periodical 14 - stern stewart &...

periodical14

The Times, They Are

Changin’

IN THIS ISSUE

Khalid al-FalihMinister of Energy, Industry and

Mineral Resources of Saudi Arabia

Jörg AstaloschChief Executive Officer, Italdesign Giugiaro

Dr. Florian BieberbachChief Executive Officer, Stadtwerke München

John DefteriosAnchor & Emerging Markets Editor, CNN International

Boris GleißnerChief Financial Officer, BENTELER International

Dr. Margarete HaaseMember of the Board, DEUTZ

Prof. Dr. Steve H. HankeEconomist, The Johns Hopkins University

Eva KienleChief Financial Officer, KWS SAAT

John PlenderColumnist, Financial Times

Dr. Ties TiessenChief Financial Officer, Wintershall

PLUS

The Stern Stewart Institute’s Spring Poll 2016

J U L Y 2 0 1 6

periodical 14

July 2016 The Tim

es, They Are Changin’

He was right. Some 30 years later it seems history is repeating itself. In fact, almost every day we can feel that the current political, social and economic climate is shattered. Demagogic leaders, terrorism, refugees, Brexit…but also the ongoing crisis of banking, the level of debt, the lack of global growth (other issues sure to come…).But while the revolution of the last century was driven by ideals to destroy the evil, it seems that we are now desperately looking for powerful forces that can make it up with the ugly.Change of scenes: Does the corporate world really look better? Well, in fact, many organizations also find themselves in a very difficult stage of maturity. They are struggling with increasing complexity, they are seeking for agility to stay innovative or become digi-tal…and they are longing for entrepreneurship in a maze of bureaucracy and compliance. The typical way out is defined in spin offs, M&A, and extensive controlling. But are those really a cure or just another curse?There is something obvious that is missing: Culture and values. These are the remedies that really can make a difference. But I’m not referring to mission statements or long-term visions. I’m talking about levers that empower the staff, give a meaning and an orientation in changing times.Examples? An ideal antidote to bureaucracy is simply the delegation of power. That’s exactly what entrepre-

neurs had before acquisition or what managers will gain after a spin off. Empowerment often produces better results than would be achieved by streams of directives and reviews. The pride in “why am I doing this” is a great intrinsic motivator and the glue to make every corporate place a one of-a-kind home.A good case for turning values and culture into suc-cess is Rackspace. This Texas-based IT hosting com-pany with a culture built around “fanatical customer support” has become leading in its industry – even in the face of competition from giant Amazon. The employees stand out as being “always-ready, always-accountable, always-helpful” specialists. They act as if it were their own company treating their clients as “fans” rather than customers.In contrast: After the Brexit referendum, one voter stated that “it’s hard to fall in love with a common market”. There is nothing more to say about the downside of missing values in our times.

I wish you an inspiring read with this 14th edition of our periodical.

Yours,

Gerhard NenningExecutive Director of The Stern Stewart Institute

THE TIMES, THEY ARE CHANGIN’In a 1988 concert, Billy Joel stood on Red Square in Moscow

singing his heart out to show what he could sense: A strong power of disruption that will change the times.

Gerhard Nenning Editorial Comment

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Content

3The Times,

They Are Changin’ Editorial Comment

Gerhard Nenning, Executive Director, The Stern Stewart Institute

6Current Trends

in Good GovernanceDr. Margarete Haase, Member of the Board,

DEUTZ AG

12Behind the Scenes of the

Automotive Industry – Disruption in the Service Provider Sector

Jörg Astalosch, Chief Executive Officer, Italdesign Giugiaro

18The Crisis of Green Sciences –

Expectations from a Business Perspective

Eva Kienle, Chief Financial Officer, KWS SAAT

22Saudi Aramco: Unleashing a GiantJohn Defterios, Anchor & Emerging Markets Editor,

CNN International

25A New Thinking

within the Kingdom

InterviewJohn Defterios, Anchor & Emerging Markets Editor,

CNN International together with Khalid al-Falih, recently appointed Minister of Energy,

Industry and Mineral Resources of Saudi Arabia

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Content

30Natural Gas – Political Weapon

and Climate Killer?Dr. Ties Tiessen, Chief Financial Officer, Wintershall

34How the Price of Oil

Impacts the Supply Industry Boris Gleißner, Chief Financial Officer,

BENTELER International

38Waking up the Sleeping Giant –

Renewables in the Heating and Cooling Sector

Dr. Florian Bieberbach, Chief Executive Officer, Stadtwerke München GmbH

42Monetary Muddle

John Plender, Board Member, The Stern Stewart Institute and

Columnist, Financial Times

46Monetary Policies Misunderstood

Prof. Dr. Steve H. Hanke, Board Member, The Stern Stewart Institute and

Economist, The Johns Hopkins University

52The Stern Stewart Institute

Spring Poll 2016Review

54Imprint

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Current Trends in Good Governance

Dr. Margarete HaaseMember of the Board

DEUTZ AG

Public perception of governance

Since the financial crisis and a number of slips in managerial behavior, a tremendous amount of con-fidence has been destroyed.

Good management starts at the top of the company, in the supervisory board, in top management and is cen-tered on the social value system and on regulatory parameters.

Not only the clients as direct recipients of products and services, but also the expectations which the public at large has of corporate governance are exerting increas-ingly more influence on the governance of companies.

These expectations shape the influence of owners and shareholders via the supervisory boards on good gover-nance. That which in owner-operated companies is transferred directly by the shareholders to the culture and the control system of the company, is effected in the public trade company via financial market communica-

tion and investor relations activities into the company indirectly.

Current developments indicate that companies today – more so than in the past – need the acceptance of the public in order to be successful. This ultimately entails that companies make a fair contribution to financing public services, also by paying taxes.

If every tax loophole is utilized by carving it out to its fullest extent, it should come as no surprise if a company comes under fire, and if there is a race with legislators to close loopholes.

Good governance means not just barely abiding by the laws, but also managing company funds with sound judgement, striking a balance among stakeholders, and voluntarily committing to and practicing a code of con-duct. The German Corporate Governance Code (DCGK) is a good starting point. Even without following the recommendations to a T, it helps to give some thought to good governance and to reflect on one’s own situation.

The management of large companies is currently being viewed very critically by the public at large.

Is there a lack of management? More likely is that there is a lack of confidence in management.

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Dr. Margarete Haase Current Trends in Good Governance

The DCGK Commission is a step in this direction. It prepares recommendations; non-compliance with them is not sanctioned directly, but nevertheless has to be pub-lished in keeping with the motto ‘comply or explain’.

Our entire economic system is currently the subject of considerable criticism and is being put to the test. We can all contribute a lot to strengthening the acceptance of the social market economy because the market economy is social, it makes people wealthy, provides them with goods, services, jobs, and ensures social integration.

The understanding that the conduct of an honorable businessman is worthwhile in the long run could help contain the urge to further regulate. And conversely, we have to expect that the regulation of business activity will further increase if numerous and significant slips and violations to the law continue to be the order of the day (see VW, Deutsche Bank, Schlecker, ADAC etc.).

The supervisory board in the spotlight

In the company the perception of practiced governance starts in the role model effect of the supervisory board. The requirements made of supervisory boards have in-creased dramatically. Not only has the risk of liability in-creased immensely, but so has the public pressure on responsible work in the supervisory board.

This is why the professionalization of the work of the supervisory board is taking shape. The supervisory board is not an honorary position anymore. Since the super-visory board has to challenge and advise the board on issues of strategy, business development, departures from the original target etc., it will not manage without indus-try knowledge and management skills to say nothing of the required independence.

Some supervisory boards like to participate in opera-tive topics. As a result, however, this does not create added value in our dual system. Instead, added value is created through so-called checks and balances. This in-cludes the ability to operate at a high level of abstraction and to participate nonetheless in a very specific way in the main topics of corporate governance and, above all, in strategy.

Moreover, the advisory board has to deal in depth with issues of compliance and reputation. Part of hitting the right “tone from the top” involves the supervisory board conveying just how important it takes issues of good gov-ernance, especially complying with laws and internal codes of conduct.

For years, waves of regulation have been rolling through German supervisory boards in short intervals, stipulating more intense oversight without any increase in pay for the supervisory boards.

In particular, while the reform of the final audit strengthens the audit committee in the supervisory board, it also adds to the responsibility and comes with a risk of new personal sanctions in the case of repeated violations of the provisions. Notably, the audit committee is going to have more duties stemming from various reg-ulations. Currently, the EU final audit reform is making considerable demands of the audit committee.

One observed tendency is that the handling of finan-cial and compliance issues is delegated completely to the audit committee. Even if the expertise is usually more bundled there than in the supervisory body as a whole, the entire supervisory board has to deal with these issues and, above all, set a good example. And that, too, is a result of growing regulation and the risk-averse nature of those supervisory board members not represented in the committees.

GOOD GOVERNANCE MEANS NOT JUST BARELY ABIDING BY

THE LAWS, BUT ALSO MANAGING COMPANY FUNDS

WITH SOUND JUDGEMENT, STRIKING A BALANCE AMONG

STAKEHOLDERS, AND VOLUNTARILY COMMITTING

TO AND PRACTICING A CODE OF CON DUCT.

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In light of this, the whole supervisory board has grow-ing expectations of the audit committee, and deci-sion-making preparations are generally happily trans-ferred to the committees.

The financial expert in the audit committee is increas-ingly assuming the role of the hinge among the chairmen of supervisory boards, the CFOs, and auditors on matters concerning the audit, compliance, and risk management. Playing this role well at this interface can contribute a lot to a well-practiced governance culture in the company. Ultimately, the whole supervisory board and the board have to be convinced of taking suitable measures for de-veloping a compliance culture.

One of the most important tasks of the supervisory board is succession planning, the selection of the board members, their evaluation, and the introduction of a re-muneration system which satisfies the requirements of company governance and the long-term character in ac-cordance with law. When it comes to the criteria for in-centivization, there are more and more discussions about including compliance targets.

Following the financial crisis, I observed that supervi-sory boards were increasingly committing themselves to risk protection and not enough to opportunity manage-ment.

But this trend appears to be in the process of reversing itself. In future, the activities of supervisory boards will shift more to strategy, HR, and further developing the company.

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Governance+I n v e s t o r s

+Cor

pora

te Cu

ltur

e

Governance and investors

With ownership comes responsibility. This responsibility is being perceived more clearly in light of the current de-velopment. Even investment companies are asking more about contacts to the supervisory bodies because for their part they are held more responsible by the shareholders.

Governance is undergoing a major change. Institu-tional investors are asking more questions about the qual-ity of governance and compliance. They are devoting par-ticular scrutiny to the management compensation system in terms of incentive criteria.

And so via investor relations a very constructive dialog is taking place with investors which requires little addi-tional regulation.

