Thursday, 22 December 2016

Future of gaming

Submissions to the Joint Parliamentary Inquiry into Future Gaming Markets in Tasmania have now been posted on line. My full submission which includes an analysis of gaming losses and Federal Hotels’ profits since 2003, how the spoils have been divided, a review of Federal Hotels’ promises and outcomes, discussion of the economic and accounting features of gaming as practised in Tasmania and suggestions for the way forward can be found HERE.

The executive summary is provided below.

Executive summary

One of the key terms of reference of this inquiry is to report on the potential structural features of the Tasmanian gaming markets from 2023 onwards. As a prerequisite, it is incumbent to fully understand the current arrangements, the size of the pie and how it is distributed. The primary focus of this submission is to cover the financial aspects of current arrangements.

Monday, 12 December 2016

Poker machine profits

Pubs and clubs have been battling to maintain gaming revenue since overall player losses from gaming peaked in 2008. Losses in pubs and clubs has been relatively stable over the past eight years. Casinos have suffered declines in that period..

The annual report of the Liquor and Gaming Commission revealed overall gaming losses in 2016 were similar to the previous year at $237 million. Casino EGM losses fell again but Keno in pubs and clubs came to the rescue with turnover jumping 10 per cent. The total tax take fell slightly as Keno tax rates are much lower than EGM tax rates.

Federal Hotels has offset reduced gaming income in casinos by expanding its stable of gaming pubs. Since 2003 when its sole license to conduct gaming in Tasmania was renegotiated Federal Hotels has increased pub numbers from four to twelve.

Gaming in pubs and clubs is the major focus of public concern, and will be at the forefront of the parliamentary inquiry into post 2023 gaming arrangements. If gaming is to continue outside casinos then a better understanding of the financial aspects is a prerequisite.

Federal Hotels cop most of the attention but other owner/operators with multiple sites have a significant presence in the industry. Glenorchy epitomizes the issue. Five out of eight of the State’s top EGM performers are in Glenorchy. Eight of nine Glenorchy venues are held by groups/persons with multiple establishments, with four of Federal Hotels’ twelve pokie pubs located here.

There is a logical reason for this hive of activity. Average losses per machine in Glenorchy are $80,000 per year or $217 per day compared to average losses across the State of $130 per EGM per day.

However it’s the split up of the associated costs, between fixed and variable, which helps make the bottom line so attractive for the top EGM earners..

For every $1 in player losses:

·       The State government gets 30 cents

·       The venue gets 30 cents

·       Federal Hotels as licencee gets 31 cents

·       GST is 9 cents

Third party pub operators get 30 cents in every dollar. If Federal Hotels own the pub the share is 61 cents.

There are direct costs that have to be met. In the case of pubs the hire of EGMs is a fixed cost. Wages of gaming staff are the main variable cost which is no more than 10 cents. Hence once fixed costs are covered a venue is making 20 cents in every dollar of player losses.

Federal Hotels as sole licencee and network operator will face mainly fixed costs to administer the network via network Gaming. Once the fixed costs are covered, Federal Hotels is making 31 cents for every $1 of losses, or 51 cents if it owns the pub. There are few variable costs. The El Dorado Deluxe EGM at the Elwick Hotel costs no more to administer than an EGM in the Dover RSL.

In economist’s speak EGM gaming has low marginal costs. Once fixed costs are covered every extra dollar of player losses sees a significant increase in the bottom line. Better than for bar operations and far superior to bottleshops. In the case of a pub the marginal EGM costs are mainly wages and these probably decline with increased turnover. For Network Gaming marginal costs would be close to zero.

In an area of public policy with heightened social risk, the current gaming system is perversely structured. Once fixed costs are covered tax removes only part of the bountiful booty. That’s why Glenorchy is so attractive, why multiple site owners already dominate and are looking to expand.

A system of stepped tax rates makes public policy sense if parameter changes such as altering the house percentage and the frequency of spins doesn’t remove some of the excess profits.

Even pubs with below average EGM turnover can easily make normal profits on their gaming, equivalent to levels in other areas of hotel operations. Average and above average venues currently make super profits.

The number of gaming staff in pubs in full time equivalent terms is only about 200 (based on gaming staff in pubs as a percentage of EGM losses). Network Gaming boasts a business unit with 30 staff running the network. Figures will be trotted out listing the number of licenced gaming staff, a total of 4,000 Statewide, but the number of FTE’s working at any time is a fraction of that figure. Stand by, however for the bogus employment argument.

Keno has exhibited contrarian behavior over time. Its relative share of the gaming pie has almost doubled since 2004, which combined with low tax rates and lower commissions to pubs and clubs compared to EGMs, is now making Keno an important contributor to Federal Hotels’ bottom line. Merely taxing Keno at the same rate as EGMs would increase Keno taxes five times. And raise $8 million per year

It’s always been a mystery why the community service levy of 4% of EGM losses doesn’t apply to losses in casinos. The notion that EGMs are part of the tourism industry is hopefully one that the parliamentary inquiry will lay to rest. Granting favourable licence conditions for EGM and Keno gaming on the pretext that the benefits will spill over into the tourism industry has demonstrably failed. The proceeds of gaming have been paid to shareholders and used to buy more gaming pubs and bottleshops. Not only is this contrary to the community’s understanding of what the 2003 sole licence agreement would provide, it has given Federal Hotels an unfair advantage over its competitors jostling to benefit from the spillover effects of MONA, paradoxically the sort of benefits that Federal Hotels were supposed to generate with the extension of its sole license in 2003 and the promised expansion of its tourism investments.

