Why are oil prices so volatile?

Hello readers, welcome back to my blog on interesting economics news stories of the week. Last time, I discussed how Brexit might not be all bad news and how the disappointed remain supporters, including myself, should focus on the positive aspects instead. For the ‘remainers’ out there that didn’t read my post simply because they couldn’t face reading any more about Brexit or for those that didn’t get a chance to read it; some of the positives I considered were: how we could still allow immigration but in a more controlled manner whereby we could select workers that we needed for certain job sectors, as well as how leaving the EU, a major trade partner could allow us to trade with other countries and view them through the same lens, therefore providing greater trade flexibility. This week I will be looking at something quite different. OIL.

Oil from an economic point of view is much more than just the black, viscous liquid that comes to mind when the word is mentioned. It has the power to start wars, transform countries from being poor to rich, cause inflation, as well as ‘fuel’ globalization and transportation across the globe.

It’s common knowledge that oil is a fossil fuel and is a finite resource, meaning it will eventually run out and will not be able to be reproduced within our lifetime; although I suspect many of you don’t know why the price of oil has fallen from US$154 dollars a barrel in June, 2008 to US$29 dollars a barrel in January, 2016. How is this even possible considering the world’s oil supply is running out? Even more so, why are oil prices so volatile? I’m sure many of you will have experienced this first hand, for example when you fill up your car how come the price of filling up the tank on one day is different to when you fill up another day. Why can we not have fixed price for a litre of fuel? Surely if we know roughly how much oil there is in the world and roughly when it is likely to run out, you would think that we could work out what the price of oil really should be.
In today’s post, I hope to be able to explain some of these ideas and look at the fundamental economics behind oil prices and their volatile nature. If you are intrigued to find out more about this topic, keep reading on and hopefully it will become much clearer to you. Alternatively, we could just all go and install solar panels and purchase electric cars, then all this wouldn’t matter to us anyway. As always if you have any questions, please post them below and I will try to respond to them. Alternatively, you can send them directly to my personal email address-rajveersira@gmail.com

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So how much is left?

The truth is we don’t really know, although geologists, who scour the treacherous depths of the Arctic, or Brazil’s Atlantic pre-salt fields, or offshore West Africa, or the deep waters of the Gulf of Mexico, seem to think they have an answer. Rather unhelpfully they have all come to different conclusions meaning we could have anywhere between 1 trillion barrels to 3 trillion barrels left.

There are, however, reasons for this wide disagreement on the size of the remaining reserves. One reason is because we don’t know how easy or practical it will be to extract the oil from such area and there are arguments as to whether we should explore undisturbed areas including Antarctica. We do have a rough estimate however of much oil we have used since the 1800’s which is 850 billion barrels, and we are currently consuming oil at the rate of about 85 million barrels every day, or 31 billion barrels per year.

Okay so we can’t have a fixed price for oil because we don’t know how much oil there really is, but why are oil prices so volatile?

The main influencer of fluctuations in oil prices is the organisation known as OPEC-the Organization of Petroleum Exporting Countries. OPEC is an association made up of 13 countries: Algeria, Angola, Ecuador, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela and controls 40% of the world’s supply of oil. It sets production levels to meet global demand and can influence the price of oil and gas by increasing or decreasing production.

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OPEC said that it would keep the price of oil above $100 a barrel for the foreseeable future, however, in mid-2014, the price of oil began to plummet. It fell from a peak of above $100 a barrel to below $50 a barrel. OPEC was the major cause of cheap oil as it refused to cut oil production. As with any commodity, stock or bond, or currency, the laws of demand and supply can explain why oil prices suddenly changed. When supply exceeds demand, prices fall, likewise, when demand exceeds supply, the price must increase.

Natural disasters are another factor that can cause oil prices to fluctuate. For example, when Hurricane Katrina struck the southern United States in 2005 it affected 19% of the U.S. oil supply and caused the price of a barrel of oil to rise by $3. In May 2011, the flooding of the Mississippi River also led to oil price fluctuation.

