The surge in US shale oil has offset declines elsewhere, stabilized world oil supply, prevented gas prices from rising

By Carpe Diem

A frequent question I’ve heard recently goes something like this: With the huge increase in the supply of domestically produced crude oil in recent years – US output is now at a 27-year high and heading for an all-time record high next year – why haven’t gas prices come down? Gas prices today, at a national average of $3.62 per gallon, are more than double the $1.61 per gallon price in early 2009. During that time, domestic crude oil output has increased by 68.5% from 5 million to almost 8.5 million barrels per day (bpd). I provided several answers to the “pain at the pump” question in a recent CD post, and will expand on that explanation here with two revealing charts.

1. The chart below shows monthly US and world crude oil production from January 1994 to December 2013 based on EIA data here for international crude oil production. Despite the 30.5%, and nearly 2 million bpd, increase in US oil output in just the last two years (2012 and 2013), the world crude oil supply has remained flat at about 76 million bpd since December 2011. At the same time, the world economy has continued to grow, with world real GDP increasing 3.9% in 2011 and 3.2% in 2012, according to the IMF, following a 5.2% growth rate in 2010.
2.  The second chart shows monthly world oil production minus US production over the same 1994-2013 time period vs. the same US oil supply. Without US oil output, the world supply of non-US crude oil was on a gradual downward trend between 2011 and 2013. Importantly, If US oil output hadn’t been surging in 2011, 2012 and 2013, the global oil supply would have been declining slightly in those years. Between the January 2011 peak and September 2013, non-US world oil output fell from by more than 2 million bpd (and by 2%) from a record high 70.2 million bpd to 68 million bpd. Oil production outside the US recovered slightly towards the end of last year to 68.8 million bpd, but that’s the same amount of non-US oil produced back in late 2004, more than nine years earlier. As the WSJ reports today, crude oil output since 2005 has been falling outside the US in countries like Mexico (-25%), Iran (-23%), Algeria (-12%) and Libya (-44%).

 

Bottom Line: As can be seen in the top chart, the increases in US shale oil in recent years have offset the output declines elsewhere and thereby prevented the world supply from falling. Thanks to America’s shale revolution, the surging US oil output has helped stabilize world oil supply at about 76 million bpd during all of 2012 and 2013 which has helped stabilize prices at about $100 per barrel. If we had instead experienced a declining world oil supply over the last few years (as seen in the second chart above) interacting with the strong oil demand from the economic growth taking place globally, we would likely be seeing much higher oil prices today and much higher prices at the pump. Even if the rising domestic oil supply hasn’t brought gas prices down, American consumers should nonetheless be thankful for the strong likelihood that without the Great American Energy Boom, they would be paying much higher gas prices today.

 

Related: Fuel Fix is reporting today that:

Geopolitical turbulence in the Middle East would have created a spike in global oil prices if not for the rise of light-crude in the United States and oil sands in Canada, ConocoPhillips CEO Ryan Lance said Tuesday.

As international conflicts have mounted in Libya, Syria and Iran over the past two years, an increase of 1 million barrels per day from U.S. shale and tight-oil production have kept global markets in check, Lance said in a discussion with reporters after the company’s annual shareholder meeting in Houston on Tuesday.

Summary of the New Ministrial Decree no. 12 issued by The Indonesian Ministry of Energy & Mineral Resources on the Purchase of Electricity from Hydro Power Plant by the state electricity co PLN

The summary of the Ministrial Decree (issued on 2 May 2014) is as follows:

