Weekend links

Assorted links to updates on some of the stories we’ve been following at Econbrowser, including declining Saudi Arabian oil production, the role of mortgage-backed securities, and pressures on public pension funds to take on additional risks.

Jeremy Gilbert, retired Chief Petroleum Engineer of BP, weighed in last week on recent speculation at the Oil Drum about whether the decline in Saudi oil production signals that production from Ghawar, by far the world’s biggest and most important oil field, has peaked:

It is, of course, almost tragic that the Saudis won’t release more detailed performance data– and their own analyses– which would show the situation clearly and avoid the need for the painstaking work reported in Oil Drum….

It seems likely to me that the conclusions the authors have reached about Ghawar’s current status are broadly correct. However, it’s a big step to take from concluding Ghawar is currently at or close to maximum achievable production rate to saying that that rate cannot be maintained, or even increased, through the addition of additional production wells, through increased or more efficient water injection schemes or through surface facility modifications.

Heading Out, TOD’s resident petroleum specialist, also put in his two cents:

So far it seems that at both Ain Dar and Abqaiq Aramco have been able to keep this flood under good control for some years as the water has migrated through the field, and the oil has been recovered…. I still suspect that they will be producing from this part of Ghawar for around a decade yet.

Tanta at Calculated Risk is providing a tremendous service by producing a primer on how the alphabet soup of mortgage-backed securities operates. Parts one and two are up; can’t wait for part three. Businomics has a prequel.

And relevant for my ongoing concerns that many public pension funds are exposed to a socially undesirable level of risk, PensionWatch notes this proposal from the Teacher Retirement System of Texas:

Trustees of the $109 billion Teacher Retirement System of Texas have signed off on a seismic shift in investment strategy that will move tens of billions of dollars into hedge funds, real estate and other alternatives to stocks and bonds….

The teacher fund now has about $4.7 billion in alternative investments, less than 5 percent of the total. Under the plan that trustees approved Thursday, that would increase to 35 percent, or $38 billion based on the current value of the fund, over the next few years….

The fund did not begin investing in alternative assets until 2001. Over the past three years the investments have returned 20.4 percent a year, far outpacing U.S. stocks. But [new chief executive officer Britt] Harris said the fund has not invested enough money in them to significantly boost overall returns. “We’ve left a lot on the table” in terms of returns, he told trustees. “We want to be in the elite category.” The teacher fund’s returns have lagged behind those of other big public pensions with assets of more than $10 billion. Over the past three years, the fund has returned 11 percent annually, below the 11.6 percent median return of big funds.

Sorry folks, but you can’t judge an investment portfolio from 3 years of returns. You just can’t.



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23 thoughts on “Weekend links

  1. C Thomson

    Of course three years is too short a period from which to judge an investment strategy. But it is a long time in politics and public sector defined benefit plans are mostly about politics. That is why such plans need to be closed to new entrants. New hires should only go into defined contribution plans.
    As a fund manager, I used to market investment management services to public sector plans, including San Diego. Getting business invariably involved working with ‘consultants’ and ‘advisors.’ At best the process smacked of bribery and was focused on promised returns, an elaborate beauty parade process and smoozing. Surprise, surprise, former consultants often wound up working for fund managers or in organisations linked to fund managers.
    Apart from general sleaze in their manager selection process, many public sector plans are dimly aware that they have a hole in the bucket. This tempts them to double up on red. Few of the public sector trustees have even a vague understanding of the concept of investment risk.
    In the US we learned long ago, as did the UK more recently, that setting interest rates is too important to be left to elected politicians. The same is true of managing pension plans where the obligations span decades.
    The only answer is to close defined benefit plans. Take the toys away ASAP.

  2. pyrhon

    3 Years not enough time to judge?
    Contingent upon being 65 or so… what do you think our expected length of investing should be assumed as?
    Three years is a substantial portion of whatever number you come up with… and more to the point… your implying that that the next three years will be no different..
    So the prudent thing is to do what? Ironically, its a recipe for doing the only rational thing…. buy Zero Coupon US treasuries… you certainly know what the return of these will be in three years time…
    The State of Texas is correct in one way… assuming the system is still here.. the only thing that counts is relative performance…their “counterfactual” arguement is unassailable..
    If the Fund has been “smart” enough or “lucky” enough to have invested in these strategies they would have been better off…
    Given your essentially uninformative prior about what the future will bring…even you should agree with them that they should shift more to these alternatives than before…
    I gather from your commentary.. that if in three years the results are similar… you’ll be in hedgefunds yourself?…Or is your prior so strong that nothing will change your mind??

