The merry-go-round of aluminum prices

Any time now, either the privatization of the aluminum industry goes forward or the process is delayed indefinitely, rather, definitely delayed until after the upcoming presidential elections.

One of the most debated issues during the run-up to privatization has been that of the establishment of the price at which the privatized entity will supply primary aluminum to the local market. The opinions of the parties involved normally reflect directly their particular interests. While on one hand, the potential bidders interested in acquiring the aluminum concerns don’t want to see any limitations imposed, the local buyers of primary aluminum naturally wish to be awarded the right to purchase unlimited volumes and minimum prices.

At the risk of sticking my nose where it doesn’t belong, I would dare say that the final price the Venezuelan state would receive for the privatization of the industry’s components would be higher should no limitations on future sales be imposed than if obligations to sell to the national market at specially favorable prices were built in from the onset. Accordingly, it is obvious that as a tax payer and party, however theoretically, to a minuscule portion of the national fiscal wealth, I retain a certain right, as co-underwriter, to make my opinions known.

I will begin by establishing certain parameters. Aluminum is a metal for which the global markets establish reference prices on a daily basis (through the London Metal Exchange), that is, it is a commodity. Supposing that today’s quotes are based on the cost of aluminum of US$ 1,500 per ton fob at a European port and that the cost of transportation to Venezuela is US$ 60 per ton, this means that anyone wishing to import primary aluminum to Venezuela must pay US$ 1,560 per ton plus the cost of the internal freight to its final destination. On the other hand, if someone wishes to export aluminum to Europe from Venezuela, he will must foot the bill for the freight in order to meet the reference price of US$ 1,500 per ton. This means he will receive US$ 1,440 (i.e. the reference price less freight charges of US$ 60 per ton to Europe) less local transportation costs.

Under normal conditions, it could be expected that prices for primary aluminum in the local market with cash terms and reasonable volume purchases would be set within the abovementioned band (that is, between US$ 1,560 and US$ 1,440). Should prices be set higher than the maximum, this is certainly due to other aspects such as the existence of protectionary measures aimed at blocking aluminum imports.

Should the opposite occur, that is that the resulting price is set below the lower level of the band, this is probably due to special regulations such as price controls and the accumulation of incentives to import. For example, the exporter may prefer to sell aluminum locally at lower prices in order to be able to offset sales taxes immediately rather than sell overseas at higher prices and waiting patiently in line for the tax authorities to reimburse him for this sales tax.

Evidently, as a loyal Venezuelan I am interested in insuring that any primary industry such as the aluminum sector can develop and invest in downstream processing facilities which will produce added value, generate employment and participate in the general well being of the country.

However, I do believe that the best method available to the State in order to insure the coherent development of internal markets is the outright elimination of artificial barriers, not the creation of new ones.

Should the National Executive, in the case of the privatization of the Venezuelan aluminum sector, concede advantages to local buyers of primary aluminum and as a result reduce the price potential investors are willing to put on the table, this reduction in price could be construed as being a subsidy paid in advance to the local market without exacting anything in return. Doesn’t seem logical to me!

It would seem logical, however, to obligate the Executive to intelligently study the future development of the market in order to manage prices within reasonable limits. Any efforts to block winning bidders from taking undue advantage of their local strengths are merely partial justifications for this study. It is much more important to identify any artificial tendencies that are normally created by the Government itself and that are usually the principal causes of these abnormal situations in the first place.

Having decided to capitalize on some of the advantages offered by privatization, let us, for God’s sake, not turn around and forsake these by nationalizing free market rules and regulations.

Accessing www.Venezuela.com

Many columnists writing about the Internet maintain that due to the type of information it makes available, it will some day allow less developed countries not only catch up with developed nations, but actually surpass them. This theory is based on the idea that the former would be able to enjoy the benefits of new inventions and discoveries without being tied down by previous ones. We don’t wish to exaggerate the importance of the net, but the fact is that it exists, that with every day that passes there are more users, and that huge amounts of resources are being invested in its development. The following are some comments related to the above.

1. Orphaned Pages: Individuals and organizations of all kinds are dedicated to the dissemination of information via the Internet by means of the creation of web pages. Many of these pages are immensely valuable and are continually consulted by thousands of users. Other have less success. Just like ships lost in space, there are many abandoned pages floating around in cyberspace as silent witnesses to those immense efforts in development that have fallen by the wayside.

These orphaned pages contaminate. Sometimes they only cause minor irritation to the net’s users, they frequently turn into instruments that are contrary to the reasons and interests for which they were created. For example: in early 1996 someone interested in Venezuela could access, via the Venezuelan Embassy in Washington, a special web page where he could find the most recent information regarding the privatization process carried out by the Venezuelan Investment Fund. The page was never brought up to date and since then, it still proudly touts the objectives of privatization of entities such as Alucasa and the Electricidad de Nueva Esparta for the fourth quarter of 1996. Evidently, the impression is totally negative.