1. The Minister authorizes PLN that PLN must buy the electricity from Hydro Power Plant with less than 10 MW (MHPP) through direct purchase and agreed feed in tariff (FIT) which is governed in the Purchasing Power Agreement (PPA)
2. In the PPA, The FIT is stated at:
• The first eight years: Rp 1,075 per kwh x Regional Factor (F); The F is 1x for Java, Bali, & Madura; 1,1xfor Sumatra; 1.2x for Kalimantan & Sulawesi; 1.25x for NTT & NTB; 1.3x for Maluku and North Maluku; 1.6x for Papua and West Papua
•  Year 9 until year 20: Rp 750 per kwh x Regional Factor as similar to above F
• No negotiation & no escalation on FIT in PPA
3. New Player (New MHPP) must start the business via:
• Proposal to the Directorate General for Renewable Energy (DGRE) to be appointed as MHPP company with all requirements ie:
• Company profile
• iPermits from Regional Government (all permits necessary) & Permits from Government (SIPPA & SIKON)
• Pre Feasibility Study which has been technically verified by PLN; PLN must complete the verfication works max 30 days after once all documents related to pre Feasibility Study is well received by PLN.
• Estimated Project Cost/Investment Cost
• Project schedule up to COD
• Statement of availability of land
• Statement of Willingness & Capability to provide 5% of total project cost in the form of certificate deposit to the DGRE within 30 days after the New Player is appointed legally to be the MHPP company
• Statement of Understanding & Willingness & Capability from the New MHPP to develop and operate the power plant which eventually will be announced by PLN
• Statement of Awareness & Responsible to accept and perform sanction which is governed in this Ministrial Decree
• The proposal to the DGRE has a template attached to the Ministrial Decree no. 12
4. The DGRE shall approve or disapprove the MHPP proposal maximum 30 days after once all the requirements within the proposal is well received by the DGRE with cc to the Directorate General Electricity and PLN Board of Directors.
5. The New MHPP shall report the progress of construction of the project every 6 months to DGRE up to COD and cc to Directorate General Electricity and PLN Board of Directors.
6. Up to 30 days after the approval of the DGRE, the New MHPP must submit the certificate of deposit (5% of total project cost) to the DGRE. If not performed then the DGRE shall revoke the approval and 2 years sanction to the New MHPP not being able to resubmit a similar proposal.
7. The New MHPP, after submitting the certificate deposit, must apply for “temporary permit for producing electricity” (Temporary IUPTL).
8. Once the New MHPP receives the permit of Temporary IUPTL then the New MHPP must submit the copy of the approval of permit to the DGRE.
9. Within 90 days after the issuance of permit of Temporary IUPTL then the New MHPP must submit the Feasibility Study (not the pre-FS) and other required documents to PLN for the signing of PPA. PLN is then obliged to sign the PPA (cc to the DGRE) within 30 days after all documents are well received by PLN.
10.  PLN shall publish the model of PPA (60 days after the issuance of this Ministrial Decree or 1 July 2014).
11. If PPA is not signed within that 30 days period, then the New MHPP approval from the DGRE shall be terminated, 2 years sanction to the New MHPP not being able to resubmit a similar proposal, and 25% penalty off the certificate deposits.
12. PLN must state in the PPA the limitation of financial closing of 15 months after the signing of PPA. If the financial closing is not fulfilled, then the New MHPP approval from the DGRE shall be terminated, 2 years sanction to the New MHPP not being able to resubmit a similar proposal, and 50% penalty off the certificate deposits.
13. Once the New MHPP has reached the financial closing then the New MHPP must apply for the Permanent IUPTL;
14. Within 3 days after the issuance of the Permanent IUPTL, the New MHPP must convey:
• the copy of the Permanent IUPTL,
• prove of financial closing, and
• the plan to use the fund in the project to the DGRE. Certificate deposits then can be released to finance the project.
15. Up to maximum 3 months after the issuance of the Permanent IUPTL, the New MHPP must start the project.
16. If the New MHPP fail to start the project then PLN must revise the first 8 year FIT with certain penalties (unless caused by force majores governed in the PPA) such as:
    