Production costs can also cause oil prices to rise or fall. While oil in the Middle East is relatively cheap to extract, oil in Canada in Alberta’s oil sands is a lot more costly. Once the supply of cheap oil is exhausted, the price of oil could conceivably rise if the only oil left is in the tar sands. Even if we did agree to extract oil from Antartica, it is likely that this would be extremely expensive, thus leading to businesses collapsing. Only the super-rich would be able to afford oil and majority of the population could be priced out of the market.

Political instability all over the world, particularly in the Middle East causes oil prices to fluctuate, as the region accounts for a huge proportion of the worldwide oil supply. For example, in July 2008, the price for a barrel of oil reached $136, due to consumers’ fears about the wars in both Afghanistan and Iraq.

Demand for oil and energy is closely related to economic activity. It also spikes in the winter in the northern hemisphere, and during summers in countries which use air conditioning. Furthermore, if producers think the price is staying high, they invest, which after a time lag boosts supply. Similarly, low prices lead to a fall in the level of investment.

What next…

  • For the first time in eight years, OPEC has agreed to reduce output – and it was followed this month by the news that Russia and other non-Opec states will also curb exports. This is likely to mean higher prices, higher transportation costs and ultimately an increase in inflation.
  • “Predictions for 2017 by major organisations and investment banks are generally not widely diverging and hovering in the US$50-$60 range,” says Oilprice.com

 

The image below summarises in a nutshell everything discussed in today’s post:

why-oil-prices-fluctuate

Sources used:

http://www.investopedia.com/ask/answers/012715/what-causes-oil-prices-fluctuate.asp

http://www.nytimes.com/interactive/2016/business/energy-environment/oil-prices.html?_r=0

http://letthesunwork.com/challenge/reserves.htm

http://www.theweek.co.uk/oil-price/60838/oil-price-back-above-55-after-positive-supply-data

http://www.visualcapitalist.com/oil-prices-fluctuate/

 

Can Brexit ever be good for the UK?

Hello readers, welcome back to my blog on the interesting economics news stories of the week.

You may remember me discussing, a few weeks ago, the impact of Britain’s decision to leave the EU on the UK economy and how this would lead to a number of damaging effects. This week I will be reviewing the situation and updating you with what has happened since then, as well as considering some of the benefits that Brexit could potentially bring with it. Many of us were disappointed with the result; however, there’s not really much we can do to change the decision but instead to look at the positives that may arise from this. Since we live in a democratic society where everyone has the right to vote then we should really respect the outcome, whatever it may be.

In today’s, post I hope to be able to put a positive spin on the whole Brexit issue that has been troubling our minds over the past few months and provide a sense of optimism going forward for the New Year. As Shakespeare wrote in Macbeth “What’s done is done and cannot be undone”. In other words, perhaps instead of still mourning the decision we should focus on how we can extract the very best solution from this. This may seem rather contradictory to the points I raised in my previous post and very much what Nigel Farrange would preach, although as with everything one must assess the situation from both sides. If you have the time, please do give my take on this story a quick read, and hopefully, you will see, from an economic point of view, why Brexit might not be all bad news. As always if you have any questions, please post them below and I will try to respond to them. Alternatively, you can send them directly to my personal email address-rajveersira@gmail.com

What has actually happened so far?

It is important to note that no major decisions or trade deals have been set in stone apart from the decision to ‘vote out’ back in June. The knock on effects of this announcement such as a fall in the value of sterling were purely down to speculation and ‘animal spirits’ in the economy.

Theresa May has announced that Article 50 of the Lisbon Treaty, which triggers two years of formal negotiations, will be invoked before the end of March 2017, which in practice this means the UK will be out of the EU by the summer of 2019. However the recent legal challenge – to force the government to give MPs a say before the Article 50 process starts – has been heard in the Supreme Court, with the decision expected in January.

The government has also agreed to publish some details of its Brexit “plan” before Article 50, but it is not clear how much detail will be released. Theresa May has said she does not want to disclose too much as this will affect her negotiating power.

What benefits could we potentially see then?

Firstly the predictions that were made about Brexit such as sluggish growth, a surge in inflation and mass unemployment, turned out not to be as severe as they were predicted and actually, we have seen an increase in Britain’s export sales, as well as a 7.1% rise in flight bookings to the UK, as a weaker pound makes Britain a cheaper destination for overseas tourists. Caissa Touristic, a tour operator specialising in Chinese travel to Europe, says it saw a 20% increase in enquiries and bookings for the UK this summer compared with the same period last year.