More specifically, investors and analysts gather the in-formation they need right from roadshows or confer-ences.

The general meeting, by contrast, has become a boring, pseudo-democratic, and mandatory event that is in des-perate need of reform.

Usually analysts are organized in such a way that they have an overview of the entire branch. This helps the an-alyzed companies to better assess their own competitive-ness.

This dialog also indirectly helps corporate governance and, in doing so, has a direct effect on corporate value. What is often overlooked and sometimes not taken ad-vantage of is the fact that analysts are the cheapest consul-tants.

There is a clear shift in the focus of analyst issues that seems to be moving away from quarterly results to infor-mation on the long-term development, the strategy, and the sustainability of business models with a strong em-phasis being placed on corporate governance.

The intention behind creating the DCGK was to make the German dual management system more familiar and understandable in the international world of finance. Since its introduction, numerous improvements have been incorporated, accompanied by umpteen suggestions from practitioners as part of the so-called consultation process. This has helped to make the system manageable.

The code and the German transparency regime have earned themselves a good reputation in the financial world, and over the long term this fact will increase the willingness of international investors to invest in Germany. Moreover, this helps promote the shareholder culture in Germany which is still embarrassingly backward.

Governance and corporate culture

A corporate culture based on values and trust is the foun-dation for governance. Many companies have drawn up a code of conduct, some even have employees and manag-ers confirm that they have received it.

If this entirely voluntary model had had a lasting pos-itive effect, we would not need any excessive rules. The notion of the medieval honorable businessman might appear antiquated to some. But, in fact, the conduct of the honorable businessman was embedded in the legal provi-sions adopted later on and taken as a basic concept.

Ethics is often just a part of the public image of compa-nies. Just how much of it is implemented and practiced internally is a whole different matter. It is impossible to write an ethics handbook that contains the right instruc-tion for every situation. Personal integrity guides every action.

In a successful corporate culture, people trust that the enacted codes of conduct will be followed; the culture re-lies on its managers and employees.

Well-thought-out compliance systems right up to whistleblower hotlines do not replace a managerial cul-ture based on trust. Showing trust in employees has a positive effect on the willingness to perform, cooperate, and be innovative, thereby reducing the effort involved in safeguarding and controlling.

The indispensable compliance tools are sometimes even an obstacle for the culture of trust. An increasing tendency to mistrust is the result of blatant cases of mis-conduct in business. Corporate management has to cred-ibly convey to employees that it will not use the system against them as long as they comply with the code of con-duct. Ultimately, the positive role model effect of man-agement is key for a corporate culture based on trust.

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Governance+C o n t r o l l i n g

IN A SUCCESSFUL CORPORATE CULTURE, PEOPLE TRUST

THAT THE ENACTED CODES OF CONDUCT WILL

BE FOLLOWED.

Governance and controlling

Good corporate governance does not function without hard facts, transparency, and suitable control systems. The right mix of hard factors (control systems) and soft factors (corporate culture) is key for corporate gover-nance.

The role and acceptance of controlling is relevant for the credibility of management. Controlling only creates the prerequisites for corporate governance and control by making the results, planning and deviations visible. The main task of controlling is to provide information that allows the supervisory board and the board to push through realistic plans and targets.

The stipulations contained in the German Act on the Appropriateness of Management Board Remuneration (VorstAG) for long-term aspects of remuneration can only be fulfilled by a forward-looking system. Moreover, qualitative aspects and strategic targets, such as an in-crease in market share, customer satisfaction, employee satisfaction, fluctuation, etc. should play a role. Yet often the target is overshot. For security reasons, remuneration systems in large companies are designed in a much too complicated way. For lack of transparency and calculabil-ity these systems cannot develop any incentive effect for board members.

Since the work of the supervisory board is moving away from retrospective oversight to evaluating future development and strategy implementation, controlling is taking on an important role in supporting the work of the supervisory board.

Conclusion

The following points can be concluded: ❱ Good governance strengthens the acceptance of our

economic system. ❱ Supervisory boards are challenged not only when it

comes to oversight, but also when it comes to strategy, succession, and governance.

❱ Investors are more actively involved in the discussion on governance.

❱ Corporate culture holds the major aspect to imple-menting good governance and has to be lived out.

❱ Without assertive controlling governance does not work.

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Many experience disruption as threatening because the existing is radically questioned, changed, or replaced by something new. And yet a disruptive

process is currently ensuring an unbelievably promising new start in the automotive industry, whose products we all nevertheless perceive to be often fascinating as well, and, in some cases, even desirable. And this will continue to be the case, but in a different way. Over one hundred years ago, people slowly transitioned from horse-drawn transportation to the first motorbikes and cars. This change was dramatic in many respects because it was completely new and unknown, and was regarded by many as threatening. The product, which we know and brought into the world, is changing, and is being abolished in this form or replaced by new products and services. We should be aware of this with regard to those who are about to experience a disruptive change. This process is all the more important in view of the opportunities which

it brings. In other words, without – quickly carrying out – such a change we can be quite certain that the chal-lenges of the years to come will not be manageable.

Mobility 2.0 and the sharing economy

Over the next few years, we are going to be faced with the same dramatic change in mobility as we were one hun-dred years ago, only this time it is going to be faster, more consistent and, hopefully, also more sustainable. At least in the city centers, but also in many urban regions world-wide, our cars or, perhaps at this point we might want to talk of mobile solutions and services, are going to be moving autonomously, networked, and electrically pow-ered. And we are going to share many vehicles and live, so to speak, in a shared economy. Today we are not yet able to fathom how this will change our daily routines as well

Disruption, there it is again, the word of the year

and in this article no less.

Jörg AstaloschChief Executive Officer

Italdesign Giugiaro

Behind the Scenes of the Automotive Industry – Disruption

in the Service Provider Sector

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Jörg Astalosch Behind the Scenes of the Automotive Industry – Disruption in the Service Provider Sector

as the urban use of space. As users of cars we just might soon be forced to do so, at least if we live in a city. On the other hand, this can free up our time and provide us with more free time if the corresponding mobile solutions are appealing for us.

Innovation from the second row

But we are not talking about the highly innovative OEMs known to all of us like Audi, BMW, Mercedes, Toyota, Ford, or Tesla. What we are talking about here are the cre-ative, fast, customer-focused service companies behind these manufacturers. In Europe, in particular, an army of these service companies has established itself with differ-ent USPs. From here, worldwide development services are worked out and vehicle concepts become reality, de-pending on the wish and in close cooperation with an OEM or even on an independent basis, to some extent right up to close involvement in the launch of the series in fabrication. The annual turnover of these external ser-vices is globally only around €17 billion in the passenger car and truck sectors. In the forecasts, this value is set to increase in the years to come by six to seven percent an-nually making it a rapidly growing market. The drivers are easily identifiable: development cycles for vehicles are declining, topics associated with digitalization in the ve-hicle or to do with the vehicle and with regard to the changing impetus away from the combustion engine are gaining momentum and are initially making vehicles even more complex than they already are today. Today, it is already hard to imagine a service appointment or an inspection being done without using a laptop.

A concentration of development service providers for the automobile with its satellite operations around the globe is something that exists mainly in Europe although in the USA and Asia new competition is emerging. And, Italdesign S.p.A., is just that kind of service provider and is one of the few companies to provide a comprehensive development process, if desired, from the styling to the conceptual development, the series development, and the production including the validation of the prototypes. It goes without saying that we are convinced that to date we have elevated this service to a very high level. There are around 60 million mass-produced vehicles worldwide that are based on our work, of them is a myriad of auto-mobile dreams that have made their way as posters into the bedrooms of children.

If we want to continue doing this in the future, we will have to dramatically rethink our business model. This is the only way we can maintain our creative and technical

WE HAVE TO DRAMATICALLY RETHINK OUR

BUSINESS MODEL.

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service, and, of course, secure our jobs. This will only work if we focus entirely on our clients, i.e. on the manu-facturers of automobiles and even in future develop vehi-cle concepts which generate success for the OEM in accordance with its objectives and allow it to inspire its clients.

Today, manufacturers are approaching development service providers and requesting complete or partial de-velopment of an automobile in more or less close cooper-ation with the own capacities, often to supplement a spe-cific skill or to maintain certain client know-how for a special target group. Subsequently, a styling is performed and developed, prototypes are manufactured, the devel-opment in cycles is improved and, finally, validations are carried out. The cooperation with the manufacturer and thus the client is shaped very differently in each case. In part, this is completely autonomous, but often it is associ-ated with considerable travel to the development centers of the OEMs.

Disruption needed

Why will there have to be a disruptive change here, too? For one, the automobile value-added chain right up to the construction of the product is becoming increasingly dig-italized. There is indeed still lots of know-how required from the employees, especially to do with how a vehicle concept is really developed in an integrative way so it can be produced precisely and in an influential way and ser-viced afterwards. This know-how is spreading in-creasingly around the world and is already available in various levels of ability and also considerably cheaper in

growing economies instead of in Europe, with factors in the double-digit region. So, ESPs in Europe have to qual-ify themselves with additional value in order to justify their salaries and costs. Consideration also has to be given to the fact that the client’s focus on main areas other than just optics, haptics, and driving performance will require a shift in focus of the skillset of engineers. The IT value- added share will increase with ESPs, with OEMs in the production and, later, in the business model in the opera-tion of the vehicle. What will also come to the fore are the requirements of the buyers and users with regard to the sustainability of the product, starting with the materials.

From new requirements to new players

The requirement the buyer has, together with the will of municipalities, cities, and lawmakers is also leading to an increase in electrification. Will the vehicle then be easier to build? Of course not in the solidity of an exemplary classic German car reserved for management. But there is no doubt that the quality requirement is changing. For many future users the gap between panels of certain vehi-cles is not important nor is the tradition of a manufac-turer, but connectivity, for instance, is something that is important. The author Christoph Keese vividly described this in his report about Silicon Valley based on an exam-ple from Stanford, and you can experience this any time in the Valley after a 12-hour flight. Take the time to ask young people or even your children about what is impor-tant to them about a car. The standards are different ones now. For engineering companies this is not a risk, but a promising development because more companies are

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going to need integration know-how for vehicles. One of the challenges is that many unconventional, and, in part, today completely unknown players in this sector are com-ing up with simple and adequate solutions for users by means of digitalization aspects and new IT and are get-ting their piece of the pie. But entirely new players are not the only challenge. Even tier 1 suppliers are surging onto the market. The number of M&A transactions is increas-ing. Disruption and an increasing change in the business model and the products and services have been taking place with the tier 1 suppliers for years.