The gaming industry if it is to continue outside casinos will be a regulated industry. There’s no argument in logic, equity or economics why a regulated gaming industry should allow operators above normal rates of return compared to other industries or above normal rates of return compared to other offerings of the hotel industry.

The parliamentary inquiry has much to consider.

(Published in The Mercury 12th December 2016)

Sunday, 6 November 2016

Australia's new class war: A return to the Gilded Age

The betrayal of an entire generation of young Australians by the political classes by refusing to do anything about the Great Housing Bubble is a national disgrace.

Matt Ellis writing as Rational Radical sets out the arguments.

 “Even the so-called party of the youth, the Australian Greens, and the traditionally progressive Australian Labor Party are just as leveraged into landed wealth as any political force in the country.”

.        .        .        .        .

“But for the most part, the vanishing class consciousness of the newly minted home owner or property investor has created a political and media culture of looking the other way as wealth inequality and economic imbalances threaten to tear the system and community apart. It is so ingrained in the every day Australian cultural psyche, that it has become a truly rarified exceptionalism, wherein any person of influence or power who dares to question the path of the great Australian Housing Bubble is patronisingly reminded that history does not apply to Australia, and that genuine reform is for doomsayers and bankrupt European states.

Indeed, our exceptionalism has morphed into full a blown collective denial of the very same imbalances that brought half of the modern world to its knees only 8 years ago. That somehow these forces do not apply to the economic miracle that is Australia, and that income inequality is only a matter of a few mega-rich corporations evading their tax obligations.”

Spend five minutes to read Matt’s compelling blog..

Monday, 31 October 2016

Forestry Tasmania's insolvency report

Resources Minister Barnett’s recent statement following the release of Forestry Tasmania’s 2015/16 annual report was by no means the first attempt to report on problems in the forest industry.

Another report summed it up pretty well:

“I received from the Hobart Chamber of Commerce a statement on “The hardship suffered by the timber industry in Tasmania,” in which it is stated “For the past few years....... the sawmilling industry has been in a very bad state, until now, with the added effect of the general depression, the position is really desperate.”

“While the Chamber of Commerce of Hobart considers “there is every justification, nay, necessity, for assistance and relief being granted by the Commonwealth to this State,” no useful information is afforded in the shape of any practical proposal for the betterment of the methods of production.”

That’s from a Report of an Inquiry into the Financial Position of Tasmania as Affected by Federation.  Its author was Sir Nicholas Lockyer.

The date of the report? April 1926. 

Here we are ninety years later.

The current government whilst in opposition didn’t appear to realise that the margins on forest sales were still failing to cover overheads, not dissimilar to problems in1926.  For some dumb reason they thought they could grow the industry and reduce the losses, and as a consequence went to an election saying no more handouts. No more budget funding for FT.

When things didn’t work as they told us they would, $30 million was slipped in the back door from Tas Networks on 1st July 2015. That was quickly seen for what it clearly was, viz a less than honest continuation of the same sins condemned when committed by political opponents.

Since then FT has received further cash of $26.5 million from government, the latest amount on 30th June 2016 being another $4.4 million from Tas Networks, this time for a transmission network at the Southwood plant.

Now Minister Barnett has announced the government will take over FT’s superannuation liability of $158 million. The 2015/16 mill door sales after contractor payments barely provided enough to cover payments to retired foresters of $12.5 million. Only $4.5 million remained to cover remaining cash operating costs of $30 million and capex payments of $8.5 million.

Whether it’s a budget appropriation, a back door injection, an arranged asset transfer or the takeover of a huge liability, it is still a government handout. If it looks and walks like a duck there’s little doubt what it is.

Wednesday, 26 October 2016

Forestry Tasmania to reveal all?

It wasn’t really surprising to hear Resources Minister Barnett finally admit Forestry Tasmania’s model is broken, the last Tasmanian to do so.

What was a little surprising was that he didn’t bother saying anything, nor did FT’s 2015/16 Annual Report released at the same time on Tuesday 25th October, about the sale of hardwood plantations needed to cover FT’s losses for 2016 and the current year 2017.

Perhaps he will reveal all today?

Perhaps he will tell us about FT’s agreement with Gunns’ Liquidator about the MIS trees growing on 14,000 hectares of FT’s land? The very trees that will bail out FT, either as a result of the proceeds of sale of both land and trees to a third party or alternatively the harvesting  for plantation chips.

The Annual Report showed a large reduction in private plantations growing on FT land and a consequent large increase in FT plantations growing on FT land, so it was logical to assume FT had done a deal with Gunns to take over ownership.

Most of MIS trees growing on Gunns’ land were all sold to New Forests two years ago and are now managed by Forico.

Other MIS trees were growing on land leased from third parties. The biggest lessor was FT. Land owners with smaller areas leased to Gunns have been encouraged to buy the trees growing on their land for $1 rather than attempt to get the Liquidator to pay rental arrears.

But the Liquidator wasn’t going to sell the trees to FT for $1. He believed they were worth much more. Some were ready to be harvested and the remainder could either be harvested or thinned so there was immediate money to be made.

A year ago the Liquidator claimed $40 million from FT for the trees, this amount being the establishment and maintenance costs. There’s probably about 2 million tonnes of trees at this stage which makes the price $20 per tonne. New Forests when they purchased from Gunns probably paid between $5 and $8 per tonne. Incidentally that’s why plantation harvesting is currently profitable. Anything below $20 is profit for New Forests.

FT weren’t going to pay that price even if it were to offset the amount of rental arrears which as at today are probably about $6 million.

We know from court documents lodged by Gunns’ Liquidator that an agreement was reached a month ago with FT and its legal representatives Abetz Curtis.

Perhaps Mr Barnett will tell us today what was agreed.

