Streetwise Professor

September 26, 2016

Laissez les bons temps rouler!

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 12:07 pm

One of the great myths of commodity futures trading is the “roll return,” which Bloomberg writes about here (bonus SWP quote–but he left out the good stuff!, so I’ll have to fill that in here). Consider the oil market, which is currently in a contango, with the November WTI future ($45.99/bbl) trading below the December ($46.52/bbl). This is supposedly bad for those with a long ETF position, or an index position that includes many commodities in contango, because when the position is “rolled” forward in a couple weeks as the November contracts moves towards expiration, the investor will sell the November contract at a lower price than he buys the December, thereby allegedly causing a loss. The investor could avoid this, supposedly, by holding inventory of the spot commodity.

The flip side of this allegedly occurs when the market is in backwardation: the expiring contract is sold at a higher price than the next deferred contract is bought, thereby supposedly allowing the investor to capture the backwardation, whereas since spot prices tend to be trending down in these conditions, holders of the spot lose.

This is wrong, for two reasons. First, it gets the accounting wrong, by starting in the middle of the investment. The profit or loss on the November crude futures position depends on the difference between the price at which the November was sold in early October and bought in early September, not the difference between the price at which the November is sold and the December is bought in early October. Similarly, in November, the P/L on the December position will be the difference between sell and buy prices for the December futures, not the difference between the prices of the December and January futures in early December.  You need to compare apples to apples: the “roll return” compares apples and oranges.

On average and over time, the investor engaged in this rolling strategy earns the risk premium on oil (or the portfolio of commodities in the index). This is because the futures price is the expected spot price at expiration plus a risk premium. The rolling position receives the spot price at expiration and pays the expected spot price at the time the position is initiated, plus a risk adjustment. On average the spot price parts cancel out, leaving the risk premium.

Second, the expected change in the price of the spot commodity compensates the holder for the costs of carrying inventory, which include financing costs (very small, at present), and warehousing costs, insurance, etc. Net of these costs, the P/L on the position includes a risk premium for exposure to spot price risk, and in a well-functioning market, this will be the same as the risk premium in the corresponding future.

Moving away from commodities illustrates how the alleged difference between a rolled futures position and a spot position is largely chimerical. Consider a position in S&P 500 index futures when the interest rate is above the dividend yield. (Yes, children, that was true once upon a time!) Under this condition, the S&P futures would be in contango, and there would be an apparent roll loss when one sells the expiring contract and buying the first deferred. Similarly, comparing the futures price to the spot index at the time the future is bought, the future will be above the spot, and since at expiration the future and the spot index converge to the same value, the future will apparently underperform the investment in the underlying. But this underperformance is illusory, because it neglects to take into account the cost of carrying the cash index position (which is driven by the difference between the funding rate and the dividend yield). When buys and sells are matched appropriately, and all costs and benefits are accounted for properly, the performance of the two positions is the same.

Conversely, in the current situation using the roll return illogic, the rolled position in S&P futures will apparently outperform an investment in the cash index, because the futures market is in backwardation. But this backwardation exists because the dividend yield exceeds the rate of financing an investment in the cash index. The apparent difference in performance is explained by the fact that the futures position doesn’t capture the dividend yield. Once the cost of carrying the cash index position (which is negative, in this case) is taken into consideration, the performance of the positions is identical.

Back in 1992, Metallgesellschaft blew up precisely because the trader in charge of their oil trading convinced management that a stack-and-roll “hedging” strategy would make money in a backwardated market, because he would be consistently selling the future near expiration for a price that exceeded the next-deferred that he was buying. This “logic” was again comparing apples to oranges. By implementing that “logic” to the tune of millions of barrels, Metallgesellschaft became the charter member of the billion dollar club–it was the first firm to have lost $1 billion trading derivatives.

So don’t obsess about roll returns or try to figure out ways to invest in cash commodities when the market is in a contango/carry. Futures are far more liquid and cheaper to trade, so if you want exposure to commodity prices do it through futures directly or indirectly (e.g., through ETFs or index funds). Decide on the allocation to commodities based on the risk it adds to your portfolio and the risk premium you can earn. Don’t worry about the roll. If you decide that commodities fit in your portfolio, laissez les bon temps roullez!

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September 16, 2016

De Minimis Logic

CFTC Chair Timothy Massad has come out in support of a one year delay of the lowering of the de minimis swap dealer exemption notional amount from $8 billion to $3 billion. I recall Coase  (or maybe it was Stigler) writing somewhere that an economist could pay for his lifetime compensation by delaying implementation of an inefficient law by even a day. By that reckoning, by delaying the step down of the threshold for a year Mr. Massad has paid for the lifetime compensation of his progeny for generations to come, for the de minimis threshold is a classic analysis of an inefficient law. Mr. Massad (and his successors) could create huge amounts of wealth by delaying its implementation until the day after forever.

There are at least two major flaws with the threshold. The first is that there is a large fixed cost to become a swap dealer. Small to medium-sized swap traders who avoid the obligation of becoming swap dealers under the $8 billion threshold will not avoid it under the lower threshold. Rather than incur the fixed cost, many of those who would be caught with the lower threshold will decide to exit the business. This will reduce competition and increase concentration in the swap market. This is perversely ironic, given that one ostensible purpose of Frankendodd (which was trumpeted repeatedly by its backers) was to increase competition and reduce concentration.

The second major flaw is that the rationale for the swap dealer designation, and the associated obligations, is to reduce risk. Big swap dealers mean big risk, and to reduce that risk, they are obligated to clear, to margin non-cleared swaps, and hold more capital. But notional amount is a truly awful measure of risk. $X billion of vanilla interest rate swaps differ in risk from $X billion of CDS index swaps which differ in risk from $X billion of single name CDS which differ in risk from $X billion of oil swaps. Hell, $X billion of 10 year interest rate swaps differ in risk from $X billion of 2 year interest rate swaps. And let’s not even talk about the variation across diversified portfolios of swaps with the same notional values. So notional does not match up with risk in a discriminating way.  Further, turnover doesn’t measure risk very well either.

But hey! We can measure notional! So notional it is! Yet another example of the regulatory drunk looking for his keys under the lamppost because that’s where the light is.

So bully for Chairman Massad. He has delayed implementation of a regulation that will do the opposite of some of the things it is intended to do, and merely fails to do other things it is supposed to do. Other than that, it’s great!