The changes with the ESPs are also quite evident. In styling, the process is presented in an increasingly com-pletely virtual way. 3D glasses, data gloves and, with that, an understandable virtual reality are replacing traditional methods to a large extent. This will lead to improved co-operation with the closely related development depart-ments in the OEMs and to a dramatic time savings in the coming three years. The idea here is for the ESPs to exhibit a technological head start in order to become even faster in development. This requires targeted investments in technology and, above all, in the creative individuals who no longer have to work in dark suits, but who now may wear whatever comfy clothes they please. Moreover, we have to permit designers and engineers alike to inform themselves in depth about local markets and, of course, even about those outside of Europe with regard to the usage behavior of clients and of up-and-coming genera-

tions. This also includes getting a feel for or developing the range of technology which will be available in 10 or 20 years. To take this notion further, the idea is to set am-bitious goals with a view to designing cars in a pioneering way which we are going to drive five years from now.

Modern CAx techniques have long since found their way into engineering. Here we have to ensure that new possibilities in electronic hardware, software, and from production processes like 3D printing are integrated into developments. The goal is, in addition to vehicle integra-tion, to better carve out future value-adding USPs and to present these in an overall concept. Moreover, engineer-ing has to gain control of its cost positions in view of the new and strong competition coming from Eastern Europe and Asia. The product and service package offered to clients will thereby have to allow for a slight surcharge vis-à-vis less innovative service providers, but not in

VIRTUAL REALITY IS REPLACING TRADITIONAL

METHODS TO A LARGE EXTENT.

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every arbitrary range. Every kind of disruptive change also requires a keen rethinking with regard to the param-eters. The training and general organization of the work has to be designed more flexibly and openly. Hierarchies are necessary at times, but sometimes they also prevent the development of more creativity which is needed in these times of change.

Don’t forget about the costs

Lastly, the goal is to work more cost effectively and more innovatively on the manufacturing of prototypes. Even today, major synergies in the cooperation among the various areas are being created. Italdesign has, for in-stance, brought together the styling, engineering, and prototyping as well as the testing and validation on the same premises and under one roof. This can generate the speed which leads to a cost advantage. Moreover, we are going to have to invest a lot in future production pro-cesses. Taken together, these developments mean that the time needed and the costs can be reduced by a high double-digit sum and that the competitiveness can be ex-panded even more.

But is this enough to be successful in this business? The short and sweet answer is no! We are going to have to think even more intensely in business models which are relevant for the OEMs, clients and users, and other stake-holders. Which city or which OEM are we, for instance, going to offer which autonomous, electrical, or shared mobility solution in which package and with which model and at what costs?

These are the questions that need to be answered by modern engineering service providers in order to master the processes described above. Only then will the manu-facturers also be willing to pay the corresponding price for innovation made in Europe.

In light of all these challenges it should be noted that these developments can only be accomplished by the most important factor, the employees, who are able to adapt to the new challenges and whose possible fears of change can be allayed.

At the outset we spoke of how the pending or already occurring technological leap will provide us with many advantages and changes. One thing will remain and be strengthened with better concepts and integration and that is the special feeling of individual or shared mobility in all of its facets.

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During this time, the yields and outputs of several crops in-creased dramatically, sometimes more than tenfold as a result of increased knowledge and skills in plant breeding, agri-

cultural technology, fertilizers, and plant protection. These develop-ments were a prerequisite for Germany’s transition from an agrarian society at the beginning of the 19th century to an industrialized nation and a welfare state.

Outside Europe today, developments are widely differentiated. Research in the agro-sciences, whether privately or publicly funded, is a highly prosperous and promising investment area, especially in de-veloping or emerging nations. As an example, Chinese public invest-ments into agricultural research increased between 2000 and 2009 at a rate of 28 percent per year, and running costs in agriculture doubled. China now boasts the largest and most decentralized public agricul-tural research system in the world with more than 40,000 scien tists. Apparently, the size of the population and the changing consumer habits in China have triggered the government into realizing that agro-research is key to future self-sustainability.

The US, the world’s strongest agricultural economy, has struggled lately with the “fiscal cliff ”. Nevertheless, the 2014 governmental budget for agro-sciences rose by 7.7 percent to an astonishing $2.8 bil-lion. In many other industrial nations, however, the hangover feeling of the crisis years 2008/2009 has still not been fully overcome. Public budgets are still in a belt-tightening mode; the restrictions in govern-mental agro-research funding that had already been initiated some years prior to the financial crisis will very likely continue for some time to come.

As a result, renowned inter national research institutions, like CIMMYT (Centro Internacional de Mejoramiento de Maíz y Trigo – the International Maize and Wheat Improvement Center based in Mexico which is a non-profit research and training institution dedi-cated to both developing improved varieties of wheat and maize, and introducing improved agricultural practices to farmers) or IRRI ( International Rice Research Institute) have been experiencing much more pressure. Several other research and innovation institutes have had to shut down in recent years.

The Crisis of Green Sciences – Expectations from a

Business Perspective

Germany and Europe can look back on very impressive agricultural developments

over the last 100 years.

Eva KienleChief Financial Officer

KWS SAAT

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Eva Kienle The Crisis of Green Sciences – Expectations from a Business Perspective

Crop chemicals

Bil. constant 2006 US dollars

Crop seed and biotech traits

Fertilizers

Farm machinery

Food animal health

Animal nutritio

n

Animal genetic

s

1

0

3

2

1994 2010

Countries with increasing trends in R&D inputs Countries with stable trends in R&D inputs Countries with decreasing trends in R&D inputs Countries with no accurate trends in R&D inputs Non-surveyed countries

Figure 1: Most growth in private agricultural research spending has occured in the crop seed / biotechnology and farm machinery sectorsSource: USDA, Economic Research Service

Figure 2: Evolution of R&D inputs dedicated to agricultural sciencesSource: Impresa, Synthesis Report 2014 on Investment in Agricultural Research in Europe

Jump in private sector R&D spending

So it comes as no surprise that in past decades, pri-vate-sector companies have become major players in de-veloping new innovations for agriculture worldwide. The emergence of biotechnology and other scientific develop-ments, the strengthening of intellectual property rights (IPR) for agricultural innovations, the global expansion of markets for agricultural inputs, and changing govern-ment regulations are some of the factors driving private companies to invest in agricultural research. A study con-ducted recently by ERS (Economic Research Service of the USDA) provides first-ever detailed information on global research and R&D spending. Private-sector R&D expenditures in input industries increased by more than 40 percent in real (inflation-adjusted) dollars from 1994 to 2010.

Whereas on a global scale, the support for agricultural innovation has shifted from public to private-sector in-dustries, some clouds are gathering over the European continent. The association of the European Academies Science Advisory Council (EASAC) concluded from the June 2013 report that Europe is falling behind all other competitors when it comes to the efficient usage of arable land for food production. Prevailing politics were identi-fied as a major drawback for innovation in agriculture. Emerging technologies such as genome editing are on the horizon, allowing plant breeding to boost yields, protect against pests and enhance nutrient content. The extent to which plant research and crop breeding will benefit, how-ever, depends on how the EU decides to regulate these innovative tools and processes. Unless there is a sensible joint approach to regulation across nations, the global trade of crop commodities may be disrupted and innova-tion stifled. The German Leopoldina concluded some years ago: “We are in the process to export excellently educated scientists and researchers, instead of advanced plant seeds or agricultural technologies.” (Acatech/BBAW/Leopoldina (2009)).

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Eva Kienle The Crisis of Green Sciences – Expectations from a Business Perspective

Promoting education and partnerships

To safeguard excellence in research and teaching on the continent, the active engage-ment of companies and private investors is an absolute must. And education and the clarification of facts and context for consum-ers and society are essential. Co-operations and partnerships involving agro-industry players and universities or educational insti-tutions are needed to give students insight early on into future needs and to encourage students to pursue a career in research. Most of the models that create win-win-situations for universities and businesses (without in-fluencing research or teaching interests) originate from the US.

Unfortunately, even if there are some ex-emplary initiatives within the agro-industry, they cannot compensate for the strengthen-

ing required on the part of publicly-funded innovation and research in Germany and the European Union. Educating highly qualified researchers and improving research are two indispensable factors for a number of rea-sons. On a non-expandable global area of arable land, every year around 80 million more people need food. Eating habits, espe-cially in prospering emerging nations, are changing and demanding more and more protein. The sustainability of agricultural production needs to be strengthened, and a faster adaptation to climate changes is essen-tial. And, last but not least, agriculture needs to contribute to the production of renewable energy.

These are challenges which European agri cultural research and innovation have to face to avoid weakening the European agri-cultural economy further vis-à-vis its global competitors.

EVERY YEAR AROUND 80 MILLION

MORE PEOPLE NEED FOOD.

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The Kingdom made its first discovery back in 1933. In the early days, Standard Oil of California was calling all the shots and it left a legacy.

The sprawling campus here has Southern California written all over it, including US-styled tract homes, white picket fences and horse stables.

The look may still be American, but the Aramco of today clearly has a Saudi DNA. Executives are proud of being known as the world’s lowest cost producer and having what they say is the best track record in oil field management.

But the low-profile oil giant is in the process of being opened up to the outside world by Deputy Crown Prince Mohammed bin Salman who wants Aramco to play a central role in his “2030 Vision.”

Through an IPO, the Prince wants to unlock over $2 trillion of value – an ambitious goal after the steep decline in oil prices. By 2018, up to five percent could be listed on a combination of stock exchanges that could include New York, London, Hong Kong, and Riyadh.

Aramco is the largest single producer of crude oil by a wide margin. At 10 million barrels a day, it has more than double the output of its closest competitor, Russia’s Rosneft.

Saudi Aramco: Unleashing a Giant

When one thinks of Saudi Arabia, oil instantly pops to mind. The country lays claim to producing one out of nine barrels

consumed around the world every day.

John DefteriosBoard Member

The Stern Stewart Institute

Anchor & Emerging Markets EditorCNN International

23 periodical 14

John Defterios Saudi Aramco: Unleashing a Giant

I had a rare one-day peak inside Aramco that started at HQ in Dhahran and finished in the Shaybah field in the fabled Empty Quarter on the border of the UAE.

An hour-long briefing was led by chief executive Amin Nasser, who seems at ease preparing his team of 64,000 employees for the big bad world on global mar-kets.

“Privatizing this, let’s call it the crown jewel is some-thing important and it’s a vote of confidence of what we have. Sharing that with the rest of the world is important,” Nasser told me in our one-on-one interview.

He is not deterred by today’s price of $40 – $50 and deftly deflected my question about whether it would have been much wiser to undertake an offering when oil was averaging $100.

“The oil market is always cyclical…It will take some time and the prices will be where they will be when we start listing,” added Nasser.

Prior to my arrival in the Eastern Province, there were reports that Aramco was already in discussions with three potential partners: ExxonMobil, BP, and Sinopec of China. But Nasser did not hesitate in swatting away that speculation.

“We have not any discussions with any of these com-panies on the privatization,” he said.