Monday, 24 October 2016

Hydro ups ante in Basslink dispute

Hydro Tasmania has upped the ante in its dispute with Basslink Pty Ltd.

A month ago it unilaterally stopped paying the monthly facility fee for use of the interconnector linking Tasmania with the national electricity market. It is using the cable, but refusing to pay.

Basslink P/L is part of Keppel Infrastructure Trust, part-owned by the Singapore Government and listed on the Singapore Stock exchange.

On Monday last week, Keppel lodged financial statements for the period ending September 30.

It revealed the woes of its wholly owned subsidiary Basslink P/L. Basslink is a reasonably simple operation. It owns an interconnector cable. Hydro has an agreement for exclusive use of the cable for another 15 years. The facility fee varies from month to month, depending on whether it is available for use, the electricity price differences between Tasmania and the mainland, and prevailing interest rates.

During the outage from December 2015 to June 2016 the facility fee was zero. It resumed again after the repair, roughly at the rate of $75 million per annum, until a month ago when Hydro stopped paying.

Basslink owes $700 million to its banks. The estimated amount Hydro owes Basslink is $500 million. That is the estimated facility fee over the next 15 years in today’s dollars.

If Hydro doesn’t pay Basslink, then Basslink has trouble paying its banks. With no income from Hydro during the outage it managed to keep paying the banks, but found itself in breach of loan covenants. It found itself unable to meet the minimum debt service coverage ratio and therefore was required to agree on a new long-term financing plan. Basslink’s $700 million of borrowings are listed as current liabilities, meaning they are repayable in this current year. A new long-term financing arrangement is the only other option.

Just as Basslink’s $700 million loan is being renegotiated with its banks, Hydro played its card. It stopped paying the monthly fee. Hydro was not insured against the Basslink outage. Hydro may have to prove Basslink was at fault to recoup damages from Basslink. But Basslink’s insurers accepted the outage was a force majeure event, an act of God, and have paid out compensation of $40 million. Hydro does not accept it was a force majeure.

The immediate problem for Basslink is that while $11 million went to partially pay for the cost of interconnector repairs, the balance was snookered by the banks. It is yet to be released. The banks are hanging on to it, pending finalisation of the new long-term financing plan.

Hydro just made Basslink’s cash situation even worse.

Everyone has a different agenda. The banks would like to see their exposure lowered, I guess. Hydro would like some compensation, no doubt. I’m sure it would accept a lower fee. It is a classic standoff. Either Basslink’s parent has to put in more, or Hydro has to resume paying, or both, else Basslink is insolvent. Basslink is an Australian registered company, so Australian insolvency laws apply.

The worst-case scenario for an insolvent company is liquidation. This is possible, but unlikely. Basslink’s banks will not want to take control of the interconnector in an attempt to recover its loans.

Yet Keppel, Basslink’s parent, will not want to tip in too much unless it can be assured the interconnector asset is worth it. What the interconnector asset is worth, however, depends almost entirely on the revenue it receives from Hydro. It is difficult to envisage a situation where someone other than Hydro operates the cable.

Has Hydro made a strategic play? A risky one perhaps?

Whether Hydro manages to negotiate a lower fee with Basslink might not have any effect on the $350 million it owes Macquarie Bank in respect of a poorly judged side deal to protect itself from interest rate rises impacting on the facility fee. Macquarie agreed to pay Hydro any extra fee that resulted from a rise in interest rates. In return Hydro agreed to pay Macquarie the fee saving resulting from a fall in interest rates. Interest rates started falling the minute Hydro agreed to the side deal. It pays Macquarie Bank about $30 million a year. Hydro will not reveal the actual figure. It is commercial in confidence.

Basslink was insured against physical loss and also business interruption. Unlike Hydro. At the parliamentary inquiry on August 4, seven weeks after the interconnector resumed, Hydro chief executive Steve Davy, in response to a question as to whether Hydro will insure against future outages, said: “We have not, as a corporation, considered or entered into discussions with other parties about covering that possibility.”

There you have it.

Imagine almost writing off the family car and then saying, “gosh I didn’t expect repairs to take so long and be so costly and I didn’t anticipate paying for hire cars for six months. How was I to know it was going to cost $180 million? It was a one-in-2600-years event, but will I insure the car now that it’s back on the road? I haven’t considered that.”

Imagine saying that?

The Basslink deal is an example of a public private infrastructure arrangement. Essentially the interconnector forms part of Hydro’s generating assets. The traditional way was to fund these was with debt. The annual finance charges of $100 million paid by Hydro to Basslink and Macquarie Bank  are de facto finance charges and were these added to interest  payable on Hydro’s other borrowings of $900 million , the total would place Hydro close to a breach of its own loan covenants.

One thing for sure is there’s plenty of water yet to flow under the bridge.

Thursday, 20 October 2016

Federal Hotels treads water

It’s been 13 years since the government and Federal Hotels agreed to an extension of the original 1993 exclusive gaming license covering table gaming, electronic gaming machines (EGMs) and Keno in Tasmania.

Federal Hotels’ 2016 financial statements lodged with ASIC last week revealed another $15 million paid as dividend to shareholders. This takes the total to $199 million in 13 years, an average of $15 million per year. The dividends represent 60 per cent of after tax profits, an extraordinarily high payout ratio for a capital intensive tourism business. These fully franked or tax paid dividends are equivalent to a before tax return of $22 million per year.

The other party helping itself to the cash tin was the bank whose borrowings were further reduced by $16.5 million. There was a time when the reverse was true. From 2003 to 2011 bank borrowings increased almost fourfold from $56 million to $200 million, but with the gradual erosion of gambling revenue prompting a decline in net profits, the banks obviously decided enough was enough. Since then borrowings have been reduced to $123.5 million, all of which is now listed as a current liability. This suggests borrowings are to be renegotiated during this current year.