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September 12, 2016

The New Deal With Chinese Characteristics

Filed under: China,Commodities,Economics,History,Politics,Regulation — The Professor @ 1:03 pm

When I was in Singapore last week I spoke at the FT Asia Commodities Summit. Regardless of whether the subject was ags or energy or metals, China played an outsized role in the discussion. In particular, participants focused on China’s newish “supply side” policy.

There is little doubt that the policy–which focuses on reducing capacity, or at least output in steel, coal, and other primary industries–has had an impact on prices. Consider coking coal:

Coking coal, the material used by steelmakers to fire their blast furnaces, has become the best performing commodity of 2016 after surging more than 80 per cent over the past month on the back of production curbs and flooding in China.

Premium hard Australian coking coal delivered to China hit $180.9 a tonne on Friday, this highest level since price reporting agency Steel Index began publishing assessments in 2013. It has risen 131 per cent since the start of the year, outpacing gold, silver, iron ore and zinc — other top performing commodities.

The main driver of the rally — which has also roiled thermal coal — is Beijing’s decision to restrict the number of working days at domestic mines to 276 days per year from 330 previously.

This policy is aimed at the improving the profitability of producers so they can repay loans to local banks. But it has reduced output and forced traders and steel mills to buy imported material from what is known as the seaborne market.

80 percent. In a month.

Or thermal coal:

Newcastle thermal coal is heading for the first annual gain in six years as China seeks to cut overcapacity and curb pollution. While the timing of the output adjustment is unavailable, it may start in September or October after recent price gains, Citigroup said in the report dated Sept. 8. Bohai-Rim is 26 percent higher from a year ago, when it was 409 yuan, while Newcastle has climbed as much as 40 percent this year.

The phrase “supply side reform” actually fits rather awkwardly here, at least to a Western ear. That phrase connotes the reduction of regulatory and tax burdens as a means of promoting economic growth. But Supply Side Reform With Chinese Characteristics means increasing the government’s role in managing the economy.

A better description would be that this is The New Deal With Chinese Characteristics. FDR’s New Deal was largely a set of measures to cartelize major US industries, in an effort to raise prices. The economic “thinking” behind this was completely wrongheaded, and motivated by the idea that there was “ruinous competition” in product and labor markets that required government intervention to fix. Apparently the higher prices and wages were supposed to increase aggregate demand. Or something. But although the New Deal foundered on Constitutional shoals only a few years after its passage, in its brief existence it had proven to be an economic nightmare rent by contradictions. For instance, if you increase prices in an upstream industry, that is detrimental to the downstream sector for which the upstream industry’s outputs are inputs. According to scholarship dating back to Milton Friedman and Anna Schwartz, and continuing through recent work by Cole and Ohanian,  interference in the price mechanism and forced cartelization slowed the US’s recovery from the monetary shock that caused the Great Depression.

The motivation for the Chinese policy is apparently not so much to facilitate the rationalization of capacity in sectors with too much of it, but to increase revenue of firms in these sectors in order to permit them to pay back debt to banks and the holders of wealth management products (which often turn out to be banks too). Further, the policy is also driven by a need to sustain employment in these industries. Thus, the policies are intended to prop up the financially weakest and least efficient companies, rather than cull them.

So step back for a minute and contemplate what this means. Through a variety of policies, including most notably financial repression (that made capital artificially cheap) and credit stimulus, China encouraged massive investment in the commodities and primary goods sectors. These policies succeeded too well: they encouraged massive over-investment. So to offset that, and to mitigate the financial consequences for lenders, local governments, and workers, China is intervening to restrict output to raise prices. Rather than encouraging the correction of past errors, the new policy is perpetuating them, and creating new ones.

Remind me again how China’s government got the reputation as master economic managers, because I’m not seeing it. This is an example of a wasteful response to wasteful over-investment: waste coming and going. Further, it involves an increase in government intervention, which obviously has those in favor a more liberal (in the Smithian sense) free market policy rather distraught, and which foreshadows even more waste in the future.

The policy is also obviously fraught with tensions, because it pits those consuming primary and intermediate goods against those producing them–and against the banks who are now more likely to get their money back. That is, it is a backdoor bank (and WMP) bailout, the costs of which will be borne by the consumers of the goods produced by industries that were supersized by past government profligacy.

Ironically, the policy also stokes something that the government purports to hate: speculation. Policy volatility encourages speculation on the goods and industries affected by these policies. The large movements in prices in the coal and iron-steel sectors in response to policy changes provide a strong incentive to speculate on future policy changes.

Further, it creates the potential for moral hazard in the future. Future lenders (and purchasers of WMP) will look back on this policy and conclude that the government may well undertake backdoor bailouts if the companies they have lent to run into difficulties. This is hardly conducive to prudent lending and investment.

This is not foresighted policy. It is extemporizing to fix near-term problems, most of which were created by past measures to fix near-term problems. There is a Three Stooges aspect to the entire endeavor.

Of course, it’s an ill wind that blows no one any good. Glencore is no doubt very grateful for Chairman Xi’s heavy-handed policy intervention. It has probably played a larger role in bringing the company back from the brink than did the company’s prudent efforts to cut debt. But it is probably too late, alas, for Peabody Coal, and Arch Coal, and all those “coal people” whom former empathizer in chief Bill Clinton mocked last week. The ingrates!

The bottom line is that China is the 800 pound gorilla of the commodity markets, and shifts in its policies can lead to huge moves in commodity prices. Given that these policy shifts are driven by the crisis du jour (e.g., commodity producer shakiness threatening to make banks and local governments shaky) rather than good economics, and that these policy shifts are difficult to predict given the opacity and centralization of Chinese decision making, they add to substantial additional volatility in commodity prices and commodity markets: who can read the gorilla’s mind (which he changes often)?, and woe to those who read it wrong.

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September 6, 2016

HKEx: Improving Warehousing in China, or Creating a Shadow Banking Vehicle?

Filed under: Clearing,Commodities,Derivatives,Economics,Regulation — The Professor @ 9:33 pm

I am on my last day in Singapore, where I participated in the rollout of Trafigura’s Commodities Demystified hosted by IE Singapore.  The event was very well attended (an overflow crowd) and the presentation and new publication (which builds off the conceptual framework of my 2013 white paper The Economics of Commodity Trading Firms) was well-received. It helps fill a yawning gap in knowledge about what commodity traders are and what they do.