But what stood out for me during my day in Aramco land is how the Deputy Crown Prince wants to maximize all the skills the energy giant has to offer. The company is being utilized as a Trojan horse that will be brought in to lead the Prince’s reform agenda.

Aramco has already overseen the building of training centers, primary schools, highways, and the largest uni-versity in the country, the King Abdullah University of Science and Technology (KAUST) north of Jeddah.

That may just be the entrée. Nasser said within a de-cade, Aramco will be responsible for creating half a mil-lion jobs in the country, 200 small and medium-sized enterprises, and 50 technology companies.

The mandate for Aramco mirrors that of the compa-ny’s chairman Khalid al-Falih, who took over not only as the minister of energy, but will oversee the ministries of industry and minerals in an expanded portfolio.

Al-Falih has been at Saudi Aramco since 1979 and has built a reputation as a no-nonsense man of his word who, like Aramco, delivers.

But it begs the question, is the bar being set too high for team Saudi Aramco?

The hard-charging Mohammed bin Salman is a man in a hurry. After the country burnt through $115 billion of reserves last year, he is eager to break the addiction to oil. He needs to jumpstart growth of just over one percent and create jobs. Unemployment is running over 11 per-cent; the youth jobless rate is more than double that level.

The changes that I see on the ground led me to recall an interview I conducted 15 years ago with Peter Brabeck-Letmathe, when he was CEO of Nestle. We talked about his biggest lesson as a global business leader.

Having waited two decades to get the top job at the Swiss food giant, he talked of sprinting out of the starting blocks wanting to transform a $237 billion company.

One year into the effort, he realized his colleagues were struggling to keep pace. He regrouped and as the saying goes, the rest is history. Today Nestle is one of the most valued brands in the world.

The global community is watching to see if Saudi Aramco – with a targeted value 10 times that of Nestle – can avoid stumbling and deliver all that the young prince has in mind.

THE LOOK MAY STILL BE AMERICAN, BUT THE ARAMCO OF TODAY CLEARLY HAS A SAUDI DNA.

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A NEW THINKING

25

In an exclusive interview after the OPEC meeting in Vienna with CNN’s Emerging Markets Editor/Anchor and Stern Stewart Institute Board Member, John Defterios, Khalid al-Falih, recently appointed Minister of Energy, Industry, and Mineral Resources of Saudi Arabia, discussed the current oil prices, the return of Iran to the international market, and the challenges facing the Kingdom.

WITHIN THE KINGDOM

26

Interview A New Thinking within the Kingdom

Al-Falih is both Chairman of Saudi Aramco and Minister of Energy, Industry, and Mineral Resources

in the new government of Saudi Arabia. Khalid al-Falih replaces Ali al-Naimi, who had held the post since 1995. This decision is unlikely to mean a change in Saudi oil policy, which is being fashioned and moni-tored to a large degree by Deputy Crown Prince Mohammed bin Salman. Al-Falih was born in 1960 in Riyadh, Saudi Arabia and raised in Dammam. He attended Texas A&M University in College Station, earning a bachelor’s de-gree in mechanical engineering in 1982, and later got an MBA at the King Fahd University of Petroleum and Minerals. After graduation he has spent more than 30 years in Aramco, where he was chief executive from 2009 until he was named chairman last year. The appointment of Falih did not come as a surprise; he has for years been considered a potential succes-sor to Naimi, who also stepped up to the post of oil minister after being the head of Aramco.

John Defterios: So, this was your first meeting. I know you wanted to put a new proposal on the table for a production quota. Would you define it as a failure not getting the quota or are you satisfied where we are at this particular time?

Khalid al-Falih: We did not have a proposal to start with, coming into the meeting. We were open to all options. There had been discussions about putting a ceiling, and we said if that made sense after having our discussions we would be willing to consider it. We came into the meeting feeling very good about the trend of the market, i.e. supply and demand re-balancing. What OPEC should do in our opinion is to monitor the market and to let that trend continue, to bring rebalancing into place.

John Defterios: Some sources I speak to within the Gulf countries seem unwilling to increase the prices too rapidly above $50 a barrel. Do you share that opinion?

Khalid al-Falih: I do not share the opinion that we should have a price target per se. I think we need to let prices come to a level where supply and demand will be in balance and investment flows go back to where they need to be in order to meet the mid to long-term demands on oil. I don’t think $50 is achieving this today.

John Defterios: Okay, could we get to $60 by the end of the year looking at the demand holding up and the non-OPEC production, particularly US production dropping off?

Khalid al-Falih: I think that is indeed very possible, yes.

27 periodical 14


John Defterios: And even higher in 2017, looking at the trend line?

Khalid al-Falih: Yes, I think demand and supply cer-tainly have converged and this seems to be a trend that is going to continue. Other determining factors include inventory drawdowns, and if these, along with some unfortunate disruptions we have wit-nessed in various regions continue, prices will certainly go up. In the mid and long term we are, of course, looking for a higher price to bring in invest-ment. At the same time, I get concerned that if there is a shortage we will have a price spike which will have a counter-productive impact on the long-term stability of oil. So we need to find that equilibrium for the market where supply, demand, and price are in a good space, and the market will determine that.

John Defterios: Now in mid-April at the Doha meet-ing with OPEC and non-OPEC players, Saudi Arabia blocked a deal for freezing the prices and even threatened to flood the market in six months with a million barrels a day if Iran did not come on board. So there is quite a difference between what we heard from your predecessor and what you are saying today. How do you explain that?

Khalid al-Falih: These rumours about us threatening others with flooding the market are totally without foundation. There is no doubt that we would have the excess capacity to always meet market demand. Nevertheless, our policy and strategy remains to balance markets to the maximum extent possible and this preferably in concert with our fellow OPEC producers and also in coordination with non-OPEC members. That remains our position.

John Defterios: So we can rule out a freeze then?

Khalid al-Falih: We have extended our hands to all major producers within and outside OPEC to work together, to coordinate, and to find that right equilib-rium I referred to. I think it’s premature to do that today given what has happened since the Doha meeting. Prices have picked up, so given the current information, the right thing to do is to just continue to monitor the market and let the market do its thing. It’s working in our favour now.

John Defterios: Let’s see if we can clear an item up here. Can you co-exist within OPEC with Iran because of the geopolitical tensions in the region and the proxy wars that we see today? They want to get up to a pre-sanction level of over four million barrels by March 2017? Let’s get it on the record, how do you feel about it?

Khalid al-Falih: First of all, OPEC is a non-political organization; it is an economic coordination and cooperation group. Iran is a key member of this group, and so are we. Saudi Arabia is the biggest and most influential member, but we will cooperate with all members of OPEC including Iran for the good of the collective membership and – equally important – for the good of our consumers. Without consumers, OPEC doesn’t exist. So we have to keep a keen eye on these issues. This is not about greed or about short-term maximization of one’s benefit; we just have to look at the whole intercon-nected market that we are in as producers on the one side and as consumers on the other side.

28 periodical 14


John Defterios: Can I be blunt with you? Do you have a problem with Iran getting back up to the pre-sanc-tions level by early 2017 which is their goal? Do you have an issue with that within OPEC?

Khalid al-Falih: Every country has the sovereign right to manage its own production. OPEC will not stop Saudi Arabia from producing what Saudi Arabia thinks is right. We coordinate, we communicate, we collaborate, and we share information. At times we have ceilings that bind the whole organization and at times in the past we’ve tried quotas. Today, we really don’t have either of those, other than coordinating and communicating with each other. So what Iran does or any other country, it is its own choice. However, if there is a consensus on setting a ceiling, organization-wide, then Iran will have to par-ticipate in that ceiling and will have to accept that it will need to freeze production like everybody else. They are coming along nicely for the reported num-ber to their pre-sanction level, so I think the next time we meet we will be able to discuss whether the time is right for a ceiling or a freeze or having some level of coordinated production. Either way, I can assure you that Saudi Arabia will not sign up to a ceiling or freeze unless everybody else does. And neither will the other countries; this is not a Saudi position alone.

John Defterios: Is this the new Saudi Arabia: three-and-a-half billion dollar investment into Uber, a man with a very wide portfolio: energy, industry, minerals? This is becoming a very open country that has changed, is that what we should walk away with?

Khalid Al Falih: Change for the better, I am confident. Saudi Arabia is opening up. We are globalizing in many different ways and this is symbolic of the new thinking within the Kingdom. The word ‘diversifica-tion’ is not only limited to the type of industries and the type of projects within Saudi Arabia; it is also deploying our capital globally in different ways, and I think what you’re seeing with this announcement yesterday is only the beginning of a diversification strategy that is truly global and multidimensional.

John Defterios: Thank you, Minister, it has been a pleasure talking to you.

Khalid al-Falih (left) John Defterios (right)

29 periodical 14

Natural gas and climate change

After the COP21 agreement was reached last December in Paris, news-papers such as the Guardian regarded

it as the end of the fossil fuel age. Elon Musk, a pioneer in e-mobility, said that the end of fossil fuels is inevitable. According to a study1, around one-third of the global fossil fuel reserves – coal, oil, and gas – would have to remain unused to have at least a 50 percent chance of keeping global warming below 2 °C. Do fossil fuels have a future despite the climate target? Yes, natural gas clearly does have a future in a low-carbon age for three main reasons.

1 http://www.nature.com/nature/journal/v517/n7533/full/nature14016.html

First, gas is the cleanest of all fossil fuels. Gas-fired power plants emit only around half of the CO2 that coal-fired plants emit. Global coal consumption releases approximately as much CO2 as the USA, the EU, India, Russia, and Japan taken together, most of it from power generation. That is around 45 percent of global emissions! This shows the huge po-tential of a switch from coal to gas. By using more gas and less coal in the power sector, the USA has managed within a few years to not only end a 30-year trend of rising carbon emissions, but even to reduce them. Besides the power sector, natural gas has enormous potential to lower CO2 emissions in the heat-ing and in the mobility sectors.

Second, natural gas is more flexible than any other fossil fuel. Natural gas-fired power plants are – as long as large-scale electricity

Natural Gas – Political Weapon and Climate Killer?

Natural gas is criticized on two fronts: First, as a pollutant that is not

compatible with achieving climate goals and, second,

for being a political weapon. Neither of these allegations

is true since natural gas can be part of the solution

in combating climate change, and it is also less of a politicized energy source

than ever before.

Dr. Ties TiessenChief Financial Officer

Wintershall

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Dr. Ties Tiessen Natural Gas – Political Weapon and Climate Killer?

storage technologies are not viable – the best solution to meet the fluctuating load require-ments in a power grid. This ability will be-come even more important in the future as the proportion of power from renewable energy sources, such as wind and solar, in-creases. Gas is the flexible backup and part-ner for renewables with their varying supply capa city!