Overall player losses from gaming have been declining since 2009 due to fewer EGM losses. Keno has bucked the downward trend. Its relative share of the gaming pie has almost doubled since 2004, which combined with low tax rates has made Keno an important contributor to Federal Hotel’s bottom line.

Federal Hotels’ opportunistic 2015 request made in response to Mona’s David Walsh’s interest in a casino license, to extend its sole license so that it could fund $100 million of upgrades to its casinos and a new venue at Port Arthur that’s been on the drawing board for years was a peerless display of chutzpah. After the 2003 extension/Saffire trade-off, the Port Arthur project sounded like déjà vu all over again? And the need for casino upgrades wouldn’t have anything to do with the decline in EGM revenue relative to pubs and clubs coinciding with a decline in overall EGM turnover would it?

If funds are needed to upgrade existing facilities they should be sourced from retained earnings, borrowings or shareholder contributions just like every other business. It shouldn’t require another special deal. This is not a start up company that may require encouragement. This is a major player in a mature industry competing with many others who aren’t given the same advantages.

It was fortunate Federal Hotels stashed a little away following the sale of its regional tourism assets at Strahan, Cradle Mountain and Freycinet in 2014, because much of it was needed to meet the demands of both the bank and shareholders in 2016. But when it came time to pay for the Newstead Hotel, the twelfth pub in Federal’s Vantage stable, all ranked in the top 24 pokie performers across the state, Federal Hotels could only come up with 20% of the purchase price from its own sources. A loan from a third party of $8.6 million was needed. The bank must be a little wary with the exclusive gaming license having a 2023 sunset clause?

With the abandonment of its regional tourism strategy and the walkout from the West Coast Wilderness railway, Federal Hotels has been long on promises, if the 2003 parliamentary inquiry into the Deed extension is a guide, but short on delivery. The only new tourism asset built since, is the mandated Saffire at Coles Bay. Other capital additions have been existing businesses, either lucrative pokie pubs or bottleshops. Even the impending, much trumpeted MACq 01 development is just a fit out.

When Federal Hotels operated its regional venues, advertising and promotion had the effect of promoting tourism across the State. The original 1993 agreement required Federal Hotels to spend at least $8 million a year promoting and marketing tourism. This clause or one with similar intent is absent from the now operative 2003 Deed.

Even critics begrudgingly admit that Federal Hotels’ advertisements had spill over benefits for the whole state. Whatever was good for Federal Hotels was good for Tasmania. But its retreat from regional Tasmania has left it back in the peloton hanging off David Walsh’s coattails like everyone else in the Hobart accommodation business.

Any attempt to link EGMs and Keno with the tourism industry should be resisted. For too long the tourism industry has acquiesced to Federal Hotel’s dominant position in the industry because in part there were spill over benefits. After 2011 however reality struck Federal Hotels and its strategy changed with more emphasis on EGM pubs and less on regional tourism. Acting as Federal Hotels’ praetorian guards as it plunders the pockets of pokie players and secures a competitive advantage for itself against others in the hospitality industry, is a bit much to behold, especially when in the next breath, the industry makes further demands on government to underwrite advertising across the entire industry and to fund AFL matches and other major events.

It is sometimes forgotten that whilst Federal Hotels dominates the electronic gaming scene in pubs there are another six or so groups with multiple venues, who in total, together with Federal Hotels own or run 90 percent of the top 50 EGM pubs. Any push to retain existing privileges will be strongly resisted by this band that largely operates on the periphery of the tourism industry, more in the broader hospitality industry servicing Tasmanians. Will they all stick together or will it be as in the case of the Lone Ranger and Tonto facing a hostile enemy when the Lone Ranger said: “It looks like we’re in a lot of trouble old friend”, to which Tonto replied “What do you mean ‘we’, Paleface?”

With the expiry of current gaming arrangement in 2023 few will be able to argue they haven’t achieved an adequate return on their gaming investments. There is no need for the government to pander to anyone. Super profits from gaming could have, for example, funded the State’s social housing backlog instead of ending up in the pockets of a few. It’s an opportune time to change the landscape.

Monday, 8 August 2016

Basslink woes continue

Plan A from the rulebook for side stepping questions at parliamentary hearings is to cite confidentially. The reason why it’s confidential is also confidential. This is a corollary to Plan A.

Plan B is to use the sub judice rule where a matter might be the subject of legal action. Plan B also has corollaries. Canvassing legal options, even a litigant’s thought bubble are covered by Plan B.

Plan A has been used at current parliamentary public accounts committee hearing into the State’s electricity companies following the Basslink outage.

The government has now invoked Plan B and asked the committee to call a halt to proceedings “to enable arrangements to be put in place to protect the state's interests in the context of contractual matters related to the BassLink failure.”

What are these contractual matters?

Basslink’s parent company, Keppel is listed on the Singapore Stock Exchange. Its latest half yearly report dated 18th July has more to say about the Basslink failure than Hydro and the government  are prepared to tell.

The report says:

Based on current circumstances and subject to further professional advice and investigation, Basslink believes that the outage is a force majeure event. The cable has since returned to service on 13 June 2016 and Basslink has been in discussions with Hydro Tasmania and the lenders on matters arising from the outage. The insurer has confirmed that the physical loss and damage to the cable as well as time element loss (such as business interruption loss) arising from the incident are insurable (subject to the relevant terms of the insurance policy) and Basslink is working with the insurer on Basslink’s claims under the insurance policy.”

Basslink believes the outage is a force majeure event. In other words, an act of God. It has insurance cover for such an eventuality.