    • 3 months delay – 1% penalty to FIT
    • More than 3 up to 6 months delay – 2% penalty to FIT
    • More than 6 months delay – 3% penalty to FIT
    • 15 months delay and more then approval from the DGRE shall be terminated, 2 years sanction to the New MHPP not being able to resubmit a similar proposal, and 100% penalty off the certificate deposits (if not yet used)
17. Those MHPP, which are now in operation under the Ministrial Decree no. 4 2012, shall not be benefitted to the new revised FIT
18. Those MHPP under the Ministrial Decree no. 4 2012, which already have PPA and are not in the commissioning stage, can negotiate the FIT with the PLN with a maximum adjusted FIT not more than Rp 880 per Kwh x F. The negotation must be approved by the DGRE, and the Minister of Energy & Natural Resources on the final stage must approve the final negotiated price. Sanctions are also applied to those MHPP when the negotiated price has been approved by the Minister and the projects are not carried through

My comment:

When reviewing the MD-12, I was full of excitement because the clarity and fairness of the decree was seen througout every article. The Government of Indonesia (GOI) via the Ministry when the decree was written must be clouded by the good spirit and enthusiasm to promote the business of hydro power plant particularly the MHPP to be prosperous and supportive to the need of the country's electricity demand.

As an Indonesian, I strongly believe that the mission of the GOI to decide the FIT for MHPP quoted in Rupiah (different than any other large power plant producers who receive US Dollar revenue) is to balance or somewhat reduce the risk of the state owned electricity company PLN on its foreign exchange exposure risk. I could say that the MHPP players have not only supported the country to electrify the nation (like any other power players), but also appreciated the problem that PLN is currently facing. This is one thing the GOI must understand and should incentify the players in MHPP. It would be great if in the MD-12, the Ministry could have thought the importance of price escalation. Escalation serves two main purpose which are to combat inflation and to give MHPP players maintaining the facility well.

The GOI realizes that the old tariff (Rp 656 per kwh) was no longer attractive, then the GOI should incentify the existing operating MHPP players so that they can reinvest the benefit for new projects. The GOI must also remember that these running MHPP developers have sweet and sour experiences in building the facility; Thus, in their next projects, that past learning curve shall support them. It would have been rewarding if the MD-12 took that concerns into account.

The last article no. 18 was a mind blowing, and out of fairness, I could say that this chapter has ruined the good spirit of the MD-12. The chapter incentifies those MHPP players, who have the PPA and are not yet in operation. These players, the chapter said, can negotiate the FIT to a certain level (maximum Rp 880 x F per kwh) which would be considered acceptable by PLN and approved by the Minister. It is very good, so that these players can right away step up its investment activities. However, the chapter discriminates the existing players who are already in operation. They can not get the benefit out of this MD-12. The GOI forgot that the existing running MHPP is now suffering with higher interest rates from the bank loans and rising costs from maintenance. Escalation clause is important especially to combat the inflation because inflation kills this business, and the negotiated FIT for MHPP article should be open for everyone, new comers or existing players.

Overall it is a step forward, and I just hope that the GOI and the community of MHPP have the similar spirit and energy for the betterment of this business to electrify the nation.

What's acceptable Project IRR for Mini Hydro in Java, Indonesia? Does it matter? or Any other things to be considered?

This question has challenged many mini hydro players in Indonesia.  With the existing feed-in-tariff (FIT) of Rp 656 per kwh (assigned by the Ministry of Energy and Mineral Resources Decree back in December 2009) for Java Island as a benchmark tariff, today is valued at only USD 5.5 cents per kwh which represents a fall by 18% since August of 2013.  At the same time, we can effectively see that all construction costs has risen by 20% in Rupiah terms.  Not to mention, the country's inflation which was 8% in 2013.

Allow us to set an example on mini hydro investment in Java Island, Indonesia.  According to our real case experience, the investment for mini hydro in Java in general is estimated to be USD 1.5 - USD 1.8 million per MW.  Of which, civil works (including transmission, project management, engineering cost, and IDC) account for USD 0.9 to USD 1.0 million per MW, and the rest is allocated for land and M&E for USD 0.6 - 0.8 million per MW.  Assuming the project is 70% financed by bank loan with capacity plant factor of 65%, the project will generate an IRR of 12 - 15% in today's interest rate of 12.0% p.a and 10 years payback period (including 2 years construction period).