Nissan, after an undisclosed deal decided to keep its production in the UK, which has secured the future for Sunderland’s 3000 workers based at and around the factory. In terms of unemployment, in the UK, this has not been impacted and remains stagnant at around 4.8%.

London house prices still remain at an average hefty price tag of £700,000 and although house prices over £5 million have been worst affected, the market seems to be slowly recovering from this initial shockwave.

One of the main reasons why people voted for Brexit was because of immigration. It is, however, questionable as to whether putting stricter controls on immigration will have positive effects, as immigrants who are strongly motivated and have a work ethic that perhaps many people in the UK do not have. Immigration is also needed to support an ageing population. Undoubtedly we do need to have some control as immigration has grown faster than construction in the UK and as basic economics principals tell us that we have to make decisions with what to produce, how to produce and whom to produce it for in order to maximize utility. In other words, there are limits as to hospital appointments/operations and places in schools. Perhaps Brexit could solve this conundrum by allowing the UK to ‘cherry pick’ the best global talent.

Outside the EU, the UK would not need to pay it’s £10 billion net contributions to the EU budget. The UK could also replace the Common Agriculture Policy, which consumes 38% of the total EU budget, with more efficient farm subsidies in the UK.

Leaving the EU, although at the outset may seem like a lot of hassle and ‘unnecessary’ stress it gives us a chance to review trade deals and make better ones. Some would argue that why change your winning formula when it was already working. Although was it really working? With a current budget deficit*” is estimated to be £19.1 billion, is this really what a winning formula sounds like?

Everything must go through everyone. For example, Canada’s trade deal with the EU was nearly ruled out when Belgium was on the verge of declining it. Similarly, with the UK it would have more control and would be able to change things much more quickly.

With regards to trade, well that really depends on whether we are heading towards a more soft or hard Brexit. If it is the latter, the option which firms and businesses seem not to be in favour of, it could lead to unnecessary tariffs, thus driving up the prices of goods as well as lead to inflation. It is estimated that by Christmas next year inflation could be as high as 5% which would lead to an almost inevitable rise in interest rates by the monetary policy committee (MPC).

If we end up with a soft Brexit this means that we will to some extent have to agree to free movement of people and since immigration was the ultimate driving force behind the vote, this would not be a favoured option by ‘Brexiteers’

In terms of growth, latest figures show the economy grew by 0.5% in the three months after the Brexit vote, powered by the UK’s services sector. This was slower than the 0.7% rate in the previous quarter, but stronger than analysts’ estimates of about 0.3%.

Brexit was referred to as ‘protest vote’ or said to be falsified by facts, although this is perhaps a slight hyperbole. If so many people were in favour of it then surely there must be of some benefit. Are we saying that 52% of the population are all ‘uneducated’ and generalizing that it was just people in socially deprived areas that voted Brexit? Boris Johnson, arguably one of the most prominent politicians has described Brexit as an escape out of prison.

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The EU “has become centralizing, regulating and controlling, the opposite of what is needed for jobs and future success,” said Gerard Lyons, a leave supporter, and Johnson’s chief economic adviser, in a column for the London evening standard. Countries that succeed in the future global economy will “need to be flexible, adaptable and control their own destiny. Brexit allows us this,” he said.

The true answer to whether Brexit can be good is that we don’t really have a clue. Economists can make predictions using probability distributions, publish complex statistics or use theories proposed hundreds of years ago by famous economists such as the like of John Maynard Keynes, although the reality is we can’t predict the future. These assumptions that economists make quickly become inaccurate when we have surprises or shocks to the state of equilibrium in the economy such as a recession or war, or natural disasters. If these assumptions are wrong, the final outcome will be predicted as wrong. Only time will tell if Britain has made the right decision or not.

These shocks are becoming more and more common, with Brexit in the UK to Mr. Trump in the USA. Perhaps we are just living in a new type of society that we have not yet come to terms with.

Sources of information:

 

 

In simple terms what does the Autumn Statement mean for you?