Hydro on the other hand does not. The estimated cost to Hydro is between $140 and $180 million.

Hydro’s risk assessment analysis apparently showed outages longer than 60 days were highly unlikely. This period was nominated in the original specifications and confirmed in the Basslink Operations Agreement signed by the Tasmanian government. The 2012 Expert Panel report into Tasmania’s electricity industry disclosed however there were no financial penalties relating to non performance.

If an outage wasn’t expected to last 60 days, the cost to cover longer outages would arguably have been minimal.

Even now Hydro is unable to tell the parliamentary hearing the cost of such insurance or whether it plans to take cover in the future.

If a force majeure event occurs the contractual obligations of the parties are temporarily suspended whilst things are fixed. Penalties may not apply unless the relevant legal contracts specifically address the matter.

Given Basslink had insurance in place to cover a force majeure event they would be keen to ensure this was the case. Finding the source of the fault proved difficult and more cable was removed than the replacement length originally earmarked. An extra length necessitated three joins. This left a length of discarded cable which Hydro would like to have tested but Basslink won’t bring to the surface. Exhibit A which may prove cable failure was other than an act of God is still on the seabed about 100 kms north of Georgetown.

Legal action between Hydro and Basslink is not new. An earlier dispute about the cable required former Chief Justice Murray Gleeson’s mediation skills. Hydro made a couple of references to the dispute buried deep in annual returns but when asked about the amount finally awarded to Hydro, CEO Steve Davy resorted to Plan A by telling the June hearings it was commercial in confidence.

Not so in Singapore. Keppel revealed publicly the amount was $6 million.

There was a time when Hydro’s annual costs of Basslink were provided in annual returns. No longer. It is now commercial in confidence. The annual financial statements record an estimate of the overall Basslink liability and the amount expected to be paid in the ensuing 12 months. But the amount actually paid is commercial in confidence.

Not so for Keppel. It discloses what it receives from Hydro but the amount is in Singapore dollars and the financial year end dates are different so it’s a little hard to line up with Hydro’s accounts.

The Basslink fee contains an interest rate component. If rates go up then so does the fee, and vice versa.  Hydro decided to swap this component with Macquarie Bank and not risk the fee rising with rising interest rates. Macquarie Bank agreed to pay Hydro the amount of the fee resulting from higher interest rates while Hydro agreed to pay Macquarie the amount of the fee saved should the fee fall with falling rates. To date this misadventure has cost Hydro about $200 million. The exact figure is commercial in confidence, as is whether or not the swap arrangement with Macquarie still applies when the fee is waived.  According to Hydro’s last financials, based on current low interest rates, the swap arrangement is expected to cost another $340 million.

Hydro’s insurance against rising interest rates have therefore cost $540 million and its failure to insure against an extended Basslink outage another $140 to $180 million.

The very person at the table when these fateful matters were first considered is now advising the government on energy security. Geoff Willis it yet to follow Justice Brian Martin recent example in the case of the NT royal commission into juvenile detention and exclude himself on real or even perceived conflict of interest grounds.

The inquiry which promised so much is in danger of degenerating into a pathetic embarrassment. Mr Bacon is solely interested in finding a paper trail to the Minister’s office. The two Liberals members are acting like Praetorian guards protecting their masters and blaming their predecessors rather than bothering to address their minds as to how it all works, what went wrong and where do we go from here.

Combined with a ready willingness to withhold information where possible, the only result will be a more disillusioned public once again let down by the political process.

Thursday, 21 July 2016

Superannuation fairness

THE age of entitlement will not end if baby boomers, in or approaching retirement, keep hijacking public policy debate.

With average superannuation balances at retirement scarcely more than $100,000 mainly funded by employer contributions, topping up with surplus private savings is but a dream for most Australians.

Being prevented from transferring more than $500,000 in surplus savings into superannuation is of little concern. Yet it almost caused the downfall of the Turnbull Government so we are told.

The purpose of super is to provide funds for members’ retirement. It is not intended to be part of an estate plan for a family dynasty.

The tax system is biased in favour of older, wealthier people. Not only are withdrawals from superannuation funds tax-free beyond the age of 60, earnings on superannuation in the pension stage, which can occur even while still working, are tax free. Once aged 65 a higher tax-free threshold applies, which means the wealthy can receive extra unearned income on a tax-free basis in addition to their superannuation spoils.

Meanwhile other taxpayers paying tax on income from toiling are subsidising this rort. Couples can earn $60,000 apart from their tax-free superannuation and still be spared the need to contribute to tax coffers. At a rate of return of 4 per cent per annum that’s $1.5 million. Adding this to the May budget proposal to limit tax-free pension balances to $1.6 million or $3.2 million per couple gives a tax sheltered nest egg per couple of $5 million.

How much do these guys want? Obviously more than $1.5 million outside superannuation is unacceptable. It is true that once tax starts being paid for incomes above the seniors’ privileged threshold it is paid at a rate of over 40c in the $1, so wouldn’t it be nice to be able to transfer a bit more into a tax-free superannuation environment.

Under the age of 65 ordinary income thresholds apply and transferring surplus savings into superannuation funds saves tax, especially if a pension can be triggered and the earnings become tax-free.

High net worth individuals run multiple pension streams, segregated from each other. Even though pension payments are tax-free beyond 60 years of age, tax may be payable if a stream is commuted and paid to non-dependants upon death. Each stream is different.

In other words the adult kids might have to pay a bit of tax, unless the pension streams can be structured correctly. That is done by withdrawing amounts funded by employer and other deductible contributions and replacing them with brand spanking new non-concessional contributions which Mr Turnbull is trying to limit. Draw out the amounts that might end up being taxable in the kids’ hands and replace them with contributions that will solve that problem. The tried and true withdrawal and recontribution strategy is perfectly legal, but a rort nonetheless.