In summary, we can argue that the project IRR of 12 - 15% is too low or just right. Many would say that it is just not very attractive since the rate is equal to the bank's yield. Whatever the IRR level might be, we can't escape from the 10 years payback period with 15 years power purchase agreement.  The key is to find the banks or financial institutions who are willing to support us for the next 10 years.  It is a long term partnership.  It is a perpetual game and a fixed income play.

The writer hopes that with the right structure and economical yield, the domestic infrastructure financing institutions like Sarana Multi Infrastruktur, Indonesia Infrastructure Fund, Pusat Investasi Pemerintah, syariah banks, and other large commercial banks in Indonesia can contribute more in boosting the investment of mini hydro power plant.  They have done so, but the interest rate is just too high momentarily. Increase in new FIT and breakthrough design of FIT that the writer proposes in his other previous writings may reenergize this lucrative investment.

Why Increase in Feed-in Tariff for Mini Hydro Power Plant in Indonesia Is Not the Only Factor Urgently Needed...New Feed-In Tariff Payment Mechanism Needs to be Changed ! -

By The Flying Garuda

Indonesia's good economic climate during 2009 until the 1st half of 2013, in addition to the Decree of Minister of Energy and Mineral Resources (MEMR) in late 2009 on the revitalization of renewable energy, had surely supported the growing interests in the investment of renewable energy sector, particularly in mini hydro power projects. More investors started to test the water in the sector.

Investing in this sector takes more than money & passion. It takes so much patient & energy. The work starts from processing the permit from the regency, detailed river & land survey, hydrology study, & soil test. These steps may take easily two months, & when the results are considered worthwhile, one can further continue making pre-feasibility study & land acquisition program. Not forgetting additional permits like the regency location permit, environmental approval, water usage, & project construction license. These steps are still not enough. Prospective investors have to start talking to the state-owned electricity company PLN whom by law will and must purchase the power from the project. Acceptable detailed engineering design & the complete feasibility study must be submitted & reviewed by PLN. In parallel, investors also have to apply for the permit to produce power from the MEMR. The whole process easily takes one year to complete until investors obtain the Purchasing Power Agreement with PLN.

The other challenge is to source secured financing from banks. Not many banks in Indonesia understand the business of mini hydro power plants. Some simply don't understand the business, but many have the views that the project is quite risky. Number of reasons why banks view this project is risky. For example, considered as a greenfield project, 60% of the mini hydro power total project cost is allocated for civil work, & the rest consists of mechanical, electrical, & balance of plants. Bear in mind many of potential mini hydro projects are located in remote areas. This factor weakens the collateral value of the bank loan in the case when the bank needs to reposses the collateral in the area which has minimal land value with unfinished assets. The project's nature of fixed local currency tariff with long-term tenor of more than 10 years has both forex risk and risk of inflation of operating costs, of which the value of Rupiah tariff will no longer keep up with the increasing costs.

The obstacle doesn't stop here. The M&E on turbines and generators are priced in US Dollar & the recent Rupiah depreciation in the 2nd half of 2013 had a significant impact to mini hydro power plant projects. Bear in mind that the Purchasing Power Agreement with PLN is in Rupiah locked up with no adjustment for 15 to 20 years. Unfortunately, the depreciation of Rupiah has also pushed the rise in cost of basic raw materials for civil works like cement, steel pipes, iron bars, & equipment rentals.