Obviously this fact is not exclusive to Venezuela. It occurs in all parts of the globe and with may types of organizations. In our experience it has been increasingly difficult to eliminate a page since, due to this dizzying growth, service companies maintaining these pages cannot keep up with the demand and don’t have the time or the interest necessary for those who wish to retire their pages.

Every user is responsible for his own page, but as far as the official pages produced by government entities, we believe a central entity should a) supervise their creation, b) maintain a registry of existing pages, c) watch over them while they are active, and finally d) give them a proper burial when they become obsolete.

2. Venezuela’s Page: With frequency we see a duplicity of efforts when organizations, both private and public, include information relative to diverse and general aspects of Venezuelan life such as geography, economics and law in an effort to make their pages more attractive. This effort is not restricted to the development of the pages but extends into their maintenance.

It is extremely important for the country to be able to capitalize on the possibilities for advancement offered by the Internet. Some of these include the education of new generations and the direct promotion of the nation’s economic growth and development. We therefore believe it would be beneficial to set up a central super-data base about Venezuela and allow all interested users to access it for free. In order to insure the success of such a page, it must comply with certain minimum requirements.

It must avoid subjective or biased data. For example, any data that a government presents in order to defend its administration automatically produces a counter-reaction, inviting “opposition” pages, detracting from the perceived validity of the information and creating the duplicity of efforts described previously. In this sense, the first basic prerequisite must be to allow only data bases that present information that is objective and real.

Evidently any organization can create its own page and include the information it wishes. The idea, however, is that, as far as a formal Venezuelan Page is concerned, everyone should be in agreement with the information presented. This is the only way we can guarantee that everyone will want to use it for their own development and that all will be interested in keeping it alive and up to date. It will also insure that it will not quickly turn into the type of floating space garbage we mentioned before and that it could, just maybe, turn into the “best web page in the world”.

Information is power, for good or for bad. All those who may have an interest in the development of this project must participate if it is to be successful. Today, the information about our country can only be qualified as pathetic. Its correct development should be of vital importance to the country and it is surprising to see the little attention this is receiving in Venezuela.

It is high time the government, the opposition, private and official organizations, universities, states and municipalities, ..... (the list can go on for ever), take a break from their individualistic efforts and dedicate a bit of their time to the development of our www.venezuela.com web site.

Unhinged economic planning

We have often heard about the lack of resources available to fund institutions such as the National Exchange Commission. The latter, by the way, would be much better off reviewing and stamping prospectus’ of new issues with stamps such as “Danger - Opportunities and Risks - Issue Not Controlled” than creating the illusion of exercising effective control. We vividly remember the Bank Superintendency during the recent bank crisis.

However, some new government initiatives such as the new Banco de Comercio Exterior (Export Bank), are receiving ample budgetary support via capitalization (this should not be construed as being a criticism or as trying to belittle the importance of Bancoex). No one can dispute the fact that economic planning seems to be a bit disjointed.

Additionally, we all have heard about the ambitious investment programs being implemented by sectors such as Petrochemicals. However, when we read in the local press about the strict orders issued to firms such as Cadafe and Hidroven, both of utmost importance for the development of the country, to drastically reduce their investments supposedly in order to fight inflation (by reducing “excess” liquidity), there is no doubt that national economic development seems to lack a backbone.

We must remember that one of the main justifications for the Reactivation of Marginal Oil Fields program was that a great number of the wells were shut down, not for lack of productivity, but because it would have required large amounts of resources and investment, and that PDVSA, lacking these resources, preferred to invest in areas that held more promise and higher returns.

Now, PDVSA is being asked to cut back on its expenditure in 1998 in order to join the attack on inflation. For the third time, we dare put forward the thesis that there is total dyslexia in our national economic planning. A more extreme interpretation of this seems to imply that investment in marginal fields under the oil opening program may go ahead while development of the high yield wells operated by PDVSA must by scaled back.

Additionally, without trying to discuss the reason why, the country has been suffering though high inflation without the corresponding devaluation of the national currency. This real appreciation of the currency flies directly into the face of the efforts of those businesses trying to compete in the international arena via exports of goods or services such as tourism.

The cutback order by the national executive in the investment programs of the above-mentioned entities specifically and unbelievably excludes the purchases of imported goods and services, paid in hard currency all under the assumption that these disbursements do not adversely affect monetary liquidity in the country. We come back again to the thesis that national economic planning is basically brain-dead. Another extreme interpretation is that it is forbidden to buy locally produced goods (no compre Venezolano) while the purchase of imported goods are encouraged.