It may be that the alleged backlash against the proposed superannuation change is being used as a rod to beat Mr Turnbull. Assuming that it is not, there may be an argument the changes violate the principle of retrospectivity. Usually that means outlawing something that has already occurred, not scaling back previously allowables on a prospective basis.

Politicians are always lambasting opponents from their high horses while ignoring their own inconsistencies. When Mr Shorten mounted his shetland pony to berate the Government about proposing retrospective changes he forgot his own policy to put a cap on the amount of tax-free earnings of pension balances also involves changing the rules midstream. But what changes are not? Perhaps all changes should be grandfathered so they only apply prospectively? Two sets of taxpayers for each and every piece of legislation? That’s the retrospectivity argument in a nutshell.

Instead of limiting the quantum of tax-free pension earnings as suggested by the ALP, the Liberals propose limiting the level of tax-free pension balances, administratively a superior method to achieve a similar result.

The ALP’s disingenuous claims of retrospectively gave oxygen to a campaign which may thwart changes that will restore a little more equity to superannuation policy.

For too long the system has been skewed in favour of the wealthy. The system could have been so much fairer and simpler if recommendations in the Henry report had been adopted. These included a flat 7.5 per cent tax on fund earnings from accumulation right through the pension stage and a contribution tax at the contributor’s marginal tax rate less 15 per cent meaning low-income taxpayers would pay nil contributions tax, more equitable than at present. Overall tax revenue from superannuation and fund balances at retirement would be higher. Currently, high-income earners are estimated to pay no tax on two-thirds of lifetime fund earnings. That’s a big subsidy. A rate of 7.5 per cent is hardly a weighty impost. Or should aged-based rorting continue to take precedence?

Superannuation failing the fairness test is not the only problem. The system is good at attracting funds. Compulsion helps. It is a form of national savings. While savings is an admirable sign of prudence at the individual level, collectively it means less is spent on current consumption. Lack of demand can restrict an economy. The paradox of collective thrift is a well known phenomenon made even worse by the fact in the case of superannuation, the screen jockeys responsible for the custodianship of $2 trillion of the nation’s savings do not invest in nation building, but instead buy and sell existing assets among themselves hoping to make a capital gain so they can clip 1 per cent to 2 per cent from the ticket to overindulge themselves even further.

It was assumed the trusty old market would solve the problem of the large pool of savings created by the superannuation. Unfortunately, it has done so by providing sustenance to the speculative economy at the expenses of jobs growth and the real economy.

The whinges of the wealthy and the wannabes are a crass example of self interest at a time when fairness, more revenue and a system that integrates with the real economy are long overdue.
(Published in The Mercury 21st July 2016)

Saturday, 4 June 2016

Australia's real lifters and leaners

Economist Philip Soos argues our current system is a racket designed to generate free banquets for the rentier class. Spend a few minutes and read the compelling analysis. It’s a crackerjack article. First posted in  Independent Australia.

WHEN THE infamous duo of Abbott and Hockey came to power in 2013, they embarked upon a polarising rhetoric of “lifters” versus “leaners” separating Australians into one of two camps.

The split was a simple one: those who earn and engage in productive activity, indicated by making a revenue or wage and hence paying income tax, in contrast to those who pay no net income tax, mostly social welfare recipients.

In Australia, the Duncan Storrar episode once again brought attention to this rhetoric. It expanded into a moral uproar with those who believe the poor should be provided more assistance, and those who think such people are a useless economic deadweight on society.

Earned versus unearned wealth and income

There is only one small problem.

The notion that the rich have earned all their wealth and income is completely false. Not only is it false, it is obviously false when one considers the issues at hand. Although the mass media and intellectuals often assert the rich must have become so by cause of effort, the available economic theory and documentary evidence, readily available, demonstrates otherwise.

Overwhelmingly, the pathway to riches is not through earned wealth and income but that which is unearned. The 18th century physiocrats and the later classical economists from Adam Smith to John Stuart Mill to Karl Marx, ultimately finding its peak expression in Henry George, argued for a clear difference between earned and unearned wealth and income. The term economic rent was used to identify this distinction. Those who make their living off economic rent are called rentiers.

Monday, 30 May 2016

Doubts about jobs and growth

Greg Jericho posted a good article HERE covering the growing doubts about the policies that are being foisted upon us. The following is a shortened version  without the charts.

As developed economies such as Australia’s struggle to encourage growth, even the disciples of austerity are admitting that they might have it wrong. For Malcolm Turnbull the election is all about jobs and growth and a belief that a company tax cut and reducing government spending is the way to achieve both. But in light of the failures of such standard economic thinking after the GFC to provide economic growth, new research is finding that policies that fail to consider other aspects such as inequality are actually undermining long-term economic performance.

Prior to the GFC, the pervading view was that neo-liberal polices of lower regulation, more competition, budget surpluses, increased trade and lower taxes had delivered the economic sweet spot.

And then the world with low regulation, budget surpluses, open markets and low taxes was blown to hell.

And yet the same thinking continues. The Liberal party pledges to cut company tax (to encourage foreign investment), crackdown on welfare spending (to reduce the budget deficit) and encourage more open markets (mostly through the talisman of free-trade agreements).

And certainly such openness has led to benefits – cheaper products that lift overall standard of living and improved the efficiency of local producers. But the neo-liberal strain of economic thought is one that would have us believe the GFC didn’t happen (ALP inherited a surplus, and then the blew it), that pursuing austerity or more open markets has no downside and that the benefits should just be taken as a given.

