Efficiency or Property Rights: Thomas Woods’ comments on the Chicago School of Economics

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This was originally posted at City of God.

Thomas Woods, in his book The Church and the Market, spends a little time in the first chapter distinguishing the Austrian and Chicago schools of economics. One major difference between the schools is on the issue of central banking and monetary policy. We’ve had occasion to discuss this on the blog in the past, and I’m not particularly interested in raising it again here. However, Woods brought to my attention another difference which is of much greater concern to me, and this is over a moral issue. The difference is this:

The classic case in Chicago law and economics, famously described by Ronald Coase, is the example of the train that emits sparks that set fire to a farmer’s crops. (The example occurs prior to the introduction of diesel engines.) Either the farmer or the train will have to bear the cost of this damage. On the basis of strict liability, of course, the farmer has the right to the property in question and therefore the right to enjoy its fruits unmolested. The train should compensate him for his loss or install some kind of spark retarding device. But Chicago decides this case in such a way that overall wealth is maximized. (25)

Thus economic efficiency becomes an ethical value that is weighed against the property rights of people. The Austrians vehemently disagree with this point. They argue

that the rights of property should not be compromised in order to satisfy any wealth maximization calculus, and that as a rule strict liability should be observed. (They offer these critiques in their capacities as moral philosophers rather than qua economists, a point to which we shall return in our discussion of economics as a value-free science.) Walter Block has described it as “evil and vicious to violate our most cherished and precious property rights in an ill-conceived attempt to maximize the monetary value of production.” (26)

Woods provides one quote from a defender of Coase to make clear that the Chicago school explicitly teaches what he says they teach:

In defense of Coase, Chicago economic Harold Demsetz argues that “[e]fficiency seems to be not merely one of the many criteria underlying our notions of ethically correct definitions of private property rights, but an extremely important one. It is difficult even to describe unambiguously any other criterion for determining what is ethical.” Here is efficiency analysis with a vengeance. (26)

Now, I’m not sure any other way to describe this theory besides the words Block used: evil. Quite clearly, this is a form of coarse utlilitarianism, and one which will undoubtedly help the well-connected over against those who have little wealth. And I think this point is something where those on the left and those who support a view of property rights as natural rights (be they conservative or libertarian) can find agreement.

What does the sale of Brigham Exploration tells us about the value of Petrobakken?

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Today we learn that Statoil has offered 4.4 billion for Brigham Exploration, a company with holdings in the US Bakken. Using a number of interesting methods of comparing the Brigham Exploration with Petrobakken, Devon Shire concludes that Petrobakken could be worth as much as 300% of its current market price (at close on Oct 17, $8). This kind of comparison is very interesting, because, as I reminded readers in a previous post about Petrobakken, the true value of an junior or intermediate oil company isn’t so much its market capital, but by how much an industry insider such as Sinopec or Statoil is willing to pay. Devon Shire writes:

I don’t know exactly what Petrobakken is worth. But common sense tells me that an acquirer would be willing to pay a lot more than the current share price.

Petrobakken is just like Brigham. They are both companies that have years and years of drilling locations ahead of them and both companies sit on vast amounts of oil. That is why the multiples of flowing barrel of production and EBITA being paid for Brigham are so high.

You can’t value these companies using the same approach as you do for a conventional oil and gas producer. Much of the value is in the huge land positions that these companies have in unconventional resource plays. And much of that doesn’t show up in proved reserves because most of the undeveloped acreage isn’t booked as proved reserves.

It isn’t just Petrobakken that is massively undervalued right now. The entire sector in Canada is. Pick an unconventional producer and I almost guarantee it is trading at 50% or less than what an acquirer would pay.

All it takes is some common sense to see it. And some patience to wait for Mr. Market to figure it out.

See also:  What does the sale of Daylight Energy tell us about the value of Petrobakken?

Review of Peter Grandich’s Confessions of a Wall Street Whiz Kid

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Please take a look at Jonathan Chevreau’s column today; he reviews Peter Grandich’s, Confessions of a Wall Street Whiz Kid. Grandich was a Wall Street legend who realized the emptiness of his quest for material wealth. Here is an excerpt:

Early on, Grandich’s church-going was mostly for show and to accommodate his Catholic wife. But when he said his newborn daughter was healed by prayer in the 1990s, he began taking his religion more seriously. He “started to believe in God on a real, daily basis,” even though he viewed himself as a “sinner . and a big one, at that.”

Despite his wealth, he felt like most Americans that he was living beyond his means, so “super-downsized” his high-net-worth lifestyle.

Please read the rest at the Financial Post.

What does the sale of Daylight Energy tell us about the value of Petrobakken?

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On the close of market on Friday, Daylight Energy had a market capital of CDN $976.9 million and a book value (according to TD Waterhouse website) of $6.06.  With the proper approvals, Sinopec will buy it for CDN $ 2,200 million which comes to CDN $10.08 per share.