  3. JDH

    pyrhon, the question is not the time horizon for your investment. I don’t care whether it is 3 years or 3 months, makes no difference. The question is how to form an estimate of what that return will be. The practice of looking at what the actual return was over the last 3 years, and using that as your forecast of what the return will be over the next 3 years is what I believe to be dangerously wrong-headed.

    To pose this as a formal statistical question is really quite straightforward. The answer you’ll find when you do this is that one has very little solid basis for knowing what the next three years will bring if all one has is the last three years of data. What one needs instead is an analysis of the fundamentals, not just a brief historical track record. My concern is that the lack of transparency in many of these investments gives one very little beyond the track record, and that’s just not good enough to ask the public to accept these risks.

  4. wcw

    While every word CT says is true, I disagree with his prescription. Defined benefit plans on the large scale are like democracy itself: the worst possible solution, except for all the alternatives.
    Well, except for a real, national retirement insurance that truly socializes risk. Alas, in the US of the now, that is not a realistic alternative.

  5. Valuethinker

    C Thomson
    Try if you can to get hold of the Roger Lowenstein piece about pensions, that was in the New York Times Sunday Magazine about 3-4 years ago.
    It really is worth a read. A sample thing I discovered there, that I have never seen anywhere else:
    - when the US Social Security system was devised, the trustees forecast the improvement in life expectancy to be achieved, from 1938 to now.
    They were off by *less than 2 years*. Incredible.
    He raised the alarm bells about public sector pensions, there, the first time I had seen that in the popular press.
    However he also notes the whole issue about what kinds of pensions we want to pay public sector employees, and what is appropriate.
    The reality is with FBI agents, or firemen, or school teachers, or social workers, we don’t want ‘revolving door’ arrangements where these people are personally incurring substantial financial risk, or moving out into the private sector. We want long term tenure, we want ‘professionalism’ in the broadest sense of the term.
    This is why companies, which offered long term employment, went for defined benefit schemes. Nowadays companies aren’t around long enough, and jobs change too frequently, for most employees to find that attractive. But what you want in a bureaucracy is people with strong professional identification, who are not primarily money-motivated.
    (outsourcing is the way the UK has gone, and it’s a mess. Outsourcing often costs governments more money. Surprise surprise, civil servants, at least at the higher levels, are typically massively underpaid relative to the private sector)
    The answer, perhaps, is something like a TIAA-CREF in the higher education sector, that takes a fixed portion of employer and employee salary each year of the career, and invests it into a fund that guarantees some level of benefits.
    I’m not a big fan of privatising social security, because you are taking risk from the place best able to bear it (government) and putting the risk of volatility of income on people for whom SS will be their *only* or *majority* source of retirement income.
    Since you can’t ‘gain’ doing that in an efficient market (to make SS investments safe, you’d have to invest them into US government TIPS ie real return securities– this is the same as is currently done by the SS Trust Fund) without taking on a higher risk, there isn’t a point in tampering with the retirement security of the bottom half of Americans, who aren’t going to have other significant amounts of retirement savings, by and large.
    The reality is that the peak demand of SS on the US economy is going to be 6.5% of GDP (vs. 4.5% now) and that is well below any other developed economy except the UK (where pensioner poverty has become such an issue, that there will be changes). It’s below Germany, France and Italy *now*, for example.
    A 10% increase in US Federal Government spending (2% of GDP) is less than GWB has achieved during his Administration. It’s not going to break the back of the US economy.
    The Baby Boomers will start to die, and the SS ‘problem’ will go away. There will have to be some changes in benefits to account for greater longevity, going forward, but the ‘deficit’ could be closed by increasing payroll taxes (employer and employee) by 1.5%. Or by a lesser increase and some benefit cuts (eg taxing more of it).
    It’s a manufactured crisis, politically.