In addition to that event, I spoke as a panelist at the FT’s Commodities Asia Summit. One of the main speakers was Charles Li, CEO of Hong Kong Exchanges and Clearing, who laid out his ambitions for plans in mainland China. Things started out well. Whereas expectations were that HKEx would create a modest spot metals trading platform in China (because it doesn’t have and is unlikely to receive a license for trading futures), Li stated that HKEx (which owns the LME) would attempt to create a “lookalike” LME metals warehousing system. In the aftermath of the Qingdao fiasco this could be a very salutary development.

I would suggest caution, however. This may be easier said than done. While Li was describing this, my mind immediately turned to a paper I wrote over 2 decades ago about the successes and failures of commodity exchanges. One of the signal failures occurred when the Chicago Board of Trade attempted to tame the depredations of grain warehouses in the 1860s. Public storage was rife with all sorts of fraud and illicit dealing. The quality and quantity of grain being stored was a mystery, and warehousemen played all sorts of games to exploit their customers. The CBT, acting in the interests of traders who relied on the warehouses, attempted to impose rules and regulations on them, but failed utterly. Eventually the State of Illinois had to pass legislation to rein in some of the warehousemen’s more outrageous actions. Furthermore, larger traders integrated into warehousing, and eventually public storage became primarily ancillary to futures trading (i.e., to facilitate delivery against futures).

The CBT’s problem is that it did not have an adequate stick to beat the warehousemen into compliance. They were kicked out of the exchange, but the gains of being able to trade futures were smaller than the gains from operating warehouses outside the CBT’s rules.

Public warehousing has proved problematic in commodities to the present day. The LME’s travails with aluminum warehousing are just one example, but others abound in commodities including coffee, cocoa, and cotton. In cotton, for instance, even though warehouses are subject to federal regulation, there are chronic complaints that warehousemen do not load out cotton promptly, in order to enhance storage revenues.

So I wish Mr. Li luck. He’ll need it, especially since lacking the ability to deny those violating the warehouse rules from futures trading, he won’t even have the stick that proved inadequate for the CBT. Public warehousemen has long proved to be a very recalcitrant group, over time, place, and commodity.

Li specifically criticized the speculative nature of China’s futures exchanges, and claimed that his new venture would be for physical players, and that it would not be “another financial speculation forum.” But his follow on remarks gave a sense of cognitive dissonance. He said the system would allow banks and hedge funds to participate in the market.

More disconcertingly, he highlighted the effects of financial repression in China (without using the phrase), which leads investors looking for higher returns than are available in the banking sector to turn to alternative investment vehicles. Li specifically mentioned wealth management products, and suggested that metals stored in the warehouses his new venture would oversee could form the basis for such products. I understood him to say that while the warehouses would facilitate the typical function of commodity storage, i.e., filling and emptying in order to accommodate temporary supply and demand shocks, there would also be the possibility that metal would be locked up for long periods to provide the basis for these wealth management products. What I envision is something like physical metal ETFs that have been introduced in the West. These are primarily in precious metals. JP Morgan proposed a similar vehicle for copper, but backed off due to the pressure from Carl Levin and others a couple of summers ago.

In other words, the new warehousing system would be part of the shadow banking system thereby providing a new speculative vehicle for Chinese investors desperate to circumvent financial repression. Hence my cognitive dissonance.

I would also note that even a purely physical spot exchange can be a speculative venue, through buying and selling and borrowing/carrying warehouse receipts. The New York Gold Exchange of Black Friday infamy was hugely speculative, even though it was purely a spot physical exchange.

I also heard Li to say that the venture would guarantee transactions, though I didn’t fully catch what would be guaranteed. Would the exchange be insuring those storing their metal against a Qingdao type event? If so, that’s a pretty audacious plan, and one fraught with risk.

This was just a speech at a conference. It will be interesting to see a fully-fleshed out plan. It will be particularly interesting to see how the enforcement mechanism for the warehouse regulation will work, and it will be especially particularly interesting to see whether this venture is indeed just viewed as a mechanism for improving the efficiency of the physical metals market in China, or whether it will be a clever way to tap into the intense interest of investors large and small in China to speculate and find better returns than those on offer in the banking system. That is, will this be another speculative venue, but one masquerading as a staid market for physical players. Given the way China works, I’d bet on the latter. Pun intended.

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August 23, 2016

Carl Icahn Rails Against the Evils of RIN City

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — The Professor @ 12:15 pm

Biofuel Renewable Identification Numbers–“RINs”–are back in the news because of a price spike in June and July (which has abated somewhat). This has led refiners to intensify their complaints about the system. The focus of their efforts at present is to shift the compliance obligation from refiners to blenders. Carl Icahn has been quite outspoken on this. Icahn blames everyone, pretty much, including speculators:

“The RIN market is the quintessential example of a ‘rigged’ market where large gas station chains, big oil companies and large speculators are assured to make windfall profits at the expense of small and midsized independent refineries which have been designated the ‘obligated parties’ to deliver RINs,” Icahn wrote.

“As a result, the RIN market has become ‘the mother of all short squeezes,”‘ he added. “It is not too late to fix this problem if the EPA acts quickly.”

Refiners are indeed hurt by renewable fuel mandates, because it reduces the derived demand for the gasoline they produce. The fact that the compliance burden falls on them is largely irrelevant, however. This is analogous to tax-incidence analysis: the total burden of a tax, and the distribution of a tax, doesn’t depend on who formally pays it. In the case of RINs, the total burden of the biofuels mandate and the distribution of that burden through the marketing chain doesn’t depend crucially on whether the compliance obligation falls on refiners, blenders, or your Aunt Sally.

Warning: There will be math!

A few basic equations describing the equilibrium in the gasoline, ethanol, biodiesel and RINs markets will hopefully help structure the analysis*. First consider the case in which the refiners must acquire RINs:

Screen Shot 2016-08-23 at 10.20.03 AM

Equation (1) is the equilibrium in the retail gasoline market. The retail price of gasoline, at the quantity of gasoline consumed, must equal the cost of blendstock (“BOB”) plus the price of the ethanol blended with it. The R superscript on the BOB price reflects that this is the price when refiners must buy a RIN. This equation assumes that one gallon of fuel at the pump is 90 percent BOB, and 10 percent ethanol. (I’m essentially assuming away blending costs and transportation costs, and a competitive blending industry.) The price of a RIN does not appear here because either the blender buys ethanol ex-RIN, or buys it with a RIN and then sells that to a refiner.