Moreover, gas can be used in various ap-plications in large power stations, in small buildings with boilers or micro-combined heat and power systems, as well as in the transport sector in natural gas vehicles or LNG trucks or ships. Recently, a report by three German academies of sciences focusing on the German power sector revealed that in 2050 with a carbon emission reduction of 80 percent or more, gas-fired power plants will still be the backbone of a secure power supply.2 In the reference scenario, based on the government’s targets and with a 90 per-cent emission reduction compared with 1990, more gas will be used in the power sector than today.

Third, and this is perhaps the most im-portant point, natural gas is cost-efficient in terms of carbon emission reduction. How-ever, in the context of climate policies there is always a price to pay. But how much does cli-mate protection cost? A good example of a lack of cost effectiveness is Germany. Many Germans regard their country as a pioneer when it comes to climate protection, al-though the per capita carbon emissions are around 40 percent higher than in EU coun-tries like France, the UK, or Italy. Further-more, there has not been much progress in carbon emission reduction in recent years. Germany emits approximately the same amount of CO2 as it did in 2009. Over the same period, the cost to consumers for subsi-dizing renewable energy sources has in-creased twofold to more than €20 billion per

2 http://www.akademienunion.de/fileadmin/ redaktion/user_upload/Publikationen/Stellungnahmen/ ESYS_Stellungnahme_Flexibilitaetskonzepte.pdf

year, paid through a levy raised on electricity. This is what I call a climate policy without climate impact! The reason for this paradox is that German policy has focused on the most expensive CO2 emission reduction technologies, such as solar power. If one ex-aggerated one could describe the guiding principle as the more expensive the technol-ogy, the better.

So what can we learn? It would have been better if policy makers had focused on the carbon emission reduction technologies with the lowest costs. Studies, such as a 2014 study done by the Institute of Energy Economics (EWI) at the University of Cologne3 showed that in the power, heating, and transport sec-tors, natural gas is amongst the cheapest car-bon emission reduction options. It is the low hanging fruit! Policy makers should design their policies accordingly instead of picking technological winners.

3 http://www.forum-erdgas.eu

A new benchmark for climate policy

What is needed is a technology-neutral pol-icy which benchmarks all carbon emission reduction options based on their cost effi-ciency. The greater the emission reduction we get for each euro invested, the better. Other targets, in particular technology- specific targets, are not necessary and would only increase the costs. One target, one guid-ing principle, that’s what is needed.

Unlike Elon Musk, I do not think that the end of the fossil fuel age is inevitable. Perhaps the end of the coal age is near, but not the age of gas due to its potential to reduce carbon emissions, to its flexibility, and its cost effi-ciency. When the energy transition is imple-mented with a clear focus on carbon emis-sion reduction, then it is inevitable that gas will be used in the decades to come.

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Dr. Ties Tiessen Natural Gas – Political Weapon and Climate Killer?

The Russian threat

Unfortunately, the climate protection poten-tial of natural gas is often disregarded due to the “Russian threat”. As recently as 2006 and 2009 with their transit crises, many policy makers regarded natural gas as a political in-strument or even weapon of Russian foreign policy. The Ukraine crisis has even reinforced this opinion.

There is fear that Russia could turn off the tap, or, at least, threaten to do so. This fear was one of the key drivers of the EU Energy Union originally proposed by Donald Tusk in 2014 (FT April 21, 2014: “A united Europe can end Russia’s energy stranglehold”), which is now being implemented. Many ideas have been tabled to mitigate the “Russian threat”. Even non-market measures such as a com-mon mechanism for purchasing gas have been discussed. Also, in the current debate about the realignment of the EU energy and climate targets for 2030 against the back-ground of COP21, many politicians repeated the EU Commission’s estimation that every additional one percent in energy savings in the EU reduces gas imports by 2.6 percent as if that were the most important political target.

Let’s consider the facts. Since Russia started to supply natural gas to Europe in 1969 there have been 14 days of supply diffi-culties and more than 17,000 days of prob-lem-free supply. Currently, around 30 per-cent of the gas consumed in the EU comes from Russia, in Germany it is around 38 per-cent. More than half of the EU’s gas con-sumption is produced domestically in the EU-28 and Norway. Other sources are North Africa and the Middle East.

These figures do not show a high depen-dency of Germany, or the EU in its entirety, on Russian gas nor that Russia has been unre-liable in supplying the EU with gas. The con-fidence in Russian supplies was also apparent during the Ukraine crisis, when the markets showed no sustainable increase in gas prices, because market players did not expect any supply shortages. The reason is also the liquidity of the gas market and the EU’s di-

versified supply portfolio. It can be expected that the complete liberalization of the energy market will contribute further to high liquid-ity and access to various gas supply sources.

In Germany, benefits of a functioning market can be observed. Many companies are competing for the best supply contracts from different suppliers who, in turn, compete for customers. The results are favorable prices and security of supply. This shows that mar-ket forces are capable of securing gas supply. But, unfortunately, not all EU member states have fully liberalized their markets yet.

Security of supply & Nord Stream 2

This may sound surprising to the reader but a pipeline like Nord Stream 2 will also contrib-ute to the security of supply. A European con-sortium with partners from France, Germany, the Netherlands, the UK, Austria, and Russia will build the pipeline stretching for some 1,200 kilometers across the Baltic Sea from Russia’s coast to the German coast near Greifswald. It will connect the huge gas re-serves in Russia with the European market. Nord Stream 2 will not only contribute to fill-ing the gap caused by the decline of the do-mestic gas production, but it will also in-crease the liquidity in the European gas mar-ket, which, again, increases the supply secu-rity. Additionally, the onshore infrastructure that connects the German coast to con sumers in other countries will increase the capacity for cross-border gas flows. The more pipeline capacity between the EU countries, the better the access to gas. These positive effects of Nord Stream 2 are often overlooked in the heated political debate on this pipeline project.

Besides the increased security of supply, the highly competitive Russian gas will, in turn, allow the European industry to remain competitive in terms of energy costs, where advantages exist in the gas-rich countries in the Middle East and in North America. With-out energy at competitive prices, Europe’s in-dustry could lose ground, lose jobs, and the countries could lose tax revenue. Alternatives to Russian gas, such as LNG, are less compet-itive (more expensive). So why not continue and deepen the mutually beneficial relation-ship between Russia as producer and Europe as consumer?

To summarize one can say that the track record of Russian gas deliveries, the supply diversity of the EU, and the liquidity of the EU market make supply problems for the EU unlikely. I would even go so far as to say that gas has, in the past, never been a less politi-cized energy fuel than it has been in recent years. If politicians now start to question market-based projects such as Nord Stream 2, we will find ourselves moving away from the idea of a liberal market and re-politicizing natural gas. That is bad for the EU’s internal market, bad for the natural gas as a fuel, and bad for the consumers in the EU.

More market, please!

The overall theme of my statement is that when it comes to climate protection and to security of supply, we should rely on market forces. Climate protection can be best achieved when all technologies compete on the basis of carbon emission reduction costs. Furthermore, security of supply can be best secured in a liquid gas market, where suppli-ers have to compete with each other. So let’s let the market do its work.

MAR KET FORCES ARE CAPABLE OF SECURING GAS SUPPLY.

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5

15

10

Natural gas Crude oil

20

30

25+38%

Estimated crude oil and natural gas prodution in the US, 2010�–�2015 in million barrels per day of oil equivalentSources: EIA estimates

2010 2011 2012 2013 2014 2015

BENTELER has a long his-tory of serving the North American oil and gas ex-

ploration markets with tubes im-ported from its German and Swiss manufacturing facilities. Historically, this market has been one of the most attractive segments in the steel/tube busi-ness. In the past decade, the rise of unconventional exploration methods resulted in especially high growth rates in this market.

BENTELER wanted to take full advantage of the growth pos-sibilities in this market. How-

ever, the company faced chal-lenges in supplying this market from Europe such as supply chain limitations, higher cost, and import duty regulations. The Group therefore decided to build a modern tube mill in Shreveport, Louisiana, which meant investing $750 million. With a total site area of 380 acres, and a capacity to produce more than 300,000 metric tons of pipes annually, it is supposed to primarily serve the North American market for oil and gas exploration products.

How the Price of Oil Impacts the Supply Industry

Opportunities in the North American oil and gas exploration market:

A deciding factor for the biggest investment in the history of BENTELER

Boris GleißnerChief Financial Officer

BENTELER International

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Boris Gleißner How the Price of Oil Impacts the Supply Industry

Large-scale project was delivered on time and within the budget

The construction and commissioning of the new seam-less tube mill in Shreveport, Louisiana, was successfully accomplished below the predetermined budget, in the scheduled timeframe, and according to the expected per-formance. Special attention was paid to the core unit, the hot rolling mill. Nevertheless, all subsequent process steps such as heat treatment, quality inspection, and finish ing have been successfully implemented with the processing facility receiving its mandatory American Petroleum Institute (API) certification for the oil and gas industries as early as November 2015.

No real comeback evident from the 2015 market collapse

In the third quarter of 2014, the North American rig count which is a key indicator for oil and gas drilling ac-tivities reached a new record high with nearly 2,000 rigs after the oil price had enjoyed several years of relative price stability, mostly hovering between $80 and $120 per barrel. However, towards the end of 2014, the world expe-rienced a dramatic fall in oil prices which subsequently led to a massive reduction in drilling activities. Rig counts fell by nearly 80 percent to about 400 in May 2016.

Furthermore, adjustments to inventories along the value chain resulted in an even sharper drop in demand for the manufacturing of tubes.

Now, within the last quarter, oil prices have started to rise again quite unexpectedly from the low of $27 per bar-rel in February 2016 to about $50 per barrel at the end of May. Nevertheless, rig count continued to decline, reach-ing the lowest level of the last decade in May.

Volatile market affects supplier industry very strongly

When the crisis reached the tube market in the beginning of 2015, the BENTELER steel mill project was already quite far along. Most of the investment had already been made and the majority of the staff had been hired and was involved in intensive trainings. The decision was made to finish the project, as BENTELER sees it as a long-term commitment. The current market situation provides the company with the opportunity to use this time to ramp up the facility as best as possible and to continue to train

2009 2010 2011 2012 2013 2014

1,000

500

1,500

2,500

2,000

Historical development rig count US onshore, 2009�–�2014

09/2014 01/2015 05/2015 09/2015 01/2015 05/2016

1,000

500

1,500

2,500

2,000

Development rig count US onshore, Sept. 2014�–�May 2016

1986 1991 1996 2001 2006 2011 2016

1,00050

500

150

2,500

3,000

2,000100

1,500

WTI spot price CPI adjusted (12/2015 = 100%) Rig count US onshore

Sources: Baker Hughes, EIA

36 periodical 14

Boris Gleißner How the Price of Oil Impacts the Supply Industry

Construction and commissioning of the plant was completed within 27 months.

Tubes on the cooling bed Shell in hot rolling mill process

the employees who will operate this plant when the mar-ket bounces back. BENTELER Steel/Tube’s promise to deliver products of the highest quality has already been affirmed by our customers, whose initial feedback has been very satisfying.