It’s the same thinking that underpins the Treasury’s justification for the company tax cut: it will eventually improve productivity via increased foreign investment and thus real wages will go up (despite it having virtually no impact on employment growth).

Productivity is a wonderful thing – increasing it improves all economic outlooks. The problem is over the past decade productivity growth has been falling and no one is really sure why.

It’s a bit of a worry (OK, a great worry) that no one is really sure that they are able to accurately measure what is basically the foundation of most economic “reform”.

Perhaps it is little wonder then that in light of the hits to economies from the GFC and the subsequent continued adherence by governments to pre-GFC thinking that the neo-liberal path is being more and more questioned – whether it be by supporters of Bernie Sanders in the USA , or more surprisingly by economists at the neo-liberal heartland of the International Monetary Fund.

An article in the IMF’s latest issue of is journal Finance and Development notes that “instead of delivering growth, some neoliberal policies have increased inequality” and jeopardised “durable” growth.

The authors note that there actually scant proof that the standard policies of encouraging foreign investment and reducing deficits and debt levels has improved economic growth.

They found that it’s tough to actually establish “the benefits in terms of increased growth” from these polices but that the costs from “increased inequality are prominent”. Even worse for those who desire economic growth above all else, they found that the “increased inequality in turn hurts the level and sustainability of growth.”

The authors note that their study of economies found that “austerity policies not only generate substantial welfare costs due to supply-side channels, they also hurt demand—and thus worsen employment and unemployment”.

As I have noted (repeatedly) lack of demand is a massive issue for our economy. Right now Malcolm Turnbull would have you believe that it is an absolute given that more foreign investment and lower taxation and government spending will deliver economic growth. The reality is such belief is based on a model that struggles to deliver proof that is actually works and which crucially ignores factors such as inequality that can actually undermine their goal of economic growth.

Nearly a decade on from the GFC it perhaps it time to acknowledge the neo-liberal model might have a few cracks in it.

Saturday, 28 May 2016

Back on track?

(As published in The Mercury 28th May 2016)

Treasurer Peter Gutwein says we’re back on track.

So how come spending will exceed revenue for each of the next three years?

The claimed surplus of $77 million for 2016/17, an accounting figure derived after a few book entries, obscures the fact that the government will spend $134 million more than it will receive.

The next two years thereafter will see similar excesses. In each of those two years revenue will be less than for 2016/17. A few years ago we had a minor dip in one year but it’s been a long time since the dip stretched over three years.

The Treasurer was determined to deliver a surplus as promised, whether by hook or crook. Revenue was brought forward, additional capital grants from the Feds were negotiated and a transfer from TTLine was arranged. All are one off items that don’t indicate a sustainable position as implied by the ‘back on track’ reference.

Tuesday, 24 May 2016

Jobs and growth within our means

It’s not long since Prime Minister Turnbull promised an end to three word slogans and the start of a mature conversation with voters.

Alas we are still waiting.

Many were hoping the PM would pinpoint the problems as he sees them and explain why his policies offer a solution. He’s now using a three word slogan, jobs and growth, to promote a solution to the problem he didn’t bother to explain.

We all know the symptoms of the problem, too many borrowed funds devoted to buying and selling existing houses instead of investing in the real economy, private debt sky high, real wage increases slowing down, oodles of unused supply capacity both capital and labour. Unused capacity and unmet demand. Nobody’s buying.

What to do? Cut penalty rates? That may increase the supply of lattes but where will the extra demand come from? From other industries? But won’t all industries suffer if wages share of the national pie falls? What if café owners reduce their high private debt instead of employing more staff? The economy will be worse off. The paradox of thrift may strike again. Cutting wages may have some effects at the margin but the case is not overwhelming. Government austerity suffers from the same drawbacks. The comprehensive rejection of the 2014 Federal budget shows the general sentiment in the community. People struggle to understand the underlying assumptions of proposals when politicians present them.

How about more jobs and growth by cutting company taxes as the PM is now promoting? If there’s unused supply wouldn’t a better solution be to find a way to introduce Mr Supply to an eligible Ms Demand? How will cutting company taxes promote jobs and growth if nobody’s buying? What comes first, the cart or the horse?

The jobs and growth plan is just another name for a two hundred year old economic theory known as Say’s law that economists used to explain how the economy works……… supply creates its own demand. The Great Depression revealed that an economy was a liitle more complicated than Say’s Law assumes. But it has never disappeared completely. Thatcher and Reagan revived it. Recently it’s been variously described as supply side economics or trickledown economics. It fades from view from time to time, and then reappears after its failings are forgotten. The jobs and growth plan is the latest reincarnation.

Even if new supply creates its own new demand, what about those who became underemployed or unemployed because of low demand before new supply created new demand? What do we do about them? Give them new skills? Apply a supply side solution to expanding VET courses and job placement agencies? Has it worked? Build bigger universities? The suppliers are building their own businesses funded almost entirely by governments but will the supply of a more skilled workforce be enough? It’s as if all the problems are on the supply side. Fix that and you’ll fix the economy? If that’s what the PM believes he should say so. After all he’s supposed to be the Great Communicator.

Underpinning the jobs and growth plan is the constant chant of the need to live within our means. It’s this falsehood, that there is a finite supply of funds the Federal government can lay its hand on that is condemning the economy to a sub-optimum future.  Sure a household may have to live within its means. It needs money to survive, income or maybe even loan funds. Any politician who says the country is like a household and has to live within its means, doesn’t understand banking at the macro level.

Sunday, 22 May 2016

Budget tricks

Treasurer Gutwein has found something new in his budget bag of tricks.

Establishing a fund to receive amounts from TTLine to enable replacement of the two Spirit vessels in 10 years time as announced with much fanfare is just an accounting ruse.