Equation (2) is the equilibrium in (an assumed competitive) ethanol market. The price an ethanol producer receives is the price of ethanol plus the price of a RIN (because the buyer of ethanol gets a RIN that it can sell, and hence is willing to pay more than the energy value of ethanol to obtain it). In equilibrium, this price equals the the marginal cost of producing ethanol. Crucially, with a binding biofuels mandate, the quantity of ethanol produced is determined by the blendwall, which is 10 percent of the total quantity sold at the pump.

Equation (3) is equilibrium in the biodiesel market. When the blendwall binds, the mandate is met by meeting the shortfall between mandate and the blendwall by purchasing RINs generated from the production of biodiesel. Thus, the RIN price is driven to the difference between the cost of producing the marginal gallon of biodiesel, and the price of biodiesel necessary to induce consumption of sufficient biodiesel to sop up the excess production stimulated by the need to obtain RINs. In essence, the price of biodiesel plus the cost of a RIN generated by production of biodiesel must equal the marginal cost of producing it. The amount of biodiesel needed is given by the difference between the mandate quantity and the quantity of ethanol consumed at the blendwall. The parameter a is the amount of biofuel per unit of fuel consumed required by the Renewable Fuel Standard.

Equation (4) is equilibrium in the market for blendstock–this is the price refiners get. The price of BOB equals the marginal cost of producing it, plus the cost of obtaining RINs necessary to meet the compliance obligation. The marginal cost of production depends on the quantity of gasoline produced for domestic consumption (which is 90 percent of the retail quantity of fuel purchased, given a 10 percent blendwall). The price of a RIN is multiplied by a because that is the number of RINs refiners must buy per gallon of BOB they sell.

Equation (5) just says that the value of ethanol qua ethanol is driven by the relative octane values between it and BOB.

The exogenous variables here are the demand curve for retail gasoline; the marginal cost of producing ethanol; the marginal cost of producing BOB (which depends on the price of crude, among other things); the marginal cost of biodiesel production; the demand for biodiesel; and the mandated quantity of RINs (and also the location of the blendwall). Given these variables, prices of BOB, ethanol, RINs, and biodiesel will adjust to determine retail consumption and exports.

Now consider the case when the blender pays for the RINs:

Screen Shot 2016-08-23 at 10.20.25 AM

Equation (6) says that the retail price of fuel is the sum of the value of the BOB and ethanol blended to create it, plus the cost of RINs required to meet the standard. The blender must pay for the RINs, and must be compensated by the price of the fuel. Note that the BOB price has a “B” superscript, which indicates that the BOB price may differ when the blender pays for the RIN from the case where the refiner does.

Without exports, retail consumption, ethanol production, biodiesel production, and BOB production will be the same regardless of where the compliance burden falls. Note that all relevant prices are determined by the equilibrium retail quantity. It is straightforward to show that the same retail quantity will clear the market in both situations, as long as:

Screen Shot 2016-08-23 at 10.20.35 AM

That is, when the refiner pays for the RIN, the BOB price will be higher than when the blender does by the cost of the RINs required to meet the mandate.

Intuitively, if the burden is placed on refiners, in equilibrium they will charge a higher price for BOB in order to cover the cost of complying with the mandate. If the burden is placed on blenders, refiners can sell the same quantity at a lower BOB price (because they don’t have to cover the cost of RINs), but blenders have to mark up the fuel by the cost of the RINs to cover their cost of acquiring them. here the analogy with tax incidence analysis is complete, because in essence the RFS is a tax on the consumption of fossil fuel, and the amount of the tax is the cost of a RIN.

This means that retail prices, consumption, production of ethanol, biodiesel and BOB, refiner margins and blender margins are the same regardless of who has the compliance obligation.

The blenders are complete ciphers here. If refiners have the compliance burden, blenders effectively buy RINs from ethanol producers and sell them to refiners. If the blenders have the burden, they buy RINs from ethanol producers and sell them to consumers. Either way, they break even. The marketing chain is just a little more complicated, and there are additional transactions in the RINs market, when refiners shoulder the compliance obligation.

Under either scenario, the producer surplus (profit, crudely speaking) of the refiners is driven by their marginal cost curves and the quantity of gasoline they produce. In the absence of exports, these things will remain the same regardless of where the burden is placed. Thus, Icahn’s rant is totally off-point.

So what explains the intense opposition of refiners to bearing the compliance obligation? One reason may be fixed administrative costs. If there is a fixed cost of compliance, that will not affect any of the prices or quantities, but will reduce the profit of the party with the obligation by the full amount of the fixed cost. This is likely a relevant concern, but the refiners don’t make it centerpiece of their argument, probably because shifting the fixed cost around has no efficiency effects, but purely distributive ones, and purely distributive arguments aren’t politically persuasive. (Redistributive motives are major drivers of attempts to change regulations, but naked cost shifting arguments look self-serving, so rent seekers attempt to dress up their efforts in efficiency arguments: this is one reason why political arguments over regulations are typically so dishonest.) So refiners may feel obliged to come up with some alternative story to justify shifting the administrative cost burden to others.

There may also be differences in variable administrative costs. Fixed administrative costs won’t affect prices or output (unless they are so burdensome as to cause exit), but variable administrative costs will. Further, placing the compliance obligation on those with higher variable administrative costs will lead to a deadweight loss: consumers will pay more, and refiners will get less.

Another reason may be the seen-unseen effect. When refiners bear the compliance burden, the cost of buying RINs is a line item in their income statement. They see directly the cost of the biofuels mandate, and from an accounting perspective they bear that cost, even though from an economic perspective the sharing of the burden between consumers, refiners, and blenders doesn’t depend on where the obligation falls. What they don’t see–in accounting statements anyways–is that the price for their product is higher when the obligation is theirs. If the obligation is shifted to blenders, they won’t see their bottom line rise by the amount they currently spend on RINS, because their top line will fall by the same amount.

My guess is that Icahn looks at the income statements, and mistakes accounting for economics.

Regardless of the true motive for refiners’ discontent, the current compliance setup is not a nefarious conspiracy of integrated producers, blenders, and speculators to screw poor independent refiners. With the exception of administrative cost burdens (which speculators could care less about, since it will not fall on them regardless), shifting the compliance burden will not affect the market prices of RINs or the net of RINs price that refiners get for their output.