Hello readers, welcome back to my blog on the interesting economics news stories of the week. Last week I discussed if it makes sense economically to renovate Buckingham Palace and whether or not using taxpayer’s money to fund the palace was justifiable, especially when the country has so many other pressing issues to deal with. This week I will be focusing on the recent announcement of the Autumn Statement, which was revealed by the Chancellor of the Exchequer, Philip Hammond, on the 23rd of November. In today’s post, I hope to be able to extract the complex economics information from the autumn statement and explain it to you in a simplified manner, as well as summarize and evaluate the key points that came out of this. If you have the time, please do give my take on this story a quick read, and hopefully, it will become much clearer. As always if you have any questions, you can post them below and I will try to respond to them. Alternatively, you can send them directly to my personal email address: rajveersira@gmail.com

Over the last few months in Britain, there has been this dark cloud of uncertainty looming over our heads, mainly down to the fact that we don’t exactly know how Brexit is going to affect the UK in terms of trade, business, and investment. The question of whether we are heading towards more of a ‘hard’ Brexit or ‘soft’ Brexit and whether we would have access to the single market, still remains unanswered. The chancellor’s statement which although does not explicitly reveal any hints as to what type of Brexit we might see, or how Brexit will impact the UK, it does provide some sense of clarity and reassurance in terms of the government’s plans for spending, and what it proposes to do for the economy over the next 5 years.

Before we get going, what even is the Autumn Statement?

According to the BBC, The Autumn Statement is the second of the two most important economic statements that the chancellor gives every year, the first being the Budget. The chancellor updates MPs on the government’s taxation and spending plans, based on the economic projections provided by the Office for Budget Responsibility (OBR) – a body set up in 2010 to provide independent economic forecasts.

What were the main announcements?

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Infrastructure:

This year, it was revealed that a new government investment program has been devised and this will mean £23 billion of government spending on Infrastructure, Construction and Innovation projects. This additional borrowing of £23 billion is spread over the next five years and aims to raise UK productivity (output per worker per hour), transform the growth potential of our economy, as well as improve the quality of people’s live. According to the chancellor, the UK’s productivity gap is “shocking” as the country lags behind the US and Germany by 30% and behind France by 20% as well as Italy by 8% and thus borrowing was needed to stimulate the economy.

A few of the proposed projects:

  • Upgrade the road links between Oxford and Cambridge and accelerate the delivery of the railway, which will link Oxford and Cambridge.
  • £4.7bn on science and innovation including £2bn a year more for research and development by 2020-21
  • A £2.3bn Housing Infrastructure Fund to deliver infrastructure for up to 100,000 new homes in areas of high demand.
  • £1.4bn to deliver 40,000 additional affordable homes
  • £2.6bn on transport networks including £220m to address traffic pinch points, £450m on digital signaling and £390m on low emission vehicles
  • £1bn in digital infrastructure including £700m on rolling out full-fibre connections and supporting 5G trials
  • £250m to the Northern Ireland Executive, £400m to the Welsh government and £800m to the Scottish government.

Although it seems at the outset that ploughing £23bn into a new national productivity investment fund is impressive, we must remember that the HS2 high-speed railway, funded separately, is due to cost £56bn at the last count. This shows that in comparison, the money being spent here is not actually that much. Furthermore, the £23bn will be spent over five years, so an average of £4.6bn a year. Even more so, the spending is weighted towards the later years; in the first year, 2017-18, the figure is just £2.4bn.

According to the Independent, the small print of the OBR’s (Office for budget responsibility) forecast document, casts doubt on the full delivery of Chancellor’s vaunted £23bn capital spending boost. They expect the Government to underspend its new ambitious capital infrastructure budget by almost £15bn over the five years to 2021-22. The forecast is likely to be an embarrassment for the Chancellor, Philip Hammond since it is equivalent to almost two-thirds of the additional £23bn infrastructure spending he announced in the Autumn Statement.

Housing:

With regards to housing, the treasury hopes that new measures such as building more affordable housing will help to improve the affordability of housing and rent, especially for those on low incomes. The chancellor is also expected to outline a ban on letting agents fees-a move which would help around 4.3 million households in private rental housing.

We must also remember that the price elasticity of supply (PES) for housing is relatively inelastic in the short run. This is down to the fact that construction companies cannot suddenly plan, and then build thousands of new homes in areas when there is an increase in demand. There are also a number of planning regulations and other constraints on new housing developments – where local authorities may restrict the building of new property in accordance with their local housing plans. Furthermore, there is a time delay in construction projects meaning that the supply of newly built properties is limited.