High pre-operating costs, long process of approvals, increased construction civil works costs and weakening Rupiah currency surely caused the fall of the project's attractive yield to the level that may no longer be suitable or acceptable for investors. This dilemma should trigger the creativity and innovation by the PLN and the Country's Ministry of Mines and Mineral Resources to do the followings:

1. New Design on Tariffs: The Ministry should divide the tariffs into two composition i.e. the Rupiah and USD portion. The total feed-in tariff should be priced proportianately in a composition of 60% in Rupiah tariff and 40% in US Dollar tariff. For example, if the government decides to improve the basic feed in tariff from Rp 656/kwh to Rp 800/kwh in Java, then the new designed feed-in tariff in Java should be 60% of the energy produced by the mini hydro power plant is priced in Rupiah i.e. Rp 800 per kwh, and 40% of the energy produced is priced in USD at USD 0.067 per kwh (Rp 800 divided by the prevailing Rp exchange rate to USD of Rp 12,000 per kwh). Thus, the energy produced from the power plant is 60% paid in Rupiah and 40% paid in USD which is converted to Rupiah when paid by PLN. By doing so, the government has created the natural hedge on foreign exchange for the project.
2. Inflationary Adjustment Factor to Tariff: It would also be fair if the basic feed in tariif can be adjusted yearly on the Rupiah portion based on the official inflation rate announced by the government. Using our example, the 60% Rupiah portion of Rp 800 per kwh is automatically adjusted by the rate of inflation yearly. This would minimize the inflation risk on a long term commitment to PLN for the next 15 years. As a result, steady fair profit generated from the power plant can be used for maintenance assuring the delivery of energy to the PLN.

Conclusion: It is just not a matter of tariff increase. The government must look beyond this tariff issue. More practical check list of approval system by the related government offices to speed up the process and investor friendly and simple tariff automatic adjustment with fair and healthy proportianately design payment mechanism can be introduced. Afterall, the electricity tariff charged to the end customers are adjusted yearly. It is then fair to adjust the feed-in tariff of power producer on yearly basis. It is the government initiative and the country's mission to prosper the renewable energy business. Let's make the flow of energy from water to power easier and more productive and beneficial to the stakeholders.

Some energy charts that weren’t included in “The Most Important Economic Stories of 2013 – in 40 Graphs,” but maybe should be?

By Carpe Diem As I was preparing this post of energy charts, I noticed that Matthew O’Brien at The Atlantic just published The Most Important Economic Stories of 2013—in 40 Graphs and guess what? Not one of the 40 graphs highlighted what might be not just one of the most important economic stories of 2013, but might qualify as the most important economic story of the last decade: The Great American Energy Boom. The amazing shale revolution taking place in America’s energy sector remains the strongest single sector of the US economy and provides the strongest reason to remain optimistic about America’s economic future. I might do a more comprehensive group of energy charts later at the end of the year, but for now I would think any of the first three charts below would quality to be included in The Atlantic’s graphs of the most important economic stories of 2013: a) US crude oil production in November was the highest in more than a quarter century, b) the US now has three active oil fields producing more than one million barrels per day, which qualifies them to join a very elite group of only ten super-giant oil fields in the world that have ever produced at that level, and c) natural gas production in the Marcellus region of Pennsylvania and West Virginia has increased almost 8 times in just the last four years, and that region now supplies 18% of America’s natural gas. For now, here are my five energy charts, based on data recently released.    1. The  Energy Information Administration (EIA) reported today that US crude oil production averaged 8.0 million barrels per day (bpd) in November, which is the highest monthly output since November 1988 (see chart above). The EIA expects US crude oil production will average 7.5 million bpd this year and 8.5 million bpd in 2014.   2. Based on an EIA report yesterday, the US now has three elite, super-giant oil fields producing more than one million bpd as of December: Permian Basin and Eagle Ford in Texas and Bakken in North Dakota (just hit the 1 million bpd mark this month). In recent years, there have been only 7 oil fields worldwide producing at the one million bpd level, and three of those are in the US. The other four non-US super giant oil fields are Ghawar (Saudi Arabia), Burgan (Kuwait), Cantarell (Mexico), and Daqing (China). In the the 1970s and 1980s, super-giant oil fields in Russia (Samotlor) and Iraq (Kirkuk) (Iraq) produced more than one million bpd level, as did Prudhoe Bay in Alaska when its production peaked in 1979 at 1.5 million bpd.   3. The EIA reported yesterday that natural gas production in the shale-rich Marcellus region that covers Pennsylvania and West Virginia has experienced such a production surge in recent years that it will provide 18% of all natural gas produced in the country this month. Natural gas in the Marcellus region has doubled in less than two years, from 6.39 trillion cubic feet per day in February 2012 to an estimated output of 13.72 trillion cubic feet per day in January 2014. EIA data also shows that estimated natural gas production in the Marcellus region in January 2014 will have tripled since May 2011 (a little more than 2.5 years), and will have quadrupled in only three years since January 2011. Remarkably, Marcellus natural gas output has increased almost 8 times in just four years, from 1.74 trillion cubic feet per day in January 2010 to an estimated 13.72 trillion cubic feet per day next month in January 2014!   4. Thanks to America’s new abundance of shale gas, prices in the US remain incredibly low compared to the rest of the world. As the map above shows, natural gas prices (in MM BTUs) are only about $3 in the US, and prices at 3 to 5 times higher in the rest of the world.   5. Thanks to the phenomenal energy boom taking place in North Dakota, the chart above shows the phenomenal housing boom taking place in the Peace Garden State. In October 1,459 building permits were issued in the state, which is a 49% increase from the same month last year, and almost 6.5 times the 225 permits issued four years ago in October 2009.