With respect to speculation, as I wrote some time ago, the main stimulus to speculation is not where the compliance burden falls (because again, this doesn’t affect anything relevant to those speculating on RINs prices). Instead, one main stimulus is uncertainty about EPA policy–which as I’ve written, can lead to some weird and potentially destabilizing feedback effects. The simple model sheds light on other drivers of speculation–the exogenous variables mentioned above. To consider one example, a fall in crude oil prices reduces the marginal cost of BOB production. All else equal, this encourages retail consumption, which increases the need for RINs generated from biodiesel, which increases the RINs price.

The Renewable Fuels Association has also raised a stink about speculation and the volatility of RINs prices in a recent letter to the CFTC and the EPA. The RFA (acronyms are running wild!) claims that the price rise that began in May cannot be explained by fundamentals, and therefore must have been caused by speculation or manipulation. No theory of manipulation is advanced (corner/squeeze? trade-based? fraud?), making the RFA letter another example of the Clayton Definition of Manipulation: “any practice that doesn’t suit the person speaking at the moment.” Regarding speculation, the RFA notes that supplies of RINs have been increasing. However, as has been shown in academic research (some by me, some by people like Brian Wright)  that inventories of a storable commodity (which a RIN is) can rise along with prices in a variety of circumstances, including a rise in volatility, or an increase in anticipated future demand. (As an example of the latter case, consider what happened in the corn market when the RFS was passed. Corn prices shot up, and inventories increased too, as consumption of corn was deferred to the future to meet the increased future demand for ethanol. The only way of shifting consumption was to reduce current consumption, which required higher prices.)

In a market like RINs, where there is considerable policy uncertainty, and also (as I’ve noted in past posts) complicated two-way feedbacks between prices and policy, the first potential cause is plausible. Further, since a good deal of the uncertainty relates to future policy, the second cause likely operates too, and indeed, these two causes can reinforce one another.

Unlike in the 2013 episode, there have been no breathless (and clueless) NYT articles about Morgan or Goldman or other banks making bank on RIN speculation. Even if they have, that’s not proof of anything nefarious, just an indication that they are better at plumbing the mysteries of EPA policy.

In sum, the recent screeching from Carl Icahn and others about the recent ramp-up in RIN prices is economically inane, and/or unsupported by evidence. Icahn is particularly misguided: RINs are a tax, and the burden of the tax depends not at all on who formally pays the tax. The costs of the tax are passed upstream to consumers and downstream to producers, regardless of whether consumers pay the tax, producers pay the tax, or someone in the middle pays the tax. As for speculation in RINs it is the product of government policy. Obviously, there wouldn’t be speculation in RINs if there aren’t RINs in the first place. But on a deeper level, speculation is rooted in a mandate that does not correspond with the realities of the vast stock of existing internal combustion engines; the EPA’s erratic attempt to reconcile those irreconcilable things; the details of the RFS system (e.g., the ability to meet the ethanol mandate using biodiesel credits); and the normal vicissitudes of the energy supply and demand.  Speculation is largely a creation of government regulation, ironically, so to complain to the government about it (the EPA in particular) is somewhat perverse. But that’s the world we live in now.

* I highly recommend the various analyses of the RINs and ethanol markets in the University of Illinois’ Farm Doc Daily. Here’s one of their posts on the subject, but there are others that can be found by searching the website. Kudos to Scott Irwin and his colleagues.

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July 30, 2016

Dogs Fighting Under the Carpet, Ex-Mullet Man Edition

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 11:54 am

There is a very revealing struggle going on in Russia right now. It is a pitch-perfect illustration of how Putinism works.

At issue is the Russian government’s privatization initiative, and specifically the privatization of the oil company Bashneft (a Russian firm with a very sordid, checkered past, but I repeat myself). Igor Sechin covets Bashneft, in large part because Rosneft production has been falling (estimates for 2016 are a 2 percent decline), and with sanctions and the company’s inefficiency, here is little hope of reversing the decline. Getting ahold of Bashneft would increase Rosneft’s production and reserves, and Bashneft’s production has grown handsomely of late (almost 11 percent in the last year): Sechin could buy what he can’t create.

But government technocrats, led by Deputy Prime Minister Arkady Dvorkovich, are adamantly opposed to a Rosneft takeover. The opposition stems in part because acquisition of Bashneft by a state-owned firm would make a travesty of privatization, and also thwart the goal of using privatization proceeds to address the government’s fiscal strains, which requires outside money. The opposition also reflects the understanding that enhancing Rosneft’s position in the Russian oil industry is detrimental to the future development of that industry. Rosneft is more parasite that creator.

Dvorkovich therefore flipped out when Russian bank VTB invited Rosneft, as well as other state-owned companies like Gazprom Neft, to participate in the privatization auction. It initially appeared that Putin had sided with Dorkovich, and an anonymous spokesman in the Presidential Administration had confirmed this. This was hailed as a huge defeat for Sechin, and perhaps a harbinger of a change in the balance of power within the Russian government.

But not so fast! An “official” said that the exclusion of Rosneft was “unofficial”. But then this week Putin’s spokesman Peskov, who had confirmed only a week before the “understanding” that Rosneft was out of the running, reversed himself, and said that “formally speaking” Rosneft was not a state owned company, and hence it could participate. You see, Rosneft is owned by a holding company, which is owned by the state. So  even though economically this is a distinction without a difference, legally it provides enough of an opening for Igor to slip through.

So who knows what will happen? Maybe Rosneft will be allowed to participate, under the understanding that it will not win. Or maybe the fix is in. Or maybe Putin is just letting Dvorkovich and (ex-)Mullet Man battle it out ender the carpet for a little while longer before ruling. This would allow him to weigh the arguments–and also to force the contenders to make bids for his support. Putin will rule depending on how he wants to balance the competing political factions, and who can offer the most to Putin or others he wants to favor.

And as in the heyday of Kremlinology, outsiders will attempt to discern deeper lessons from the outcome. Who is on top? How committed is Putin to reforming the Russian economy? How wedded is he to the idea of state champions? Or is he willing to concede that given Russia’s economic straits it is necessary to make accommodation to more Western commercial and legal norms?

The problem with the answers to all of these questions is that even if you are right today, nothing is set in stone. Putin could reverse course later. Maybe next month. Maybe next year. This is an inherent problem with autocratic systems: autocrats can’t make credible commitments. The only precedent is that there are no precedents. Today’s decision matters. . . for today.