  6. Barkley Rosser

    Regarding Saudi, the big question after al Ghawar is what is going on in the Empty Quarter and what are the reserves out there? The Saudis just recently signed a deal with the Russians (first ever), to build pipelines to al Abqaiq from out there. Looks like the new area to expand capacity, and they have always been super secretive about the reserves out there. Long had one lone facility there, but it is high cost and difficult to operate there in the middle of the world’s harshest desert. I remind that it was only in 1917 that Harry St. John Philby became the first European to cross the Empty Quarter, ar Rub al Khali.

  7. Valuethinker

    Barkley R
    Ken Deffyes, at least, thinks that area has been mapped by oil geologists, more than once. Deffyes was an oil industry geologist, and then a professor at Princeton, so he does have credentials (albeit he is a ‘peak oiler’).
    New mapping techniques might find new deposits of oil, but they are unlikely to be 10s of billions of barrels.
    My own thought is that Gawar, East Texas and the few other ‘superfields’ were unique, and that our additional oil supply from now will be incremental (100k bl/day here, 1-2bn bl fields) and in hard to access unknown areas (deep offshore etc.), as well as in ‘alternate’ oil (Athabaska Tar Sands and Venezuelan assets).
    There was also a lot of talk about Saudi gas (Simmons covers this well), some, I think in the Empty Quarter. AFAIK this has never come to anything.

  8. Valuethinker

    JDH
    Texas has a distinguished history. There was a piece in Harper’s, a few years back, about the relationship between UTIMCO (the Texas University fund) and the Bush Family.
    In particular, UTIMCO put a lot of money into Hicks-Muse, a Texas buyout fund whose founders were heavy contributors to Bush 2000, and backed the Texas Rangers buyout. Hicks Muse has had a torrid time, and the partnership has effectively broken up.

  9. C Thomson

    Funded – or more typically – underfunded defined benefit pension schemes do not suffer from the same problems as Social Security which is an unfunded intergenerational transfer scheme.
    Defined benefit schemes have their own problems but even San Diego’s is backed by some assets, however insufficient, and has a clear legal obligation to the pensioners. The folks who should worry most about the underfunding of public sector defined benefit schemes are the tax payers. Big bills are coming, compliments of our magnificent politicians.
    A national intergenerational transfer scheme is as good as the politicians’ promises that back it.
    Any bets on those political promises being paid in full?
    Not many bet takers are there? Most Americans clearly expect some mix of tax increases and cuts in the promises. What about a little lateral thinking as well? After all FDR died a long time ago. We don’t buy cars designed in the 1930′s.

  10. Barkley Rosser

    valuethinker,
    I have read Simmons’ book and seen some related materials. I suspect that you are underestimating just how harsh that environment is. I doubt it has been fully explored.
    In any case, the Saudis are definitely increasing activity out there as the pipeline deal with the Russians demonstrates. They are not paying a former enemy to build pipelines to carry nothing.

  11. david

    What would be the rationale for Saudi Arabia to overstate its reserve base? Is it some type of cartel-enforcement mechanism?
    I would think that if I was the dominant producer that I would understate my reserves to prop prices up.

  12. PrahaPartizan

    david posted 22 April 2007 at 08:57 PM
    “…I would think that if I was the dominant producer that I would understate my reserves to prop prices up…”
    Yes, one would think that but the Saudis’ goal is just a little bit different. The Saudis have always felt they would be the last oil supplier standing when most other sources were essentially totally tapped out. So, they’ve been playing the long game.
    They’ve also been interested in making sure that alternative energy sources and alternative power systems were not developed to supplant petroleum. If crude oil becomes too expensive, those alternative energy systems start to become commercially viable and operational. Before long the Saudis would find that their customers had move one from petroleum, leaving them with less valuable barrels of oil in the ground and no market. Hence their desire to make petroleum somewhat expensive but always cheaper than the alternatives which might replace it. It’s a tough game but they have played it masterfully. What they haven’t considered is the world’s fury when everyone finds out they’ve been lied to for forty years.

