategy at Morgan Stanley Infrastructure. “You can see and understand the businesses involved — for example, ships come into the port, unload containers, reload containers and leave,” she said. “There’s no black box.”
  • Some foreign pension funds that jumped into the game early have already reaped rewards: The $52 billion Ontario Municipal Employee Retirement System saw a 12.4 percent return last year on a $5 billion infrastructure investment pool, above the benchmark 9.9 percent though down from 14 percent in 2006.
  • Ten to 20 years from now infrastructure could be larger than real estate,” said Mark Weisdorf, head of infrastructure investments at JPMorgan. (hopefully they don't create the same type of debt instruments for infrastructure as they do in real estate - but don't worry they will create some Frankenstein object to fleece the masses - that's what they do and damn if they are not great at it)
Last story for all the "woe is me, China is going to crumble from 12% growth to (gasp) 7% - the world is ending" - well at least Rio Tinto seems to disagree. Granted their biased but for those who have a 40,000 point of view rather then the next 6 trading days, we continue to be huge bulls on commodities. An example here from the Guardian UK - Chinese Skyscraper Builders to put up Equivalent of 10 New Yorks.
  • Rio Tinto yesterday shrugged off talk of an impending collapse in the commodities market, pointing to recent research that suggested China will build up to 50,000 skyscrapers in the next 20 years, the equivalent of 10 New Yorks, creating sustained long-term demand for steel and other raw materials. The company cited research from McKinsey, the management consultancy, which said the scale and pace of urbanisation would continue at an unprecedented rate.
  • The company said that North America and Europe were becoming decreasingly relevant to the setting of metals prices, as demand is driven by China, India and other emerging markets (however American quant hedge fund computers are as ethno centric as their programmers and as you know, when the US sneezes China cries out in anguish and drops from 12% growth to -12% growth, or so stock prices reflect)
  • Chinese imports of iron ore are running 20% ahead of the same point last year. (yes but that is backwards looking; looking forward we should expect a drop off of at least 50% - or so the stock prices reflect) The average copper price charged by Rio in the first half was 20% higher than last year, gold was 38% higher and aluminium prices were up 2%. (strange, considering the globe is imploding ex- USA of course)
Sit back and think about this
  • By 2025, the report predicts that China will have 221 cities with more than a million inhabitants, compared with 35 in Europe today. (demographics is destiny)
  • McKinsey projects that China will build between 20,000 and 50,000 skyscrapers, many of them in less developed interior provinces far from Beijing and Shanghai.
So let's assume they and their management consultancy firm are engaging in hyperbole and are off by a factor of 50%. So it's only 5 New Yorks. Think about that while you hear the pundits on CNBC cry about the end of commodity boom and how its time to buy wonderful asset classes in the US such as financials and retailers with their growth rates of... wait, did I say growth rates? HAL 9000, the hedge fund quant computer, does not read the Guardian nor did his programmer - so the fact we are facing an army of HAL 9000s does not allow us to trade on such data. Hence we sit in stocks with unprecedented 20 year opportunities, losing money by the week, and have to wait until their algrorithims return back to the 'long term reality' trade. Yes the entire globe is slowing - we've exported our infamy and debauchery worldwide and our virus will infect the world - we're sneezing, and sneezing and sneezing. But it is all relative - but just keep this on your radar as we sit here feeling idiotic for believing a country "hobbling" along at 8% growth might actually be a better investment than one with a (rebate induced) 3% otherwise known as -1 to 1%.

And please, give your Congress(wo)men and a hug and a pat on the back - "Heck of a job Brownie!"

Long American Superconductor in fund; no personal position

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