So whatever the outcome of this current dog fight, it will tell you about the current state of play and the current balance of power, and not much more, because for an autocrat, tomorrow is another day.

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Say “Sayonara” to Destination Clauses, and “Konnichiwa” to LNG Trading

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 11:12 am

The LNG market is undergoing a dramatic change: a couple of years ago, I characterized it as “racing to an inflection point.” The gas glut that has resulted from slow demand growth and the activation of major Australian and US production capacity has not just weighed on prices, but has undermined the contractual structures that underpinned the industry from its beginnings in the mid-1960s: oil linked pricing in long term contracts; take-or-pay arrangements; and destination clauses. Oil linkage was akin to the drunk looking for his keys under the lamppost: the light was good there, but in recent years in particular oil and gas prices have become de-linked, meaning that the light shines in the wrong place. Take-or-pay clauses make sense as a way of addressing opportunism problems that arise in the presence of long-lived, specific assets, but the development of a more liquid short-term trading market reduces asset specificity. Destination clauses were a way that sellers with market power could support price discrimination (by preventing low-price buyers from reselling to those willing to pay higher prices), but the proliferation of new sellers has undermined that market power.

Furthermore, the glut of gas has undermined seller market and bargaining power, and buyers are looking to renegotiate deals done when market conditions were different. They are enlisting the help of regulators, and in Japan (the largest LNG purchaser), their call is being answered. Japan’s antitrust authorities are investigating whether the destination clauses violate fair trade laws, and the likely outcome is that these clauses will be retroactively eliminated, or that sellers will “voluntarily” remove them to preempt antitrust action.

It’s not as if the economics of these clauses have changed overnight: it’s that the changes in market fundamentals have also affected the political economy that drives antitrust enforcement. As contract and spot prices have diverged, and as the pattern of gas consumption and production has diverged from what existed at the time the contracts were formed, the deadweight costs of the clauses have increased, and these costs have fallen heavily on buyers. In a classic illustration of Peltzman-Becker-Stigler theories of regulation, regulators are responding to these efficiency and distributive changes by intervening to challenge contracts that they didn’t object to when conditions were different.

This development will accelerate the process that I wrote about in 2014. More cargoes will be looking for new homes, because the original buyers overbought, and this reallocation will spur short-term trading. This exogenous shock to short term trading will increase market liquidity and the reliability of short term/spot prices, which will spur more short term trading and hasten the demise of oil linking. The virtuous liquidity cycle was already underway as a result of the gas glut, and the emergence of the US as a supplier, but the elimination of destination clauses in legacy Japanese contracts will provide a huge boost to this cycle.

The LNG market may never look exactly like the oil market, but it is becoming more similar all the time. The intervention of Japanese regulators to strike down another barbarous relic of an earlier age will only expedite that process, and substantially so.

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July 23, 2016

For All You Pigeons: Musk Has Announced Master Plan II

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — The Professor @ 11:29 am

Elon Musk just announced his “Master Plan, Part Deux,” AKA boob bait for geeks and posers.

It is just more visionary gasbaggery, and comes at a time when Musk is facing significant head winds: there is a connection here. What headwinds? The proposed Tesla acquisition of SolarCity was not greeted, shall we say, with universal and rapturous applause. To the contrary, the reaction was overwhelmingly negative, sometimes extremely so (present company included)–but the proposed tie up gave even some fanboyz cause to pause. Production problems continue; Tesla ended the resale price guarantee on the Model S (which strongly suggests financial strains); and the company has cut the price on the Model X SUV in the face of lackluster sales. But the biggest set back was the death of a Tesla driver while he was using the “Autopilot” feature, and the SEC’s announcement of an investigation of whether Tesla violated disclosure regulations by keeping the accident quiet until after it had completed its $1.6 billion secondary offering.

It is not a coincidence, comrades, that Musk tweeted that he was thinking of announcing his new “Master Plan” a few hours before the SEC made its announcement. Like all good con artists, Musk needed to distract from the impending bad news.

And that’s the reason for Master Plan II overall. All cons eventually produce cognitive dissonance in the pigeons, when reality clashes with the grandiose promises that the con man had made before. The typical way that the con artist responds is to entrance the pigeons with even more grandiose promises of future glory and riches. If that’s not what Elon is doing here, he’s giving a damn good impression of it.

All I can say is that if you are fool enough to fall for this, you deserve to be suckered, and look elsewhere for sympathy. Look here, and expect this.

As for the “Master Plan” itself, it makes plain that Musk fails to understand some fundamental economic principles that have been recognized since Adam Smith: specialization, division of labor, and gains from trade among specialists, most notably. A guy whose company cannot deliver on crucial aspects of Master Plan I, which Musk says “wasn’t all that complicated,” (most notably, production issues in a narrow line of vehicles), now says that his company will produce every type of vehicle. A guy whose promises about self-driving technology are under tremendous scrutiny promises vast fleets of autonomous vehicles. A guy whose company burns cash like crazy and which is now currently under serious financial strain (with indications that its current capital plans are unaffordable) provides no detail on how this grandiose expansion is going to be financed.

Further, Musk provides no reason to believe that even if each of the pieces of his vision for electric automobiles and autonomous vehicles is eventually realized, that it is efficient for a single company to do all of it. The purported production synergies between electricity generation (via solar), storage, and consumption (in the form of electric automobiles) are particularly unpersuasive.

But reality and economics aren’t the point. Keeping the pigeons’ dreams alive and fighting cognitive dissonance are.

Insofar as the SEC investigation goes, although my initial inclination was to say “it’s about time!” But the Autopilot accident silence is the least of Musk’s disclosure sins. He has a habit of making forward looking statements on Twitter and elsewhere that almost never pan out. The company’s accounting is a nightmare. I cannot think of another CEO who could get away with, and has gotten away with, such conduct in the past without attracting intense SEC scrutiny.

But Elon is a government golden boy, isn’t he? My interest in him started because he was–and is–a master rent seeker who is the beneficiary of massive government largesse (without which Tesla and SolarCity would have cratered long ago). In many ways, governments–notably the US government and the State of California–are his biggest pigeons.