The dramatic reduction in the economic activity of the country over the past few years has created unemployment and hunger in a great part of its population. It cannot be disputed that we urgently need to develop a plan to reactivate the economy. This plan must go much further than simply stimulating an increase in the demand for consumer goods, which is usually a simple hedge against inflation and not the result of a coherent plan.

However, when we observe that our planning teams, lacking the courage to confront inefficient public spending, the main cause of all most of our ills, continue to raise smoke screens such as the argument of excessive liquidity, we can only add another attribute to our national economic planning, lack of heart.

I’ve mentioned this before in a previous article and I repeat it now. The omnipresent preoccupation with excess liquidity is like a physician who worries about possible leftovers of food when a patient refuses nourishment and begins to fade away. The problem is not the food, it is the appetite. The problem is not excess liquidity, it is the lack of a healthy economic plan aimed a generating production and productivity.

A way to assess the bond swap

The calculation of present value is a valuable tool of analysis in today's financial world. When managed by rookies or people with wrong intentions it can be very dangerous, as all tools are. This is good to keep in mind when issuing judgment on Venezuela's 1997 Brady Bond swap. The concept of present value can be clearly illustrated by using the classic example of inheritance. In this example, someone asks a grandchild for the amount he is willing to trade today for a future inheritance of $1 million, which will be willed him by his grandmother. The answer to this question will be a function of three factors.

The first factor involved is time. If the grandchild considers that the grandmother is still healthy and that she therefore may live for quite a few more years (say 20 years), then he will obviously be willing to apply a greater discount and accept a lower present value. On the other hand, should the grandmother be rather ill, and death apparently just around the corner, then this discount will be smaller and the amount of the inheritance will be greater.

The second relevant factor is risk. This is based on the philosophy that it is better to have one bird in hand than a hundred in the bush. Should the grandchild think that his grandmother may actually change her mind and leave him penniless, he will again be willing to apply a greater discount and therefore accept a lower value today.

The third factor that must be mentioned is opportunity cost - in other words, the alternative use that maybe made of the funds. If the grandchild urgently needs the funds to pay off a gambling debt before someone breaks his kneecaps, it is obvious that he gill accept a greater discount and again accept a lower sum as present value of his inheritance . If, on the contrary, he expects to invest the funds in long term 30-year United States Treasury bonds, the discount he will offer will not defer too drastically from the yield produced by these instruments.

The risk factor and the opportunity cost factor come together in what we know as the discount rate. The mathematical process whereby present values are calculated consists in discounting (at the discount rate) the amount being analyzed (the inheritance) over an established period (time).

At this point, we have only come to the conclusion that even when we hide this calculation under the mantle of sophisticated financial techniques, there is a fundamental logic to the same. The value of something in the future is lower than it is today.

Having herewith complied with the initial objective of this article – to transmit as concisely as possible the concept of present value - let's now examine how this can be abused. The recent case of the Brady Bond swap was based on the analysis of supposed benefits found in two arguments: first, the fact that financial experts loudly praised the operation; and second, the analysis of the present value of the operation.

As far as the source of the praise, I do not wish to go into detail. But initially it seems that $28 million in commissions plus information of great income generating potential should be enough to justify the creation of a good Swap Fan Club.

As a result of the swap, Venezuela obtained $1.3 billion. The present value of this evidently is the same $1 .3 billion. In exchange, Venezuela had to undertake additional payments. These payments are: additional annual interest of $70 million over-- a 23-year period until 2020 as well as $370 million to be paid for seven years between the years 2021 and 2027. A final payment of $4 billion is due in the year 2027.

The classification of this operation as "financially sound" depends on whether or not the present value of the additional payments described in the previous paragraph is lower than the $1 .3 billion received initially. It all depends on the infamous discount rate applied. With a discount rate of 8.8 percent, the operation is neutral (Blah Matos). With a higher rate, the operation could be rated as marvelous (Viva Matos!). Finally, with a lower discount rate, the operation is an unmitigated disaster (Down with Matos!).

We will not issue opinions about who is right. I would like though to alert readers about the vicious circle caused by the erroneous use of the present value principle which, in the hands of the wrong people (politicians maybe?) could generate catastrophic results.

Because it has implemented shortsighted policies, Venezuela has problems of high indebtedness. When the country runs into problems, the discount rate applied by international markets is normally increased. When the rate is increased the value of the present value of future payments is reduced. When the value of the future payments is reduced, additional indebtedness is stimulated. And the vicious circle continues to turn!