Entergy’s Economic Trends Analysis – March 2011

When last we visited the most perplexing aspect of an otherwise brightening economic scene was the
continued inability of the nation’s economy to generate meaningful job growth. We’re happy to
report that particular conundrum beginning to clarify, as the latest monthly employment report
actually indicates some progress. But just as we were beginning to bask in the glow of a fully
functioning economy the world provided grim reminders that it can be an unpredictable and
dangerous place. First political turmoil in the Middle East drove a spike in oil prices that had
everybody wondering about a replay of 2008, where the run-up in gasoline prices triggered a
dramatic drop in consumer spending and turned a there-to-fold mild recession into a route. That
worry was almost immediately superseded by the tragic and unprecedented disaster in Japan, which
both literally and figuratively altered the landscape. As we write this there is still too much
uncertainty about the scope of the destruction and the impact of the unfolding nuclear crisis to predict
the ultimate impact these events will have on global economic growth. Suffice it to say, however,
that factors other than pure fundamentals will be driving economic trends in coming months. The
good news is that the U.S. economy is in fundamentally better place than it was in 2008 and should
be able to weather the impact of higher energy prices, volatile interest rates and disruptions to Asian
economic growth and global supply chains without a significant dent. But we have lost some margin
for error.
Sector Contributions to Growth
Source: U.S. Department of Commerce
Before we get into some of those issues % of GDP Growth
8.0
let’s do a quick update on Q4 economic 6.0
growth: the initial reading of 3.2% 4.0

annualized growth was revised 2.0

0.0
downwards to 2.8%, with almost the -2.0
entire downgrade resulting from a less -4.0
-6.0
positive contribution from personal -8.0
consumption. This was mildly surprising -10.0
and a bit disconcerting, since we Q4'08 Q1'09 Q2'09 Q3'09 Q4'09 Q1'10 Q2'10 Q3'10 Q4'10

blathered rather lengthily last month Personal Consumption Private Investment Net Exports & Gvt. Spending

about how stalwart consumers were last

quarter. Fortunately, the downgrade
wasn’t enough to change the basic storyline of strong consumption being balanced by weak inventory
growth, all of which augurs well for
Labor Market Indicators
production and hiring growth during the Source: U.S. Dept. of Labor
(in 000's) (in %)
first half of 2011. Assuming, of course, 600 12.0
that consumer confidence isn’t so badly 400
10.0
shattered by recent events that they crawl 200

back into the shells from whence they so -

8.0

recently emerged. (200) 6.0

(400)
4.0

The downward revision in GDP, however, (600)

2.0
did not even begin to take the shine off (800)

(1,000) 0.0
the first decent employment report in a Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11
good while for February. Despite more Change in Non-farm Payrolls Unemployment Rate
bad weather, which clearly also reduced

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 Entergy’s Economic Trends Analysis – March 2011

job growth in January, non-farm employment rose by 192,000 during the month and the
unemployment rate dropped to 8.9%. Private sector payrolls rose by 222,000, offsetting yet another
brutal month for government-sector employment (get used to that trend). Prior months were also
revised upwards by nearly 60,000. While not the blockbuster month that some were expecting it was
real progress and confirms that the recovery is indeed broadening.

One of the interesting aspects of the report, however, is that the total labor force was essentially
unchanged during the month. Usually as hiring begins to improve the labor force expands as
previously discouraged workers jump back in the water. Didn’t happen last month, which is leading
to some cogitating on reasons why. Steve Liesman, the senior economics reporter on CNBC took an
interesting look at labor force participation data from the Bureau of Labor Statistics by demographic
group. We didn’t try to reproduce his data for this report because, well, it would be hard, but what he
found is that the entire decline in the labor force during the recent up/down in the economy can be
accounted for by teenagers. Labor force participation among the more mature members of the
population, age 55 and older, actually has increased. This is counter to the received wisdom, which
was that older laid-off workers were retiring because they couldn’t find a job and their skills were
atrophying. Instead, it’s basically been the youngest and most unskilled workers who’ve been
dropping out and hitting the road, or going to college, or whatever. Older workers, meanwhile, are
apparently putting off retirement in greater numbers, likely because their 401ks got squashed in the
downdraft and/or the equity in their homes went poof. This actually makes a bunch of sense –
construction has been the hardest hit area by the recession, and a lot of teenagers who aren’t in school
are in construction. Also, the minimum wage was raised by Congress in the summer of 2009 and,
although we’re sure they meant well, that made entry level labor more unaffordable at a time when
employers were pinching pennies on labor in general. So we got what we got, which is 23.9%
unemployment among teenagers.