Nevertheless, the brand new plant is only being uti-lized today at a very low level. Customers who were ex-pected to order thousands of tons per month are only ordering hundreds per quarter now. The whole industry went from high profit margins in 2014 to losses in 2015; exploration companies, distributors, and manufacturers are suffering. This is also true for important competitors of BENTELER in the tube market. Many of them operate in the oil and gas markets where they make 60 to 75 per-cent of their total sales. Typical figures reported by those companies for 2015 indicated sales drops in the range of 30 to 40 percent year for year and earning losses of nearly 20 percentage points.

Luckily, BENTELER has a broad portfolio of business segments. A total of 75 percent of sales are in the automo-tive supply division and around 11 percent in steel/tube; the oil and gas business has only a minor share. The con-sequences of the oil crisis are painful, but due to the diversification of the company they are not jeopardizing the Group.

When will the market bounce back?

Oil prices may be recovering now, although they are still well below their record levels. “Expert” forecasts for the midterm are constantly being readjusted depending on current oil prices. At the start of the year, hardly anyone forecasted that we would be at $50 per barrel now. No-body has a crystal ball. Political discussions have a big influence and are almost impossible to predict. We expect that the balance of supply and demand and high inven-

tory levels are likely to continue to put pressure on oil prices which will remain below $100 per barrel for the remainder of this decade. Nevertheless, drilling activity usually follows oil price development, so that we expect a recovery in the steel/tube market in early 2017.

US rig count follows WTI price with a correlation of >90 percent resulting in a drop of rig counts by 75 percent in March 2016.

Conclusion

In nearly a century and a half of producing steel and steel pipes, BENTELER has seen and weathered market fluctu-ations. The rise and fall of oil prices is not an unknown factor. Over the past 30 years, we have witnessed seven dips, with the latest one being in 2009. We therefore gen-erally expect the US demand for pipes to return to previ-ous volumes in the midterm. Consequently, we will not change our long-term strategy because of the current market situation. However, we will closely monitor oil prices which have become more volatile again as well as rig counts, which are an important indicator for the drilling industry and its suppliers.

With the new hot rolling steel mill in Shreveport, Louisiana, BENTELER has strengthened its position as an international partner in the market for steel tubes. The facility is a key building block in the global growth strat-egy for the company’s steel/tube division.

In this industry, a long-term investment perspective is prerequisite. However, markets are becoming increasing-ly complex and volatile. Well-prepared business decisions may meet with completely different market conditions when implemented. In order to limit risk in such an envi-ronment, there are two long-term success factors: a solid financing and a broad product portfolio that helps to bal-ance negative effects from trends in one single business.

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Energiewende describes the transition of an energy supply system from fossil and nuclear fuels to renewable energies. In the aftermath of the Fukushima nuclear disaster in 2011, the German government decided

to cut nuclear power from its future electricity mix and further promote renewable energies through a fixed feed-in tariff. Between 2009 and 2015, the share of renewables in Germany increased from 16 percent to 30 per-cent.1 Last year, 22.8 percent of electricity worldwide was generated from green sources, compared to 18 percent in 2009.2 Increasing this percentage is critical to achieving the two-degree target set in Paris last December.

Munich has been at the forefront of this historic transition, having set itself an ambitious target. By 2025, Stadtwerke München GmbH (SWM), the municipal utilities company, intends to meet the whole demand for elec-tricity in Munich from renewable energies and invest around nine billion euros, primarily in wind power. Since May 2015, SWM installations have been feeding as much green energy into the grid as is consumed by all the city’s private households.

1 Source: BDEW, Energie-Info, Erneuerbare Energien und das EEG: Zahlen, Fakten, Grafiken (2016)

2 Source: REN21, Global Status Report 2015, Global Status Report 2010

Waking up the Sleeping Giant – Renewables in the

Heating and Cooling Sector

Dr. Florian BieberbachChief Executive Officer

Stadtwerke München GmbH

After the term Waldsterben (forest dieback) was coined in the eighties, another more positive climate-related German

term has found its entry into dictionaries worldwide.

39 periodical 14

Dr. Florian Bieberbach Waking up the Sleeping Giant – Renewables in the Heating and Cooling Sector

But transforming the electricity market is just one part of the job en route to becoming a fossil-free energy world. In Europe, half of the energy consumed accounts for heating and cooling. In residential housing, 85 percent3 of the energy used is for heating, in the US this figure is 66 percent4 (including water heating, air conditioning, and space heating) while cooling accounts for 70 percent5 of the electri city used in the Gulf Cooperation Council (GCC). The transition in the electricity market is well underway, and it is time to awaken its forgot-ten sibling. Energy efficiency, especially in the building sector, needs to be increased, and the cooling and energy sector transformed to renewable energy. At the same time, it is very important to design an efficient link between the electricity sector with regards to cost effec-tiveness, sustainability, and reliability.

There is no such thing as a free Energiewende

It is worthwhile to have a look at the findings from the Energiewende, because changing the face of its energy system has come at a cost:

Firstly, quick changes can result in high macroeconomic costs. The EEG levy, resulting from the difference between the set feed-in tariff guaranteed by the government and the trading price of electricity, ac-counts for approximately 21 percent6 of the power retail price and puts a strain on low income households and non-exempt industries. Secondly, green power needs to be transported to consumers via a stable grid. While Germany is well on its way to its electricity mix target, it has a long way to go in terms of the grid. Between 2009 and 2015, only 614 kilometers of the 2021 target of 1,816 kilometers was developed.7 Thirdly, changing legislation is important for companies and investors alike to make investment decisions.

3 Source: EU Strategy on Heating and Cooling

4 Source: U.S. Department of Energy; http://www.eia.gov/ consumption/residential/

5 Source: http://www.strategyand.pwc.com/me/home/press_media/ management_consulting_press_releases/article/50813165

6 Source: BMWi

7 Source: http://www.netzausbau.de/leitungsvorhaben/de.html

Locally tailored solutions require political support

Since the power and heating markets are linked, those lessons learned should be considered when designing the change to a fossil fuel heat-ing and cooling sector. Energy efficiency comes first. But technical, architectural or economic constraints put limits on energy efficiency. If fewer energy efficiency measures are taken such as insulation, more renewable energies are needed. That’s why policy and corporate strate gies for energy efficiency and renewable heating have to be aligned and interlinked.

Moreover, there is no one-size-fits-all approach. The transition in heating and cooling has to be realized in a technology-neutral way. Cost efficiency is critical, and solutions with low economic costs need to be prioritized – and they exist! Last but not least, district heating networks are the backbone for renewable heating and cooling in cities due to space and economic limits of decentralized solutions.

Understanding the success factors for the next phase of energy transition is crucial for policy makers – and vital for the energy indus-try. We are the last generation to live in a fossil-fueled world. And if energy companies are not lion-hearted enough to wake up that sleep-ing giant themselves, it might kill them.

❱ Solar thermal energy ❱ Near-surface heat

sources / heat pumps ❱ Biomass

LOCAL, DECENTRALIZED

SOLUTIONS

❱ Waste heat ❱ Regenerative share

in residual waste ❱ Deep geothermal energy

SOLUTIONS ONLY POSSIBLE

WITH HEAT GRID

❱ Power-to-heat ❱ Power-to-gas

INTERACTION OF ELECTRICITY AND HEATING SECTOR

Figure 1: Renewable heating: No one-size-fits-all solution; Source: SWM

40 periodical 14

Dr. Florian Bieberbach Waking up the Sleeping Giant – Renewables in the Heating and Cooling Sector

The Munich way: Tapping on hot and cold water

That’s why in Munich we have already embarked on an integrated energy transition. Being densely populated and full of architectural wonders, centralized heating and cooling solutions are the way to go. The city has one of Western Europe’s largest district heating grids with a length of approximately 800 kilometers. At present, it is largely being fed from combined heat and power plants, generated predominately from fossil energy sources, pro-ducing approximately 675,000 tons of CO2 emissions. By 2040, the Bavarian capital is to become the first German city with district heating entirely provided from renew-able energy sources. Geothermal energy will make the main contribution, thanks to Munich’s favorable location in the Bavarian Molasse basin. A huge amount of hot wa-ter lies deep beneath the city, which can be used for zero- carbon heating. Meanwhile, the cold water in our city’s streams not only serves as a pristine surf spot, but is also used for district cooling. The benefit is twofold: com-pared to conventional air conditioning, primary energy demand is halved and precious real estate space saved.

Theoretically, the geothermal deposits stored in the upper three kilometers of the Earth’s crust would suffice to cover the current global energy demand for more than 100,000 years. But while not every city sits upon such a geological treasure, there are local solutions to be found en route to a decarbonized energy world. It’s our job not to stumble upon them but to start actively looking for them.

WE ARE THE LAST GENERATION TO LIVE IN A

FOSSIL-FUELED WORLD.

Figure 2: Munich’s city streams are a splash for surfers – those streams underground are used for green cooling. Source: SWM / Stefan Obermeier

❱ Solar thermal energy ❱ Near-surface heat

sources / heat pumps ❱ Biomass

LOCAL, DECENTRALIZED

SOLUTIONS

❱ Waste heat ❱ Regenerative share

in residual waste ❱ Deep geothermal energy

SOLUTIONS ONLY POSSIBLE

WITH HEAT GRID

❱ Power-to-heat ❱ Power-to-gas

INTERACTION OF ELECTRICITY AND HEATING SECTOR

41 periodical 14

At a general level markets simply do not believe that the world’s leading central banks are capable of meeting their inflation targets. They are pricing

inflation in five to ten years’ time significantly below those targets as well as below current rates of inflation.

The Japanese example

More specifically, market responses to changes in policy interest rates have become increasingly subversive. This is most obviously true in relation to the Bank of Japan,

which has adopted the most extreme set of unconven-tional monetary measures via the world’s biggest quanti-tative and qualitative easing program. When the Japanese central bank announced its move to negative interest rates back in January, the yen – perversely – strengthened over time. Since the one component of Abenomics that appeared to have had a beneficial impact on the Japanese economy was the policy of competitive devaluation, this was, to put it mildly, unhelpful.

A further difficulty for the BoJ came from the yen’s status as a safe haven during the period of extreme mar-ket volatility in February and March. Yet when investors

Monetary Muddle

John PlenderBoard Member


ColumnistFinancial Times

Central bankers have traditionally regarded themselves as members of a global elite whose activities are

surrounded by a protective mystique. If any mystique remained after the financial crisis of 2008 – 09, the last vestiges have surely been swept away by events in 2016.

Since January, central banking impotence has been ruthlessly exposed by global markets.