Fuel Duty:

A fuel duty is essentially a tax that is imposed on the sale of fuel. It remains the biggest component of the price of diesel and petrol, and motorists also pay 20% VAT on those fuels. The autumn statement revealed that a rise in this fuel duty was cancelled, for the seventh year in a row, costing the government 850 million and saving the average car driver £130 and van driver £350 a year. This means fuel duty has been held at 57.9p per litre since the 2011 budget. Mr. Hammond also pledged £390m in the low emission vehicle industry.

You may read this and think, excellent! The government has finally realized that we simply cannot afford to just keep paying more taxes, especially when incomes are not rising at the same rate. However, you should also remember that this will cost the government £850 million meaning that other sectors such as education, housing, healthcare and social welfare may experience cuts as the money has to come from somewhere else in order to fund this. Some may argue, particularly environmentalists, that we should increase the fuel duty as oil is a fossil fuel and has a number of negative externalities associated with it. Thus by reducing this tax the government is essentially failing to acknowledge the damaging effects of these externalities. Also since the demand for fuel is relatively inelastic due to there being few suitable substitutes available, the government could, in theory, get away by increasing the fuel duty as in the short run people will still buy fuel for their cars. In the long run, people may even switch to electric cars or vehicles powered by hydrogen and this would allow the UK to meet its CO2 targets and help contribute to the global 2oC target.

A few other factors announced:

  • An extra 2,500 prison officers will be recruited during 2016/17, a 15% increase in the existing 18,00 officers which will cost £104 million. This will tackle “unacceptable” levels of violence in jails. Extra officers will be paid out of new government funds. 400 of these staff will go to the 10 “most challenging jails”
  •  Promise to abolish Autumn Statement. Philip Hammond, the new chancellor has scrapped the Autumn Statement. “No other major economy makes hundreds of tax changes twice a year and neither should we. So, the spring budget in a few months will be the final spring budget.”

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Sources used:

  1. BBC
  2. The Economist
  3. The Guardian
  4. The Independent

Does it make sense economically to renovate Buckingham Palace?

Hello readers, a warm welcome back to my blog on interesting economics news stories of the week. Last week I discussed some of the reasons for India introducing its new denomination of the Rupee and removing, the 500 and 1000 notes from circulation, as well as the implications of doing so. This week I will be focusing on the UK and will be looking at the recent announcement of the Buckingham Palace renovations set to take place over the next 10 years. The aim of this post is not to create a contention between royalists and non-royalists, but to simply analyse and discuss this recent announcement from a purely economic point of view.

In today’s post I will explain why there was a need for the renovations, who is actually paying for them and the impacts of them financially as well as whether or not they will actually benefit the everyday person. If you have a few minutes to spare, give my take on this story a quick read and hopefully you may pick up a thing or two that you didn’t know about this topic. As always please post any comments or questions below and I will try my best to respond. Alternatively you can send them directly to me at rajveersira@gmail.com

 

Who is paying?

When we think of the royal family, images of gold, crowns and castles flood our minds. With a net worth of over 500 million, the queen has around 1000 times more than the average person on minimum wage could ever earn in a lifetime of working. Or think of it this way; around 6 times the euro millions jackpot! Whichever way, its clear the queen is not exactly tight.

When the recent announcement was made that £370 million will be spent on renovating Buckingham Palace; at the outset it may have seemed like a brilliant idea. Improved structural support, new wiring and piping and a bit more ‘sparkle’; what’s not to like? Not only would this have improved the aesthetics and safety, but it may have even attracted more tourists to the UK, who would spend their money in the UK and hence boost the economy. Does this sound too good to be true. Well, yes. Sorry to ruin it for you, but the Queen is not actually paying for these renovations and this large sum of money is all being funded through taxpayers’ money. Now when you think that the government has all these other issues like healthcare and areas of deprivation to focus on, surely these issues would be prioritised. Unfortunately this doesn’t seem to be the case. What makes matters even worse is that, according to the Guardian, Buckingham Palace is the queen’s least favourite royal residence and she only spends a third of her time there. Some reports are even claiming that LEGOLAND or the shops on Oxford Street are more popular attractions to tourists from abroad than this so called magnificent historical masterpiece.