And rather than ending, the government gravy train reckons to continue. Last week the White House announced that the government will provide $4.5 billion in loan guarantees for investments in electric vehicle charging stations. (If you can read the first paragraph of that statement without puking, you have a stronger stomach than I.) Now Tesla will not be the only beneficiary of this–it is a subsidy to all companies with electric vehicle plans–but it is one of the largest, and one of the neediest. One of Elon’s faded promises was to create a vast network of charging stations stretching from sea-to-sea. Per usual, the plan was announced with great fanfare, but the delivery has not met the plans. Also per usual, it takes forensic sleuthing worthy of Sherlock Holmes to figure out exactly how many stations have been rolled out and are in the works.

The rapid spread of the evil internal combustion engine was not impeded by a lack of gas stations: even in a much more primitive economy and a much more primitive financial system, gasoline retailing and wholesaling grew in parallel with the production of autos without government subsidy or central planning. Oil companies saw a profitable investment opportunity, and jumped on it.

Further, even if one argues that there are coordination problems and externalities that are impeding the expansion of charging networks (which I seriously doubt, but entertain to show that this does not necessitate subsidies), these can be addressed by private contract without subsidy. For instance, electric car producers can create a joint venture to invest in power stations. To the extent government has a role, it would be to take a rational approach to the antitrust aspects of such a venture.

So yet again, governments help enable Elon’s con. How long can it go on? With the support of government, and credulous investors, quite a while. But cracks are beginning to show, and it is precisely to paper over those cracks that Musk announced his new Master Plan.

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July 6, 2016

Brexit: Breaking the Cartel of Nations. Could Position Limits Be a Harbinger?

Filed under: Clearing,Commodities,Derivatives,Economics,Politics,Regulation — The Professor @ 7:50 pm

One of the ideas that I floated in my first post-Brexit post was that freed from some of the EU’s zanier regulations, it could compete by offering a saner regulatory environment. One of the specific examples I gave was position limits, for as bad as the US position limit proposal is, it pales in comparison to the awfulness of the EU version. And lo and behold! Position limits are first on the list of things to be trimmed, and the FCA appears to be on board with this:

Britain-based commodity exchanges may have some leeway in the way they manage large positions after the UK exits the European Union, but they will still have to comply with EU rules from 2018, experts say.

Position limits, a way of controlling how much of an individual commodity trading firms can hold, are being introduced for the first time in the Markets in Financial Instruments Directive II (MiFID II) from January 2018.

Britain voted to leave the EU last month, but its exit has to be negotiated with the remaining 27 members, a process that is meant to be completed within two years of triggering a formal legal process.

“It is too early to say what any new UK regime will look like particularly given pressure for equivalence,” James Maycock, a director at KPMG, said, referring to companies having to prove that rules in their home countries are equivalent to those in the EU.

“But UK commodity trading venues may have more flexibility in setting position limits if they are not subject to MiFID II.”

. . . .

Britain’s Financial Conduct Authority (FCA) said in a statement after the Brexit vote that firms should continue to prepare for EU rules. But it has previously expressed doubts about position limits on all commodity contracts.

“We do not believe that it is necessary, as MiFID II requires, to have position limits for every single one of the hundreds of commodity derivatives contracts traded in Europe. Including the least significant,” said Tracey McDermott, former acting chief executive at the FCA in February this year.

“And I know there are concerns, frankly, that the practical details of position reporting were not adequately thought through in the negotiations on the framework legislation.”

Here’s hoping.

This could explain a major driver behind the Eurogarchs intense umbrage at Brexit. Competition from the UK, particularly in the financial sector, will provide a serious brake on some of the EU’s more dirigiste endeavors. This is especially true in financial/capital markets because capital is extremely mobile. Further, I conjecture that Europe needs The City more than The City needs Europe. Hollande and others in Europe are talking about walling off the EU’s financial markets from perfidious Albion, but the most likely outcome of this is to create a continental financial ghetto or gulag, A Prison of Banks.

If financial protectionism of the type Hollande et al dream of could work, French, German and Dutch bankers should be dancing jigs right now. But they seem to be the most despondent and outraged at Brexit.

A (somewhat tangential) remark. Another reason for taking umbrage is that the UK has served as a safety valve for European workers looking to escape the dysfunctional continental labor markets. This is especially true for many younger, high skill/high education French, Germans, etc. (especially the French). With the safety valve cut off, there will be more angry people putting pressure on European governments.

This could be a good thing, if it forces the Euros (especially the French) to loosen up their growth-and-employment-sapping labor laws. But in the short to medium term, it means more political ferment, which the Euro elite doesn’t like one bit.

This all leads to a broader point. Cooperation is a double edged sword. The EU’s main selling point is that intra-European cooperation has led to a reduction in trade barriers that has increased competition in European goods markets. But the EU has also functioned as a Cartel of Nations that has restricted competition on many dimensions.

I note that one major international cooperative effort spearheaded by the Europeans is the attempt to reduce and perhaps eliminate competition between nations on tax. “Tax harmonization” sounds so Zen, but it really means cutting off any means of escape from the depredations of the state. But tax is just one area where governments don’t like to compete with one another. Much regulatory harmonization and coordination and imposed uniformity is intended to reduce inter-state competition that limits the ability of governments to redistribute rents.

This is one reason to believe that Britain’s exit will have some big upsides, not just for the UK but for Europe generally. It will invigorate competition between jurisdictions that statists hate. And it is precisely these upsides which send the dirigistes into paroxysms of anger and despair. Feel their pain, and rejoice in it.

 

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June 29, 2016

Will the EU Cut Off Its Nose to Spite Its Face on Clearing, Banking & Finance?

Filed under: Clearing,Commodities,Derivatives,Economics,Exchanges,Politics,Regulation — The Professor @ 7:45 pm

French President Francois Hollande is demanding that clearing of Euro derivatives take place in the Eurozone. Last year the European Central Bank had attempted to require this, claiming that it could not be expected to provide liquidity to a non-Eurozone CCP like London-based LCH.

The ECB lost that case in a European court, but now sees an opportunity to prevail post-Brexit, when London will be not just non-Eurozone, but non-EU. Hollande is cheerleading that effort.

It is rather remarkable to see the ECB, which was only able to rescue European banks desperate for dollar funding during the crisis because of the provision of $300 billion in swap lines from the Fed, claiming that it can’t supply € liquidity to a non-Eurozone entity. How about swap lines with the BoE, which could then provide support to LCH if necessary. Or is the ECB all take, and no give?