TTLine has been planning to replace the ferries for years and has been setting funds aside.

Borrowings on Spirits 1 and 2 were finally paid off in the 2010/11 year. Prior to then,TTLine was paying $25 million a year off the debt owed to Tascorp and it was a bit of a struggle.

Since then the cash surpluses have been allowed to build up in TTLine as it was exempted from paying any returns to the Government.  Since 2010/11 cash at bank has increased from $16 million to $90 million in 2014/15. The increase in the latter year was only $9 million as the refurbishment of the two Spirit vessels commenced in Feb 2015.

The government now plans to transfer cash reserves from TTLine to a special Fund run by the Department of Finance.


Can’t the Board of TTLine be trusted to look after such a large amount of cash?

The answer is the payment of two special dividends of $40 million in each of 2016/17 and 2017/18 by TTLine is recorded as income by the government and will boost the bottom line by $80 million, a bottom line sadly suffering from Hydro’s Basslink woes.

When the replacement vessels are eventually purchased the accumulated funds will be transferred back to TTLine, but as an equity contribution which won’t affect the bottom line in the year of transfer.

It’s just an accounting trick.

Wednesday, 11 May 2016

Hydro CEO's reassurances

It was good to see Hydro’s CEO Steve Davy belatedly addressing a few of the concerns that have been raised about his company’s financial position in today’s opinion piece in The Mercury titled It's a huge hit but it won't sink us. He emphasised a keenness to ensure commentary is accurate and based on facts.

Factual accuracy doesn’t necessarily preclude attempting to lead a reader to erroneous conclusions.

Take this statement:

“Hydro Tasmania’s financial position is sound. Its net debt balance of $826 million, as at March 31, was less than the balance at the end of each of the previous five financial years. We are projected to have enough liquidity and debt facilities in place to fund the implementation of the Energy Supply Plan without extending existing borrowing arrangements with the state’s borrowing arm Tascorp.”

Factually correct no doubt.  Hydro will cope without extending existing borrowing arrangements. Most readers will think this means debt won’t increase. But what’s actually said is that existing arrangements are adequate. If that’s the case why not say what those arrangements are?  

Hydro’s current arrangement with Tascorp is a borrowing limit of $1.055 billion meaning a further $229 million can be borrowed. Why not say the costs of the outage are not expected to exceed the $229 million extra borrowing facility already in place?  Maybe even say what increase in borrowings is likely

Then we have this statement:

“Over the past five years, Hydro Tasmania has achieved an average underlying result before tax of $149 million. For the same period, average cash flows from operations have been $160 million, well in excess of the average core capital expenditure of $108 million during the same period. “

To dredge up five year averages covering the carbon tax years is bordering on wilful deception. The only historical figure of any current relevance is the post carbon tax operating cash flow figure of $26 million in 2015. Whilst the latter includes returns to government, it is considerably boosted by income from renewable energy certificates which won’t occur at that level for a while. Why not explain this to the punters instead of attempting a Pollyanna imitation?

The five year averages were used to suggest Hydro was not insolvent. It probably isn’t but past averages are irrelevant to proving the case. Future ability to pay debt is the key as Mr Davy knows, but he’s not about to take punters into his confidence. Yet anyway.

Then we get this:

“Hydro Tasmania’s gearing ratio, which provides an indication of the amount of debt held by the company, was lower in June 2015 than in 2011, and lower than its peers in the National Electricity Market such as AGL, Snowy Hydro and Origin Energy. As at June 30, 2015, our total equity was $2.06 billion, which represents a strong net asset position.”

The book value of assets at June 2015 is of little relevance, nor is the gearing ratio based on that book value. AGL and Origin aren’t hydro generators after a period of drought so why introduce them into the picture? The crucial question is the interest cover provided by operating cash and whether there’s any left over for annual capex. Why not explain this to the curious instead of a one line assertion about profits resuming in the 2018/19 year? Maybe  include the costs of fixing the interest rate portion of the Basslink facility fee, the Macquarie swap deal, to get a more accurate assessment of interest cover?

The factors that will impact on the revised book value of generation assets are given a good coverage:

“As in previous years, the valuation will take into account a range of factors, of which the need to rebuild storages is but one. Given the long life of the assets, the valuation will also be impacted by current and forecast energy and large-scale generation certificate prices, and estimates regarding the level of investment required to appropriately maintain the assets. While the reduction of generation to rebuild storages will, in isolation, have a downwards influence on the valuation of assets, the final valuation figure included in the annual accounts will be the product of a number of factors.”

Except there’s no mention of the fact that asset values will have to be written down further if the cause of  the outage remains unknown and the link is not fully restored and capable of fully delivering what was originally intended .

The following would have left a few readers puzzled:

“Another issue that has been used to question our financial strength was last year’s debt transfer to Hydro Tasmania of $205 million from TasNetworks. What is not said is that amount counterbalanced what had been transferred to Hydro Tasmania in 2012-2013 when we were given responsibility for the Tamar Valley Power Station.”

Talk about a debt transfer from TasNetworks and a counter balance to the transfer of the Tamar Valley Power Station (from Aurora Energy incidentally) might make sense to Mr Davy but is pretty confusing for most readers. Sure the amount of $205 million originally came from TasNetworks but from Hydro’s viewpoint it was a cash injection used to pay a $118.5 million dividend to the government with the rest used to fund capex which couldn’t be met from operating cash flow. The transaction didn’t highlight Hydro’s financial weakness, rather the shareholder’s greed. But I guess the CEO can’t say that.

The CEO’s contribution, the first real attempt in five months to accurately and factually describe the financial ramifications of the Basslink outage was more honoured in the breach than the observance.

It was anything but reassuring.