The pictures below really help to exemplify this idea:

Many people have also reacted in a similar way. Here are just a few comments from people on the Guardian’s website:

“£370m over 10 years? Let’s fund the NHS instead”.

“Could they not just buy her one of those London houses that the builders have just reduced in price and open the palace as a museum? That would save £369M.”

“A week’s savings from being outside of the EU according to the Brexiteers”

“None of the royal palaces features in the top 50 Tourists attractions in Britain. Just   thought I would put that out there”.

“I see, so there is no money to build social housing for thousands of families but the Queen can have £370m to refurbish one of her palaces? It’s her gaff so she should pay for it”.

“Disgraceful – absolutely disgraceful”.

According to the telegraph, “The cash has been approved by the Prime Minister, Theresa May, and the Chancellor, Philip Hammond, and is expected to be rubber-stamped by Parliament in the next six months”. The work will include replacing 100 miles of electrical cabling – much of it 60 years old – 30 miles of water pipes, 6,500 electrical sockets, 5,000 light fittings, 2,500 radiators and 500 pieces of sanitary ware. It will also involve lifting 30,000 sq. m of floorboards, the equivalent of three-and-a-half football pitches. It is estimated that the work will extend the life of Buckingham Palace and make it ‘fit’ for residence for a further 50 years.

So why on earth has this been approved by the chancellor and prime minister?

Perhaps the renovations are in fact needed and are actually well overdue. Although the question now is why is the Queen not paying for this. The queen earns around 38 million a year, and the cost of renovations over 10 years, would be around £37 million a year. Perfect, she would even have £1 million spending money left over. Even if it is her least favourite place of residence can it really be justified to use taxpayers’ money when there are so many people living in poverty in the UK. The government talks about ‘reducing social inequality’ and ‘improving the lives of its poorest, most vulnerable citizens’, although they certainly don’t seem to be doing that in this instance. Now you may well disagree and say that the queen brings in income to the country and that she contributes significantly to the UK’s economy. This is without a doubt correct. The royal family are extremely iconic and influential and bring in around £500 million a year. Yes this is great but this is not just from Buckingham Palace. It includes income form all the historic sites/royal influences in the UK put together as well as all the tourism from abroad. Despite all this if you still aren’t convinced and believe that taxpayers should pay because that £500 million the queen brings in, directly benefits the UK’s economy, it is still arguable that with so much wealth, why doesn’t the queen pay for this and do something that her people will remember her for. The only way to tackle this idea of social inequality and reduce poverty across the globe is for money to be transferred from the rich to help out the poor. Already billionaire tech gurus such as Bill gates and others like Mark Zuckerberg have pledged to give away most of their fortune to help face some of the most challenging issues that we face in today’s society.

An example to explain what is happening here if you’re a bit lost?

Suppose you wanted to install a new kitchen for £10,000 but you didn’t have the funds. You would probably decide to pay for it over 10 years or re-evaluate to see whether or not you actually need it. You wouldn’t go and ask everyone living on your street for £100 to contribute to this. The new kitchen might mean that you are more likely to  invite them over and cook them a meal every now and then or bake them cookies every Christmas, although to be honest it wont really benefit them for most of the year. In this case, the palace upgrades may improve the palace and make visiting a more pleasant experience although in reality we are only going to visit a maximum of once a year, as there is nothing new to be gained by visiting again and again. Therefore just like the neighbours don’t really see any of the benefits, here the everyday person is not really better off. The ultimate policy objective for governments is to ensure that we maximise human welfare and happiness. In this instance, it appears that the government has just brushed this aside and is too engaged in renovating this iconic building.

So what now…?

To say that this is controversial is simply a euphemism. It is, as some put it ‘outrageous’. The palace may well need upgrades but with, but with 13 million people living in poverty, 913,000 people using food banks last year and anti-austerity marches so big, how can spending £370 million into the Queen’s estate be a smart move. A petition, which was recently launched, has now reached over 100,000 signatures and perhaps when this is debated in parliament, a different, better, more appropriate outcome may be achieved.

 

The image below shows the plan for the whole renovation process:

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