  13. Valuethinker

    Praha
    Good analysis. It’s also worth reflecting that the Saudi state *depends* on abundant oil into the foreseeable future.
    If the National Security apparatus of the US could persuade itself that Iraq would be a cakewalk, (and apparently have some difficulty distinguishing between a Shia and a Sunni), then one can see how a feudal monarchy might have trouble believing that what keeps it in power, and keeps the different internal factions in their delicately balanced standoff, might not be there for as long as it is counting on.
    As long as they have enough oil left to buy our Eurofighters and keep our defence industry ticking over, I guess I am happy ;-).

  14. Valuethinker

    C Thomson
    You still have an intergenerational equity problem in a ‘funded’ system.
    Whether pensions are paid by a payroll tax, or by dividends and interest, they are paid by one workforce to the retired workforce.
    The ‘government won’t deliver’ line always seems to me to be paranoid. The US has yet to default on a public debt, in over 200 years of history.
    Similarly the argument that ‘the world has changed since Roosevelt’s day’ seems to ignore the durability of institutions. The US Constitution is still in place (antiquated though it is to foreign eyes), the US Marine Corps etc.
    The British old age pension system was introduced in 1904. The German in 1890.
    The experience of ‘user funded’ pension systems isn’t great. Chile is a disaster (even Marginal Revolution admits that). The British effort to ‘buy out’ individuals out of the second state pension will cost our government 10s of billions of dollars, and has meaningfully hurt the retirement prospects of millions.
    Sweden and Lithuania it is too early to tell.
    Inevitably, such a system imposes a ‘double taxation’ on the transition generation. They have to pay into the pensions of their parents, whilst saving to create the new system. *there* is an intergenerational equity disaster.
    Australia I have my doubts about the system. It seems to have been sold on a ‘no cost’ basis. ie it is Australian *employers* who pay in 10% of income to the Superannuation Scheme, not the employees. And Australia now has a negative personal savings rate (a la the US). It seems as if there has been almost perfect asset reallocation– individuals taking the Super, and cutting their own savings rates.
    The reality is, having the long term *base* financial future of individuals decided by gambling on the stock market, doesn’t make the economy more efficient, and can have all kinds of other negative consequences in terms of equity and risk transfer.
    In the case of state and local pension schemes, the issue is different. This isn’t the base retirement income of Americans paid less, often well less, than the national average. So all the arguments for funding are stronger. it’s really a way of getting local governments to recognise the financial cost of future obligations.
    But I would argue that for the first 25-30% of retirement income (relative to average wages), the state is the first, and only place, that can bear that burden of risk. The intergenerational equity problem comes out in the wash, and pay as you go is the best means of meeting that need.
    As I say, in the US case, the intergenerational pension problem is less than chronic: 2% of GDP from now to the absolute peak.
    And the US SS system does what it says on the tin. Poverty rates *drop* after age 65. That’s a phenomenal achievement, that what the US system cannot achieve in adult working life, it can at the end of that life.

  15. c thomson

    Valuethinker is mistaken. US Social Security is not a form of government debt and is not a legal contract. It is promises, promises. Let’s just wait and see what happens.
    Valuethinker would do better to focus on the real world. It is simply much harder for politicians to steal/reallocate/change the terms of millions of little pots of money that appear on an annual statement.
    Does Valuethinker truly believe that an increasingly brown US work force is going to toil its butt off to keep a bunch of inconvenient promises to aging honkies? Pity that Intrade doesn’t have a bet on this one.

  16. Buzzcut

    As good as 3D siesmic technology may or may not be (and who says that Aramco uses it anyway?), the best way to determine output from a field is to drill LOTS of wells.
    In the US, more than a million wells have been drilled over the course of our oil production history. This large number of wells means that we know with a high degree of certainty just what lies below the surface of our country.
    The Saudis have around a thousand wells. They in all likelihood have no idea what’s under the surface of their God forsaken sandbox.