Bloomberg financial conditions index closes at record high

Posted: 02 Nov 2013 by Carpe Diem Blog

The Bloomberg U.S. Financial Conditions Index (BFICUS) provides a daily statistical measure of the relative strength of the U.S. money markets, bond markets, and equity markets, and is considered an accurate gauge of the overall conditions in U.S. financial and credit markets. The values of the Bloomberg index are calculated as Z-scores, which measure the number of standard deviations that daily financial conditions lie above or below the average of financial conditions during the January 1994-June 2008 period. The Financial Conditions Index closed yesterday at 1.65, setting an all-time record index high going back to 1994 when the index started (see chart above).

The record high level for the BFICUS is a positive sign that financial markets are back on very solid ground, and overall financial conditions in the US money, bond and equity markets have returned to the strength and stability of the pre-recession period – and those strong financial conditions are supporting record-high stock market levels.

Update: The weekly Chicago Fed National Financial Conditions Index (NFCI) is a composite index based on 100 different financial indicators, and has proven to be a highly accurate leading indicator of financial stress at horizons of up to one year. Increasing risk, tighter credit conditions, and declining leverage are consistent with tightening financial conditions and produce positive values for the NFCI, while negative values indicate the opposite conditions. The NFCI fell to -0.87 last week, which is the lowest reading (strongest financial conditions) since the second week of February 2007, providing additional statistical evidence that financial conditions in the US have returned to pre-recession levels.

Everything You Need To Know About Janet Yellen

By Evan Schnidman

 

When the internet erupted with commentary about President Obama's official selection of Janet Yellen to be the next Fed Chair, I deliberately decided to write about the largely overlooked FOMC minutes released an hour before the President's press conference. Now that a few days have passed, I am going to distill down the important points about Dr. Yellen's appointment.

Personality

Although this is not usually touted as a key trait for a leader of a technocratic organization, I suspect Dr. Yellen's personality and notoriously diligent work ethic (in economic circles she if often referred to as a "rigorous thinker") will play a key role in her leadership style. Writing specifically about her humility, University of Michigan economics Professor Justin Wolfers said:

I remember being a visiting scholar at the San Francisco Fed when she was president of the bank. Typically, Fed presidents remain safely cloistered in the executive offices, away from the great unwashed. Not Janet. It wasn't unusual to see her in the cafeteria, tray in hand, looking for a table of friendly economists to join. She had an enviable ability to make even the most junior staffers feel at ease and valued.