Daylight Energy is a company that has similar assets, such as a large undeveloped Cardium base, to Petrobakken.   The difference is that Daylight has greater natural gas weighting than Petrobakken, and given the current commodity prices, Petrobakken should probably be more valuable.  But the thing that makes Daylight most like Petrobakken is the current debt load.  According to Bloomberg:

Investors feared Daylight’s relatively high debt load compared to peers, combined with a fall in oil prices, would crimp earnings, Geoff Ready, an analyst with Haywood Securities LLC in Toronto, said in a telephone interview. Daylight has total outstanding debt of C$872.5 million, according to data compiled by Bloomberg.

In this respect, Daylight is very much like Petrobakken–the market has shunned it for the same reason.  While both companies pay a great dividend, have great cash flow and sit on large, very valuable land bases, Mr. Market has spurned them and thrown them under the bus.  This is what makes them a great value investment.  I have written about book value in previous posts (e.g., here), that the price of a private sale of a company which has positive cash will never fall short of the book value of the company.  Unfortunately, the price for Daylight was only a small premium above book–just about $4 per share.  This is the true value of the company, not what Mr. Market is willing to pay but what industry insiders (such as Sinopec, a large Chinese Petroleum company), who would buy the business outright, would pay.

Therefore, I would like to assign a market value to PBN based on the same metrics (in CDN $$; book value from the TD Waterhouse website):

Daylight: book value $6.06; sale price 2.2 billion or $10.08 per share; sale price as a percent of book = 166%

Petrobakken: book value $17.43;  $28-29 per share (i.e., 166% above book price)

Now ultimately we have in this offer from Sinopec a fairer evaluation of the value of a Canadian dividend paying intermediate oil company than what Mr. Market is providing.  I would think that if you want to get in on Petrobakken or any other CDN intermediate oil company, it may be too late to do so based on the prices that we’ve seen in the last two weeks.  I’m holding my ground.

Furthermore, I would like to say that in the global monetary crisis that politicians and central banks will resort to currency devaluation to solve their problems–i.e., they will inject liquidity by recapitalizing banks, buying up troubled assets, etc.  The Chinese holders of debt are now in search for quality assets based on resources, and they are getting a steal with this offer to Daylight.  Personally, I am glad for the offer.  But as a shareholder of Daylight Energy, I will probably vote against the deal (provided that I continue to hold until the vote).

Nota Bene postlude:  Finally, I would add that this sale seems to repudiate the method of evaluating Petrobakken using only proven reserves (see here, here and here).  The Chinese experts have decided that the land is worth something–a lot more along the lines of the industry experts in Canada such as the CEOs of Petrobakken and Daylight Energy.    I would say that this sale makes some of us, who focus on the land base and the oil in the ground and such metrics as low book/price, look a lot smarter than some would allow.  A certain blogger offered some pretty self-confident and disparaging comments about how I was gonna lose money on Petrobakken and how I didn’t know what the hell I was doing.  To be sure, I’ve already lost a ton of money, but $25 is my top price for the company ($27 put minus) as I have averaged down from there (my average price is much lower).  I’ll continue to collect a nice dividend on all my shares until a buyer takes it out for $28+ or the market realizes what it’s really worth.

Chinese offer $10.08 per share for Daylight Energy

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Subject to approvals, China’s Sinopec is buying Daylight Energy (DAY.TO) for $10.08, which closed at $4.59 CDN Friday. Here is another example, like Petrobakken, where Mr. Market doesn’t know what something is worth, but another industry giant does.  I feel sorry for those who bought at $11.74, the 52 week high. You win some and you lose some.

My friend Mich won big on this one.  He bought near the market close on Friday 1000 shares–that is a one day return of over 100%!  My returns are far more subdued.  I will make 8.8% return on capital at risk on this deal.  It helps me, because my current position was in the BIG RED.

But I’m not that happy, because this is Canada’s future, and I don’t think we should sell our assets to foreigners at enterprise value but at a significant premium.  But hey, it will bring capital into Canada and it will create jobs, and so I am happy about the short term help it will bring.

While this is 2.2 billion dollars and it seems like a lot of money, it fits into the larger meta-narrative:  The international trading scheme, whereby US consumers buy goods from creditor nations which in turn  lend the money back to the US government,  is unravelling.  This asset purchase is a rebuke of the US dollar, just as the dumping of $56 billion in treasury notes by foreign creditors.  We should expect more of this and as suggested by Zero Hedge, it is perhaps the beginning of the end of the US dollar:

Of course, there is a far simpler explanation [for the dump of 56 billion in US treasury debt]: the dreaded D-day in which foreign official and private investors finally start offloading their $2.7 trillion in Treasurys with impunity (although not with the element of surprise – China has made it abundantly clear it will sell its Treasury holdings, the only question is when), has finally arrived.