Besides looking at employment data, economists are keeping their skills sharp by pondering the
implications of the recent run-up in oil and gasoline prices. Over the past month, prices for the West
Texas Intermediate (WTI) crude benchmark leaped about 20% to around $105 per barrel before
settling back in response to presumed demand destruction from the Japanese earthquake and tsunami.
Prices for other global indices, such as Brent North Sea rose even higher (to around $115) due to
some peculiarities that have recently developed in oil markets. There’s lots of oil in Cushing
Oklahoma, which is sort of the Henry Hub for WTI, but a fat lot of good that does you if you need
gasoline in, say, Madrid. Intuitively, if people have to spend more money on the same amount of
energy, they’ll have less to buy fun stuff, like iPods or cars. The rule of thumb is that every $10 rise
in the price of a barrel of oil shaves about 0.2% off the GDP growth rate through reduced
consumption. That implies that if you thought GDP was running in the 3.5% range prior to the spike,
it might actually wind up closer to 3.0% if oil prices sustain at $100 per barrel or greater.

The problem with rules of thumb, however, is that they assume that all other things stay constant and,
fact is, they almost never do. One aspect of the recent price rally is that it has been driven almost
entirely by speculation and fear, because the world is well supplied with oil. The unrest in Egypt was
more of a psychological trigger for the market, while the subsequent unrest in Libya actually affected
global crude supplies a little, but neither event represents any fundamental shift in supply/demand

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 Entergy’s Economic Trends Analysis – March 2011

balance. Libya is not a top ten producer, but it produces a “light sweet” product (it has an elegant
nose and a delightfully smooth aftertaste) that is prized by European refiners. Saudi Arabia has
announced plans to increase production to compensate for the lost output, but their spare capacity
tends to the heavier sour crudes, so that’s had some impact on the spread between different grades of
crude. But the fear is that the unrest will eventually roll its way around to the other major oil
producers/dictatorships in the Middle East, especially Saudi Arabia. As long as that fear lasts it will
add a geopolitical risk premium to the price of oil that adds to the premium that was already in the
commodity markets because of the Federal Reserve Board’s easy money policy. Those risk
premiums have now, in turn, been dented by expectations of demand destruction from Japan, but
there is still a lot a fear and greed priced into oil. The expectation of demand destruction in Japan is
actually pretty weak at this point – they’ll be some short-term weakness, but after the country gets
back on its feet fossil fuel demand will likely be stoked by rebuilding and the need to replace
damaged or destroyed nuclear generating capacity. We think you’re getting the picture – global
energy prices are likely to continue to be highly volatile in coming months and driven by inherently
difficult to predict geopolitical events.

We’ll give a guess, however, that we’re nearer the top of oil prices than most people realize and that
the impact on the U.S. economy from this recent burst of elevated prices is likely to be relatively
benign. The impact of higher energy prices very much depends on what else is happening in the
economy at the time. The last time we had a big spike in prices was during early 2008, which was
the final straw for an economy that was already in recession, suffering massive financial problems
due to the housing collapse, and that was heavily leveraged. In this environment consumers reacted
to the uncertainty and financial stress of higher energy prices by violently pulling back on spending,
triggering the second and much worse phase of the recession. With the economy now traveling in the
opposite direction to the 2008 trajectory, we don’t believe that consumers are likely to be quite as
traumatized by the current level of gasoline prices.