  17. thefinancedude

    You are wrong Buzzcut….look at these 3D seismic cuts of KSA wells….
    http://www.theoildrum.com/files/ghawar_oilsat_rev.png
    http://www.theoildrum.com/node/2459
    http://www.theoildrum.com/node/2393
    That last one is FULL of 3D seismic pictures of well heads and wells in Ghawar. it’s funny how people seem to think this can be stopped. Texas was the model for the world and the North Sea, Cantrell, & Burgan oil fields have all declined to this day! So how is KSA going to be any different when the world’s appetite is GROWING and the supply is infinitely lower?

  18. Peter


    What would be the rationale for Saudi Arabia to overstate its reserve base? Is it some type of cartel-enforcement mechanism?


    OPEC member quotas are based on stated reserves. When that rule was implemented, OPEC members doubled the reserves they were claiming within a year.

  19. Anonymous

    I liked Gilbret’s comment:
    “I have to emphasise that in any reservoir engineering analysis there are almost always more unknowns than equations. As a result, one is generally faced with having to make estimates for part of the solution and then be concerned about the uniqueness of the solution derived. This is a situation which users of complex reservoir simulators are continually faced with.”
    This is my point. Our experience with Texas and “peak oil” was based on much, much more hard data from REAL OIL WELLS. The number of wells drilled in Texas simply dwarfs the number in the entire middle east. I just think that the alarmists are making conclusions without enough data.
    Of course, that’s not your fault. We’d all like more data. The analysis as to why the Saudis don’t release more data is fascinating.
    Anyway, it doesn’t mean that you’re not right, it just means that I could flip a coin to decide the issue and have as much confidence in the results as the seismic analysis. That’s a little overstated, but so is the entire “peak oil” hypothesis.

  20. Hal

    Last week The Oil Drum editor Robert Rapier reported on a phone conference held with the head of the American Petroleum Institute, Red Cavaney:
    http://www.theoildrum.com/node/2478
    Asked about Peak Oil, Caveney pointed to the situation with regard to exploration in Saudi Arabia:
    “The other point I would say is if you look at most of the rest of the world where oil is forecast to be, they are so underexplored that its not even (laughable?). For example, only three percent of the exploration thats taken place in the Middle East, even though theyve got, you know 70 percent of the proven reserves, in Saudi Arabia alone, which most people would argue has probably got a fair amount of oil there, they had fewer than 300 new exploratory wells that have drilled, and less than 30 of them were drilled since 1995.”
    I thought that was pretty interesting, fewer than 30 new exploratory wells drilled in Saudi Arabia since 1995. That seems to fit with the other commentary here suggesting that much of that territory is still unexplored, with the potential for major new oil finds.

  21. Valuethinker

    C Thomson
    Your real colours came out in that post. You addressed it to the ‘audience’ rather than to me, by referring to me in the third person.
    You said ‘I wasn’t focusing on the real world’. That’s usually a strategy for someone who isn’t grasping the other side’s argument, or can’t find a reasonable way to address it.
    You managed to use a racist epithet as well, highlighting fears about the changing ethnic makeup of America (when I was a kid, the same things were said about Catholics with all their babies, by the way): well done.
    Nice to see your true colours.

  22. Valuethinker

    PS C Thomson
    The ‘debt’ I referred to was of course the Trust Fund debt, which *is* a US government debt. There’s actually a clause in the US Constitution that says the US will alienate no debt, but I don’t know if that specifically refers to US government debt.
    Agreed the US can flex its state pension plan. And indeed it will.
    But the ‘crisis’ is simply an anomaly of birth rates, that birth rates soared 1946-1964, and then fell very rapidly. It’s self rectifying, as US birth rates and population growth slowly recovered after that. The ‘pig in the python’ gets eaten, in US terms. And it’s less of a ‘crisis’ than was the case when Ronald Reagan had his historic compromise.
    The notion that you can ‘create’ a solution to a problem of fiscal imbalance by speculation is as old as John Law and the invention of paper money in Louis VX France, not to mention the South Sea Bubble.
    As Greg Mankiw wisely pointed out when Clinton first floated the idea, the US government borrowing money, so that US citizens can take a punt on the stock market with their retirement savings, cannot be a sensible or prudent philosophy. And that is precisely what GWB has proposed– the US future pensioner will borrow money at 3% real, and invest it in the stock market. If his or her returns fall below 3% real, tough.
    Best
    Vt

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