Hollande (and other Europeans) are likely acting partly out of protectionist motives, to steal business for continental entities from London (and perhaps the US). But Hollande was also quite upfront about the punitive, retaliatory, and exemplary nature of this move:

“The City, which thanks to the EU, was able to handle clearing operations for the eurozone, will not be able to do them,” he said. “It can serve as an example for those who seek the end of Europe . . . It can serve as a lesson.” [Emphasis added.]

That will teach perfidious Albion for daring to leave the EU! Anyone else harboring such thoughts, take note!

The FT article does not indicate the location of M. Hollande’s nose, for he obviously just cut it off to spite his face.

In a more serious vein, this is no doubt part of the posturing that we will see ad nauseum in the next two plus years while the terms of the UK’s departure are negotiated. Stock up with supplies, because this is going to take a while, since (1) everything is negotiable, (2) almost all negotiations go to the brink of the deadline, or beyond, and (3) these negotiations will be particularly complicated because the Eurogarchs will be conducting them with an eye on how the outcome affects the calculations of other EU members contemplating following Britain out the door–and because immigration issues will loom over the negotiations.

When evaluating a negotiation, it’s best to start with the optimal, surplus maximizing “Coasean bargain” (a term which Coase actually didn’t like, but it is widely used). This, as Elon Musk would say, is a no brainer: allow € clearing in London, through LCH. That is, a maintenance of the status quo.

What are the alternatives? One would be that € clearing for those subject to EU regulation and some non-EU firms would take place in the Eurozone (say Paris or Frankfurt), some € clearing might take place in London or the US, and most dollar and other non-€ clearing would take place in London and the US.  This would require the EU to permit its banks to clear economically in the UK or US, by granting equivalence to non-EU CCPs for non-€ trades, or something similar.

There are several inefficiencies here. First, it would fragment netting sets and increase the probability that one CCP goes bust. For instance, if a bank that is a member of an EU and a non-EU CCP (as would almost certainly be the case of the large European banks that do business in all major currencies) defaulted, it is possible that it could have a loss on its € deals and a gain on its non-€ deals (or vice versa). If those were cleared in a single CCP, the gain and loss could be offset, thereby reducing the CCP’s loss, and perhaps resulting in no loss to the CCP at all: this is what happened with Lehman at the CME, where losses on some of its positions were greater than collateral, but losses on others were smaller, and the total loss was less than total collateral. However, if the business was split, one of the CCPs could suffer a loss that could potentially put it in jeopardy, or force members to stump up additional contributions to the default fund during a time when they are financially stressed.

Second, default management would be more difficult, risky and costly if split across two or more CCPs. It would be easier to put in place dirty hedges for a broader portfolio than two narrower ones, and to allocate or auction off a combined portfolio than fragmented ones. Moreover, it would be necessary to coordinate default management across CCPs in a situation where their interests are not completely aligned, and indeed, where interests may be strongly in conflict. Furthermore, there would be duplication of personnel, as CCP members would be required to dispatch people to two different CCPs to manage the default.

Third, even during “peacetime,” fragmented clearing would sacrifice collateral and capital efficiencies and increase operational costs and complexity.

But it could be worse! Maybe the Europeans will cut off their noses and ears (and maybe some other parts lower down), and deny a UK CCP equivalence for any transaction undertaken by an EU bank. The outcome would be EU banks clearing in Europe, and most everybody else clearing outside of Europe. This would result in multiple inefficiently small CCPs clearing in all currencies that would exacerbate all of the negative consequences just outlined: netting set inefficiencies would be even worse, default risk management even more difficult, and peacetime collateral, capital, and operational efficiencies would be even worse.

Oh, and this alternative would require the ECB to obtain dollar and sterling (and other currency) liquidity lines to allow it to provide non-€ liquidity to its precious little CCP. How hypocritical is that? (Not that hypocrisy would cost Hollande et al any sleep. It hasn’t yet.)

The fact is that CCPs exhibit strong economies of scale and scope, and although mega-CCPs concentrate risk, fragmentation creates its own special problems.

So the wealth-maximizing outcome would be for the EU to come to an accommodation on central clearing that would effectively perpetuate the pre-Brexit status quo. Wealth maximization exercises a strong pull, meaning that this is the most likely outcome, although there will likely be a lot of posturing, bluffing, threatening, etc., before this outcome is achieved (and at the last minute).

I would expect that EU banks would support the Coasean bargain, further increasing its political viability. Yes, Deutsche Borse would be pushing for a EU-centric outcome, and some Europols would take pride at having their own (sub-scale and/or sub-scope) CCP, but the greater cost and risk imposed on banks would almost certainly induce them to put heavy pressure behind a status quo-preserving deal.

This raises the issue of negotiation of banking and capital market issues more generally. There has been a lot of attention paid to the fact that British banks would probably lose passporting rights into the EU post-exit, and this would be costly for them. But European banks actually rely even more on passporting to get access to London. Since London is still almost certain to remain the dominant financial center (especially since the UK government will have a tremendous incentive to facilitate that), European banks would suffer as much or more than UK ones if the passporting system was eliminated (and a close substitute was not created).

Thus, if the negotiations were only about clearing, banking, and capital markets, mutual self-interest (and political economy, given the huge influence of the finance sector on policymakers) would strongly favor a deal that would largely maintain the status quo. But of course the negotiations are not about these issues alone. As I’ve already noted, the EU may try to punish the British even if it also takes a hit because of the effect this might have on the calculations of others who might bolt from the Union.

Furthermore, the most contentious issue–immigration–is very much in play. Merkel, Hollande, and others have said that to obtain a Norway-style relationship with the EU, the UK would have to agree to unlimited movement of people. But that issue is the one that drove the Leave vote, and agreeing to this would be viewed as a gutting of the referendum, and a betrayal. It will be hard for the UK to agree to that.

Perhaps even this could be finessed if the EU secured its borders, but Merkel’s insanity on this issue (and the insanity of other Eurogarchs) makes this unlikely, short of a populist political explosion within the EU. But if that happens, negotiations between the EU and the UK will likely be moot, because there won’t be much of the EU left to negotiate with, or worth negotiating with.

In sum, if it were only about banking and clearing, economic self-interest would lead all parties to avoid mutually destructive protectionism in these areas. But highly emotional issues, political power, and personal pride are also present, and in spades. Thus, I am reluctant to bet much on the consummation of the economically efficient deal on financial issues. The financial sector is just one bargaining chip in a very big game.

 

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