Also, prices have not yet risen to the point

where they are cutting into real spending Gas Pains
Indices with Jan. '05 = 1
power. In the attached graphic, we’ve Sources: U.S. Labor Dept., U.S. Energy Info. Ad min. And Entergy Sales Forecasting

charted indices of total spending on 1.7

gasoline to total personal income, with 1.5

January 2006 as the base month and both 1.3

indices adjusted for inflation. Through
1.1
December of last year (the most recent
0.9
month we have data) the gasoline index
was about 25% under the income index, 0.7

indicating no real stress to consumers. 0.5

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10
Even with the recent price run-up the gas
Gas Pain Index Real Income Index
index only will rise to around 1.05 or so,
which is roughly coincident to the income
index. To get to the obviously bad heights we trod in 2008 would require gasoline to spike above
$5.00 per gallon, which would likely require something else really bad to happen to another big oil
producer’s government. Possible, but unlikely.

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 Entergy’s Economic Trends Analysis – March 2011

Another way to look at this point before we finish beating it into the ground completely is that the
economic drag from oil only slightly
Personal Income and Spending
dents the positive fiscal/monetary impact % Change Prior Year
Source: U.S. Dept. of Commerce
that is occurring as a result of QE2 and 4.0

the December tax cuts. Last year, the 3.0

U.S. imported about 4.3 billion barrels of 2.0

oil. So each $10 rise in oil prices adds, in 1.0

round numbers maybe $45 billion to our 0.0

energy bill. We also produced nearly 2.0 -1.0

billion barrels, however, so there is a -2.0

partial offset from the increased income -3.0

Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11
of domestic producers. We know that
won’t make you feel better as you fill up Real Personal Disposable Income Real Spending

your tank, but it makes Exxon

shareholders happy. At any rate, the net negative impact of the recent price spike would therefore be
around $50 to $75 billion if sustained for a year. The positive impact of QE2 and the tax cuts should
be around $900 billion. Disposable (after tax) personal income rose $78 billion in January alone, at
least partly the result of the tax cuts. So we can handle the price increases in aggregate, although
lower income consumers are likely already feeling the pinch of higher energy and food prices.
Which, ironically enough, are partly being caused by QE2 and the tax cuts. It’s a slippery slope.

Besides oil prices, analysts are attempting to quantify how the earthquake and tsunami will affect
global economic growth. In the global economy, Japan’s most important role is as a supplier of both
high-end manufactured goods – semi-conductors, machine tools, cars, consumer electronics – and of
capital – the Japanese are prolific savers even though their government spends way too much.
Although there are likely to be short-term disruptions in global supply chains, the disaster largely
spared the key industrial areas of the country. The area of the country most affected accounts for
about 8% of Japan’s total economic output which, in turn, accounts for about 8% of global economic
output. The reduction of less than 8% of 8% isn’t likely to deal the global economy a body blow,
especially since there will be some offset from spending on rebuilding. So the short-term impact of
the disaster on global economic activity is likely to be pretty small.

What may be more impactful is how the disaster affects global capital flows over the medium to
long-term. Estimates of damages are still in the rough stage, obviously, but the tag is likely to be
$200 billion. The Japanese government and institutions are likely to fund the rebuilding by
liquidating some of their overseas financial holdings, the largest chunk of which is in U.S. treasury
bonds. So, ironically enough, one possible result of the Japanese disaster will be higher long-term
interest rates in the U.S. The yen actually rose in value versus the dollar in the immediate aftermath
of the disaster in anticipation of the future need to convert dollar denominated assets to yen, which is
contrary to the dollar’s usual role as a safe haven currency. To counter the negative impact of the
yen’s appreciation on Japanese exporters, the Japanese central bank will be sorely tempted to start
printing money. The U.S. Federal Reserve meanwhile, to counter the negative impact on U.S.
interest rates by the repatriation of Japanese savings will be sorely tempted to keep printing money –

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 Entergy’s Economic Trends Analysis – March 2011

there’s already loose talk around D.C. about rolling out QE3 this summer after QE2 runs its course in
June. For developing countries that are already battling the inflationary impacts of QE2 this prospect
is exceedingly unwelcome. And it will make the eventual exit from accommodative monetary policy
that much more challenging for the U.S.