I suspect this humility will not only allow Dr. Yellen to relate to the common man affected by Fed policy, but also to her staff and colleagues on the Board.

Leadership Style

Aside from the personality traits that will undoubtedly impact her leadership style, the two most important leadership traits Dr. Yellen possesses are her skills as a consensus builder and her willingness to embrace conflict when necessary. Both of these skills contrast from Chairman Bernanke, although he has proven himself to be a reasonably good consensus builder.

Writing specifically about her consensus building skills, Bloomberg News stated:

In spite of her identification as a leading dove, Yellen has shown an ability to forge consensus with the more hawkish, anti-inflation members of the Federal Open Market Committee -- a quality that could come in handy as the central bank wrestles with when and how to unwind all the stimulus it has pumped into the economy.

This statement was followed by the observation that Yellen has gone out of her way to meet with Fed district bank presidents on a number of occasions.

Yellen's calendars, obtained under the Freedom of Information Act, show more than 90 meetings by phone or in person with Fed district bank presidents in 2011 and 2012, when she visited the Boston, New York, Philadelphia, Atlanta, Cleveland, Chicago, Minneapolis and San Francisco.

While Dr. Yellen's consensus building skills have been reasonably well reported for several months, the more interesting point about her leadership style is undoubtedly her assertiveness, as reported by The New York Times:

Ms. Yellen is also a more assertive leader than Mr. Bernanke and appears less averse to conflict. While both encourage open debate and seek to make decisions by consensus, Ms. Yellen has been a more vocal and persistent advocate for her own views. Mr. Bernanke has allowed Fed officials to air their views freely, while Ms. Yellen has expressed concern that the cacophony undermines the Fed's effectiveness by sowing confusion about the direction of policy.

The New York Times article went on to explain Dr. Yellen's willingness to challenge the Maestro himself, Alan Greenspan:

Ms. Yellen was the rare Fed official to challenge Mr. Greenspan and succeed. In 1996, she marshaled academic research, including a paper she had encouraged Mr. Akerlof to write, to argue that the Fed should seek to moderate inflation rather than eliminate it. The research showed that a little inflation helped to minimize unemployment. Employers that were reluctant to impose wage cuts could instead allow inflation to erode the real value of wages, allowing them to reduce labor costs.

The Times article continued by pointing to Yellen's role in building internal support for the explicit 2% inflation target (a move with which I disagree). Perhaps more important, the article also quoted Peter Orzag referencing Dr. Yellen's "rigorous" thought process in a veiled reference to Brad Delong's point that Dr. Yellen would be an excellent Fed Chair in normal circumstances, but perhaps not as good in a crisis where creative policy decisions must be made quickly. Orzag said:

I could see why people believe she's particularly good at situations in which there are important decisions to be made that involve pulling facts and weighing consequences carefully without pulling the trigger right away.

Policy Focus

Stepping away from the personality and leadership traits of Dr. Yellen into the more important policy issues. One thing is very clear about how a Yellen Chairmanship will unfold: communication is key. As Tim Duy systematically evaluated, the Fed's existing communication policy is confusing and lacking strategic vision; it needs improvement. Given that Dr. Yellen has been the head of the communication subcommittee at the Federal Reserve Board for the last couple years, she certainly knows more about the existing strategy than anyone else and has played a bigger role in expanding communication over the last couple years than basically any other individual in Fed history. However, that does not mean she is the best person to improve the Fed's communication strategy.

In recent months she has been in almost open dispute with Fed Board member Jeremy Stein who has suggested that communication can have a magnified effect and thus induce market volatility in the form of wider rate spreads. This led Stein to advocate for tapering the Fed's asset purchases sooner as opposed to later. Although the Yellen camp obviously won this argument at the September FOMC meeting (with Stein also voting to sustain the current pace of asset purchases), the market (over)reaction to talk of tapering and the ensuing dispute between Yellen and Stein highlights the need to more tightly manage Fed communication.