43 periodical 14

John Plender Monetary Muddle

subsequently regained their appetite for risk assets the yen continued to appreciate. Between the January an-nouncement and BoJ governor Haruhiko Kuroda’s ‘no change’ statement at the end of April, the yen saw a trade weighted appreciation of eight percent. The most plausi-ble explanations for the yen’s continuing strength after markets stabilized are, first, that the US federal reserve has become more cautious about tightening policy and second, because belief in the effectiveness of the BoJ’s pol-icies has ebbed away. Salt has subsequently been rubbed in the BoJ’s wound as the British vote to leave the European Union prompted a further safe haven apprecia-tion of the yen.

The European approach

Something similar has been afoot in Europe. After Mario Draghi, president of the European Central Bank, made his celebrated declaration about doing ‘whatever it takes’ to save the monetary union, markets hung on his every word. But no longer. A package of policy-loosening mea-sures in March was greeted by a rise in the euro. Increas-ingly it looks as though the Eurozone currency is being driven by a huge current account surplus amounting to €329.5 billion last year, equivalent to 3.2 percent of the Eurozone gross domestic product.

In effect, the markets have exposed the contradiction in pursuing an (unstated) policy of competitive devalua-tion when there is no competitiveness problem in the Euro zone in the aggregate. Within those numbers a German current account surplus running at an astonish-ing eight percent of GDP has prompted the US Treasury to complain that Germany is not only imposing a defla-tionary bias on the Eurozone but on the global economy.

An important implication here is that competitive de-valuation no longer works predictably for large advanced economies, if it works at all. It remains effective only for those small countries which choose to target the exchange rate rather than inflation, notably Switzerland and Denmark. At the same time, negative interest rates impart marginal stimulus to stagnant economies and have unin-tended consequences that include squeezing the profits of banks that are unable to pass on negative rates to retail depositors who can always withdraw their cash and put it under the mattress.

“Looser for longer”

In the higher-growth advanced economies such as the US and the UK, waning central bank credibility takes a dif-ferent form. The market verdict on the US Federal Re-serve’s decision in December to raise interest rates as a first step towards interest rate normalization has been highly skeptical. The futures markets simply do not be-lieve that rate rises will come as fast or go as far as Fed chair Janet Yellen implied back then. In other words, the December rate hike is perceived by many to have been a mistake.

Ms. Yellen, meantime, hedges her bets somewhat by declaring that policy will be ‘data dependent’. This formu-la is a de facto admission that the Fed does not know how the economy works in the post-crisis environment. The Bank of England’s failed experiment with forward guid-ance for markets betrayed a similar lack of understanding about the workings of the real economy.

There is no escaping the fact that for economies where recovery is relatively advanced the risks in monetary pol-icy are asymmetric. Central banks have more ammuni-tion with which to address an unanticipated rise in infla-tion than for doing battle with recession and deflation.

44 periodical 14

John Plender Monetary Muddle

That points to a presumption of ‘looser for longer’ and potential for central banks to be wrong footed by an un-expected upturn in inflation in due course.

In fairness to the central bankers, it has to be acknowl-edged that they are carrying too much of the burden of driving global economic growth, while fiscal policy has been underutilized. And though there has been some modest loosening of fiscal policy in the Eurozone this year, the world economy will nonetheless remain overde-pendent on monetary policy to stay afloat for some time to come. The question, then, is: What will the central banks do next?

Japan may provide a steer since its policy dilemma is the most acute among the leading advanced economies. Given that current policy appears to be failing, the Bank of Japan’s choice lies between abandoning unconventional measures and gambling on yet more extreme policies. The latter approach would point to further loosening of fiscal policy and to ‘helicopter money’ – expanding the monetary base through direct handouts of cash to the public, so bypassing the banking system, or through overt financing of fiscal deficits by the central bank. Yet wheth-er this is constitutionally permissible in Japan is moot, as indeed it is in the US and the Eurozone.

Muddling through to the next shock

As so often, the most plausible scenario is the muddle through option. Muddling through will almost certainly continue until another severe shock forces politicians to accept that there is no alternative to a return to fiscal ac-tivism, and we are all forced to recognize that central banking mystique is a myth. Prepare to swallow this un-palatable truth: central bankers are emperors with no clothes.

CENTRAL BANKING MYSTIQUE IS A MYTH.

“It’s the economy, stupid,” was the slogan around which the success of Bill Clinton’s first presidential campaign was built. The same logic underpinned the campaign of the for-mer British prime minister David Cameron in this year’s ref-erendum on British membership of the European Union. It was fundamentally flawed. What concerned the majority of British voters had as much to with identity as economics. The exit campaigners focussed on immigration and return-ing control from Brussels to Westminster. The paradox here was that voters who worried most about immigration were not in the big cities with large immigrant populations. They tended to be in areas where globalisation had de-stroyed jobs and to which immigrants had no incentive to move. In effect, a protest over immigration became a proxy for a wider discontent about the failure of political and busi-ness elites to show concern for those in depressed regions. Before the vote in favour of a British exit the British econ-omy was one of the best performers in the developed world. Loss of confidence has now produced a short term demand shock as businesses and households put off spending decisions. But anything more than a mild reces-sion would be needlessly self-induced. A combination of weaker sterling, further monetary relaxation and more ex-pansionist fiscal policy could readily prevent any worst case scenario. The more interesting question concerns the supply side of the British economy. After an exit from the EU the nation’s capital stock will have to adjust to meet new sources of de-mand and cope with a different set of trading relationships. This takes time. But since the Thatcherite revolution of the 1980s Britain is much closer to being a genuine market economy than France, Italy or even Germany. It is possible that it will prove flexible in the face of a supply side shock, especially against the background of sterling depreciation. The outcome will turn on whether government policy and the business response ensure a stimulus to investment that enhances the underlying growth potential of the British economy. An equally interesting question arises in relation to the im-pact of British exit on the Eurozone. Political contagion is a serious risk and could make the issue of debt sustainability more acute across southern Europe. In the past, the EU’s response to crises has always been “more Europe”. In the new political context after the British vote that may no longer be an option.

The British Exit

45 periodical 14

Monetary Policies Misunderstood

A Keynesian hangover

This obsession with taper talk – the interest rate story – is simple, but strange. Indeed, it is misguided – wrongheaded. So, why the obsession? It is, in part, the result of a Keynesian hangover. The

Keynesians focus on interest rates. The mainstream macro model that is widely in use today is referred to as a “New Keynesian” model. The thrust of monetary policy in this model is entirely captured by changes in current and expected interest rates (the price of money). Money is nowhere to be found, however.

The misguided focus on interest rates not only poses a problem for those who are observing the current economic environment and for-mulating expectations, but also for those who are interpreting im-portant economic and market events of the past. For example, Nobelist and Keynesian Robert Shiller, in his famous book, Irrational Exuberance, comes to the conclusion that the stock market crash in 1929 was caused by the Fed’s excessively restrictive monetary policy. That’s because Shiller focuses on interest rates and thinks that the

Ever since the US Federal Reserve (Fed) began to consider raising the federal funds rate, which it eventually

did in December 2015, a cottage industry has grown up around taper talk. Will the Fed raise rates, or won’t it?

Each time a consensus congeals around the answer to that question, all the world’s markets either soar or dive.

Prof. Dr. Steve H. HankeBoard Member


EconomistThe Johns Hopkins University

47 periodical 14

Prof. Dr. Steve H. Hanke Monetary Policies Misunderstood

Fed’s increase in the discount rate in August 1929 signaled monetary tightening. But, as Elmus Wicker carefully documents in Wall Street, the Federal Reserve and Stock Market Speculation: A Retrospective, which was recently published by the Center for Financial Stability in New York, the Fed was accommodative, not restrictive, prior to the 1929 stock market crash.

This interest rate obsession is amazing, particularly since Keynes dedicates quite a few pages in A Tract on Monetary Reform (1923) to money and its role in national income determination. Then, in his two-volume 1930 work, A Treatise on Money, Keynes devotes a great deal of space to banks and their important role in creating money. In particular, Keynes separates money into two classes: state money and bank money. State money is the high-powered money that is pro-duced by central banks. Bank money is produced by commercial banks through deposit creation.

Keynes spends many pages in The Treatise dealing with bank mon-ey. This isn’t surprising because, as Keynes makes clear, bank money was much larger than state money in 1930. Well, not much has changed since then. Today, bank money accounts for almost 82 percent of the broad money supply (M4) in the United Kingdom.

We should keep our eyes on money broadly measured (state, plus bank money) and money properly measured (when available, Divisia, not simple sum measures). A monetary approach to national income determination is what counts over the medium term. The link be-tween growth in the money supply and nominal GDP is unambiguous and overwhelming. Never mind. There remain plenty of deniers of basic principles and centuries of clear evidence.

Since the collapse of Lehman Brothers in 2008, there has been a dramatic change in monetary policies in most parts of the world. Bank regulations have been tightened and supervision has become much more severe. Large-scale bank recapitalizations and deleverag-ing have become the order of the day. These policies, which impact the production of bank money, have been ultratight and procyclical.

48 periodical 14


Quantitative easing as cure?

In an attempt to expand the total supply of broad money, many cen-tral banks have had to engage in quantitative easing (QE). This state money policy is ultraloose and countercyclical. But, given that state money accounts for a relatively small portion of broad money, broad money in many countries has been growing relatively slowly. So, over-all monetary conditions have been relatively tight and modestly pro-cyclical. In consequence, real GDP growth and inflation, which con-stitute nominal GDP growth, have come in below their trend rates.

The accompanying table (Figure 1) shows the changes in state money, bank money, and broad money for the 10 largest economic regions in the world. The US, Japan, the Eurozone, the UK, and Korea lead the field in terms of QE. All have ramped up their production of state money. This can be observed by noting that the proportion of state money to broad money jumped up from September 2008 to January 2016 in these countries. For China, Canada, Brazil, India, and Russia, the picture is different. The share of state money to broad money declined, indicating that they did not engage in QE. When we look at bank money, the situation in the US, Japan, and the UK has been stunning. For these countries, the amount of bank money in the economy was lower in January 2016 than in September 2008. Talk about tight bank money policies. It’s not surprising that the US, Japan, and the UK embraced QE early in the game. If they had not done so, the growth in broad money would have been much more anemic than it was, and deep recessions would have ensued.

The Eurozone arrived at the QE party a bit late. But, it arrived nev-ertheless. Now, European Central Bank (ECB) President Mario Draghi and QE face a wave of criticism. Many in Germany, for exam-ple, oppose QE. Many even argue that the ECB (and other central banks) are out of ammunition. This is nonsense.

Figure 1:Sources: Federal Reserve Economic Data, Center for Financial Stability, Statistics Canada, People’s Bank of China, Bank of Japan, Bank of Korea, Reserve Bank of India, European Central Bank, Central Bank of the Russian Federation, Bank of England, and Banco Central do Brasil.

Note: Bank Money is equal to the Money Supply minus State Money. UK Money Supply is M4; US Money Supply is Divisia M4; China Money Supply is M2; Canada Money Supply is M3; Eurozone Money Supply is M3; Brazil Money Supply is M3; Russia Money Supply is M2; Japan Money Supply is M3; Korea Money Supply is M2; and India Money Supply is M3.

Calculations by Professor Steve H. Hanke, The Johns Hopkins University.

Changes in State, Bank, and Broad MoneyCountry United

StatesChina Japan Eurozone United

KingdomCanada Brazil Korea India Russia

State Money as a % of the Money SupplySept. 2008

5.1% 25.9% 9.0% 9.8% 4.2% 4.3% 7.5% 4.2% 22.3% 37.8%

State Money as a % of the Money SupplyJan. 2016

19.2% 20.5% 28.8% 16.8% 18.3% 3.8% 5.1% 5.7% 17.5% 29.3%

Total State Money Growth Sept. 2008�–�Jan. 2016

316.9% 147.5% 284.6% 103.1% 402.0% 45.1% 75.5% 121.8% 109.5% 96.0%

Bank Money as a % of Money SupplySept. 2008

94.9% 74.1% 91.0% 90.2% 95.8% 95.8% 92.5% 95.8% 77.7% 62.2%

Bank Money as a % of Money Supply Jan. 2016

80.8% 79.5% 71.2% 83.2% 81.7% 96.2% 95.0% 94.3% 82.5% 70.7%

Total Bank Money Growth Sept. 2008�–�Jan. 2016

–6.5% 235.5% –5.9% 8.9% –0.9% 62.8% 167.7% 60.2% 183.7% 186.5%

Total Money Supply Growth Sept. 2008�–�Jan. 2016

9.9% 212.7% 20.3% 18.0% 16.2% 62.0% 160.8% 62.8% 167.1% 152.3%

49 periodical 14


Not all of the central bank’s ammunition is spent…

Let’s take a look at one QE operation that would directly boost the money supply without increasing the government’s net debt. The pro-cess begins with the government borrowing from commercial banks. Short-dated government paper is transferred to banks. In exchange, the deposit balance of the government is credited.

This new government deposit is not counted as a part of the money supply. The government then uses its bank deposits (which are not considered money) to purchase long-dated government bonds from the non-bank private sector. These transactions add to the non-bank private sector’s bank deposits and directly to the money supply, be-cause bank deposits in the name of private persons and entities are money. So, the quantity of money is directly increased by this debt market operation, and an equivalent amount of long-dated govern-ment debt is reduced – literally eliminated.

Of course, the amount of short-dated government debt increases when the government initially borrows from the commercial banks. Accordingly, these debt market operations leave the government’s total net debt unchanged, but it does change the composition of the government’s debt, leaving it with a shorter average duration.

So, forget claims that central banks are out of ammunition. Again, the reason that most come to that incorrect conclusion is that they focus on interest rates.

Moving from the broad picture to the US, we see in the accompa-nying table (Figure 2) that there have been three QEs. Their impact on state, bank, and broad money is shown in the table. Each QE was as-sociated with a significant increase in state money, which offset, to some degree, the negative “contributions” of bank money to the total supply of broad money.

Figure 2:Sources: Federal Reserve Economic Data; Center for Financial Stability.

Note: US Money Supply is Divisia M4. Bank Money is equal to the Money Supply minus State Money.


Figure 3:Source: Federal Reserve H.4.1 Economic Research Data Download Program.

Note: Monetary Liabilities equals the two week average of Federal Reserve Total Liabilities minus Reverse Repos, Treasury General Account Deposits, and Foreign Official Deposits.


09/2

008

12/2

008

03/2

009

07/2

009

10/2

009

01/2

010

05/2

010

08/2

010

11/2

010

02/2

011

06/2

011

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011

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011

04/2

012

07/2

012

10/2

012

01/2

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05/2

013

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013

11/2

013

03/2

014

06/2

014

09/2

014

12/2

014

04/2

015

07/2

015

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015

01/2

016

05/2

016

4,500

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

QE 3QE 2

QE 1

United States Monetary LiabilitiesSeptember 2008 to April 2016 in Billions of $’s

US Changes in State, Bank, and Broad MoneyPeriod QE 1

(Nov. 2008 – June 2010)QE 2 + Operation Twist

(Nov. 2010 – Sept. 2011)QE 3

(Sept. 2012 – Oct. 2014)Sept. 2008 – Jan. 2016

Change in State Money (Billions of $’s)

866.02 664.54 1,406.54 2,883.05

Total State Money Growth 38.8% 33.7% 54.2% 316.9%

Change in Bank Money (Billions of $’s)

–2,456.54 –604.67 –462.18 –1,113.60

Total Bank Money Growth –12.3% –4.0% –3.0% –6.5%

Change in Money Supply (Billions of $’s)

–1,590.52 59.87 944.36 1,769.45

Total Money Supply Growth –8.2% 0.3% 5.3% 9.9%

50 periodical 14


The accompanying chart (Figure 3) traces out the monetary liabil-ities of the Fed and profiles the course of state money since the Lehman Brothers bankruptcy. By the summer of 2014, QE 3 had run its course, and the level of state money has remained stable.

The last chart (Figure 4) depicts the huge expansion of state money. This is shown by the widening of the yellow area since the Lehman Brothers collapse. Although expansive, the QE has hardly been enough to offset the tightness in bank money. In consequence, broad money has only been growing at a 1.72 percent annual growth rate since October 2008. So, it’s not surprising that nominal GDP has grown relatively slowly and that we have not witnessed the inflation surge predicted by many who were only watching the Fed’s balance sheet balloon.

To say that money and monetary policies are misunderstood is an understatement. What’s worrying is that the political class does not have the faintest understanding of the importance of bank money. Their populist bank-bashing rhetoric and regulations are putting a drag on the growth of bank money and economic activity.

United States Money Supply (M4)in trillions of US dollars

01/2

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25

20

15

10

5

State Money (MB) Total Money Supply (MS) Bank Money (MS – MB) Money Supply – Exponential Trend

From Jan. 2003 to Sept. 2008, the exponential annual trend

growth rate for M4 was 8.79%.

Since Oct. 2008, the exponential annual trend growth rate for M4 is 1.72%.

Figure 4:Sources: Center for Financial Stability, Federal Reserve Economic Data and calculations by Prof. Steve H. Hanke, The Johns Hopkins University.

Note: The trend line for the money supply is calculated over the period from Jan. 2003 to March 2016. The trend line used is an exponential trend line – an exponential trend line has a constant growth rate over time in percentage terms in contrast to a linear trend line, which has constant incremental change over time in nominal terms. For example, this exponential trend line grows at 3.92% per year but a linear trend line would grow by 0.59 trillion US dollars per year.

51 periodical 14

THE STERN STEWART INSTITUTE SPRING POLL 2016

Rest of the emergingcountries

Growth in…

AccelerateStagnateDecline

US EU China

24%

64%

12% 21%

57%

21% 34%

55%

11% 40%

56%

5%

65%

35%

Yes No 18%

61%

21%

High

Medium

Low

Costs to leave are too high

Comment

1

2

3 1%

4%

0%

95%

EZB Topic becomes less relevant for populists in Europe as they identified other polarizing themes

Majority of decision makers are “Pro Euro”

Germany actively leaves

Selected countries have to leave

Continous “muddling

through”

Complete crashof the currency union

1 What are your growth expectations for the next 12 months, compared to today’s levels?

5 Would a Brexit have a significant negative economic effect on Europe?

7 Currency union – What is a likely scenario for the euro?

In June 2016, we asked key executives in our Institute network about their view on different topics. These ranged from subjects like growth expectations and global risks to the Brexit (poll before the vote) right up to the outlook of their businesses. The responses we received generated quite an interesting picture.

Review The Stern Stewart Institute Spring Poll 2016

6 What is the likelihood of a “Yes” on Brexit?

ouch!

52 periodical 14

7%

89%

4%

< $40 $40–$60 >$60

4 Oil price – What oil price are we going to see by the end of the year?

39%

56%

5%

Medium

Low

High

Other causes may be…

Slowing growth in China

Elections USAInstability at Europe’s borders

Unstable bank balance sheetsCollapse of European institutions

Low commodity prices

Reinstallation of trade barriersTerrorism in the West

Ineffectiveness of monetary policyYes to Brexit

Social unrest

1

2

3

4

63% 44%

40% 31%

27% 27%

21% 17%

12% 3% Other

Reduced global consumer demand

Debt burden or debt overhang with unfavorable demographics

22%

65%

11% 2%

<2 years 5–10 years >10 years

2–5 years

Sour

ces

of fu

ture

gr

owth

Review of business strategy due to high volatility

Degree of maturity of business models including disruptive threats inno

vate

Impact of digitalization on business model and the organization

MOVE OF PRODUCTION FOOTPRINT

RESTRUCTURING, CONSOLIDATION

PROTECTIONISM (IMPORT TARIFFS) BY EU, US AND CHINA

Abi

lity

to

RE

GU

LA

TIO

N

C O S T S

W A R F O R T A L E N T S

90%

10%

Be�er

Worse

2a In general, what is the probability that we will experience a major global economic downturn in the next 12 months?

2b If so, what might be the major causes of such an economic downturn? (multiple answers possible)

3 Interest rates – How long do you expect interest rates in Europe to remain near zero?

8 What are the major concerns on your business’ agenda over the next 12 months given this environment? 9 Is your organization in better

or worse shape today compared to 12 months ago?

Review The Stern Stewart Institute Spring Poll 2016

THE STERN STEWART INSTITUTE SPRING POLL 2016

53 periodical 14

Imprint

About this publicationThe periodical of the Stern Stewart Institute

14th Edition, July 2016Published half-yearly

Publisher and Chief EditorGerhard Nenning

Board of The Stern Stewart InstituteMarkus Pertl Gerhard Nenning

Managing EditorAnja Deucker

Design Production and ArtworkKW NEUN Grafikagentur

PrintingIndustrie-Druck Haas

The opinions, beliefs, and viewpoints expressed by the various authors in this publication do not necessarily reflect the opinions, beliefs, and viewpoints of the editorial staff or of The Stern Stewart Institute. The publisher accepts no responsibility for errors, omissions, or the consequences thereof.

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Picture Credits123rf.com / koosen (p. 30); istockphoto / thomaslenne (p. 1), amenic181 (p. 21), anek_s (p. 25/26), Barry Gregg (p. 48); shutterstock / Rawpixel.com (p. 9), dikobraziy (p. 25/26), Kodda (p. 32), Iaroslav Neliubov (p. 44); Thinkstock / matka_Wariatka (p. 18).All other images are property of the authors or companies.Illustrations by Iris Schmitt for KW NEUN Grafikagentur.

54 periodical 14

periodical 14

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