Perhaps Dr. Yellen's more "assertive" leadership style (than Chairman Bernanke) will serve her well in managing communication, but it is also important to note that modern Fed communication is more complex than ever before. For instance, in highlighting the difficulty in managing forward guidance, Felix Salmon writes:

…it's one thing for a Fed chairman to rally his FOMC troops and get them all to agree on a certain course of action at a certain meeting. It's another thing entirely to try to get those troops to agree to a future course of action, stretching out as far as mid-2015, despite the fact that no one really knows what the economy is going to look like then.

Salmon suggests that Yellen manage the cacophony not by squelching out dissenting voices, but by embracing them. He suggests that Dr. Yellen make it clearer than ever before that FOMC members disagree, but that policy is going in a particular direction based on committee consensus. While I like this strategy in theory, I think it would be very hard to manage in practice and runs the risk of diminishing Fed credibility the way the Supreme Court has diminished their own with so many 5-4 decisions. It is far more likely that as Chairman, Janet Yellen will limit communicators to stay on point in an effort to provide a clear signal about monetary policy.

Global Market Response

Thus far the global market response to the Yellen nomination has been pretty subdued. Developing markets responded favorably to the prospect of continued stimulus, but with a little trepidation about the possibility of a weaker dollar. Perhaps more important is the unrelated economic event of two of America's biggest trade partners, Europe and China, signing a currency swap deal. This marks a major step toward the Chinese Yuan becoming a global reserve currency. Although the timing is largely coincident with the Yellen nomination, this move is likely associated with perceived global weakness in the stability of the dollar due to the impending debt ceiling breach. It will be Chairman Yellen's job to ensure that the dollar remains a global reserve currency, despite the fiscal and monetary ramifications of strife between the Legislative and Executive branches.

Aside from the long term prospect of managing the dollar abroad, Dr. Yellen has already had an enormous impact on global central banking. In India, new central banker Raghuram Rajan has already followed Dr. Yellen's steps with an implicit inflation target. Similarly, Bank of England Governor Mark Carney has pursued an aggressive communication policy, similar to the one Dr. Yellen has advocated since rejoining the Fed in 2010. Perhaps the only dismissal of Dr. Yellen's policy proclivities comes from Chairman Bernanke's graduate school adviser and former head of the Bank of Israel, Stanley Fischer. Dr. Fischer has suggested that forward guidance and the plethora of other new communication policies confuse markets and run the risk of diminishing central bank credibility. While I do not expect this view to sway Dr. Yellen, it is worth revisiting to see if she at least manages the forward guidance strategy more precisely.

Hawk or Dove?

While the media narrative has consistently categorized Dr. Yellen as a dove, I think this is not completely fair. In the 1990s she expressed hawkish inflation views about the dangers of asset bubbles, and although slow to repeat these concerns in the 2000s, she was still ahead of the curve in spotting the crisis on the horizon. Perhaps more important than her individual past is the history of other Fed Chairmen. Specifically, new Fed Chairs have historically been quick to raise interest rates and tighten policy in order to establish their credibility as an inflation fighting central banker. To be fair, economic cycles have lent themselves to this pattern, but the pressure to establish credibility is definitely there. Nevertheless, I suspect the pressure on Dr. Yellen will be more towards generating continued job growth since inflation remains low and stable and her challenge appears to be persistently high unemployment.

Conclusion

Will all of the commentary, anecdotes and other information available about Janet Yellen, I think it is exceedingly unlikely that markets will be surprised by her leadership style or policy outcomes. So, investors and traders should expect an extension of the Bernanke years in terms of loose policy designed to stimulate job growth, but investors might also be pleasantly surprised (and traders slightly dismayed) by a tighter and more carefully managed communication strategy that avoids undue market confusion and increased volatility.