Streetwise Professor

June 17, 2017

We Can Now Bound From Above the Price of German Principles

Filed under: Commodities,Economics,Energy,History,Military,Politics,Russia — The Professor @ 12:30 pm

If you really concentrate, I’m sure you can stretch your memory to recall those long past days when Angela Merkel was hailed as the new Leader of the Free World, most notably because of her stalwart stance on Russia, in contrast to Trump, who was deemed a squish on Russia at best, and a collaborationist at worst. But that was so . . . May. Now in mid-June, the Germans and much of the rest of Europe and their fellow travelers here in the US are totally losing it over the 98-2 vote in the US Senate (the two dissenters being ideological bookends Rand Paul and Bernie Sanders) to strengthen the sanctions regime on Russia, and notably, to limit Trump’s ability to relax sanctions unilaterally.

So: In May, soft on Russia bad, hard on Russia good. In June, hard on Russia bad. In May, Trump had too much power. In June, limiting Trump’s power is inexcusable.

What changed? Actually nothing changed. This is volte face reflects an enduring constant: German commercial interests. The Senate sanctions bill would impose potential penalties on those assisting in the construction of Russian pipelines, most notably NordStream 2. NordStream 2 is a joint project between Gazprom and a handful of major European, and particularly German, corporate behemoths.

German explanations of the motivation behind the Senate’s action betray extreme psychological projection. Echoing Gazprom (an action which if you were to do it in the US would immediately bring down upon on your head screams of “RUSSIAN TROLL”), several European policymakers have claimed that this action was intended to advance the interests of US LNG exporters.

Um, no. Not even close. The objections of the US to NordStream date back to the Obama administration, which was hardly a major promoter of the US natural gas industry. Further, the main drivers in the Senate were people like McCain, for whom economic considerations are tertiary, at best: McCain et al have had it in for Russia generally and NordStream particularly for geopolitical reasons, and their opposition dates back years. Moreover, the bill reflects the current anti-Russia hysteria in the US, which in turn reflects a strange mix of political factors, not least of which is the clinical insanity of the Democratic Party post-November, 2016.

Indeed, US opposition to Russian gas pipelines into Europe dates back to the Reagan administration. The US tried to stop the pipelines through Ukraine that Putin is now trying to outflank with NordStream, because it thought the pipelines provided an economic benefit to the USSR and made Europe hostage to Russian economic pressure. This was in fact a source of one of the few disagreements between Thatcher (who supported the pipelines) and Reagan.

How much did the US hate the USSR-Europe gas pipelines, you ask? Enough to blow them up. Blow them up real good: “The result was the most monumental non-nuclear explosion and fire ever seen from space.”

Those who claim economic motivations say a lot more about themselves than they do about the US Senate: adopting a policy to advance German/European economic interests is exactly what they would do, and they are projecting this motivation on the US.  Indeed, the Germans’ hysterical reaction demonstrates just how important economic considerations are to them, and how marginal are geopolitical considerations vis-a-vis Russia.

If you think the Russians are as big a threat as the Germans and other gas-poor nations say, they should be deeply grateful for the emergence of US LNG which reduces their dependence on the evil Russkies. But the Germans say: we don’t want your methadone, we’d rather continue to buy smack from this really nasty dealer.

The hypocrisy and projection don’t stop there. Of course German economic policy is strongly oriented towards boosting its exports, often at the cost of beggaring its supposed European brothers and sisters (especially the swarthy ones down south). What’s good for zee goose, kameraden. .  .

Further, recall (if you can remember back that far) that one reason for the German/European freakout over Trump in May was his refusal to acknowledge solidarity with our allies by mouthing the words “Article 5.” All for one! One for all!

Right?

Well, eastern Europeans–the Poles in particular–think that NordStream basically sells them out to the Russians in order to benefit Germany. The Germans have totally blown off this criticism, and have subjected the Poles and Baltic States to considerable criticism and pressure for their opposition to NordStream. So much for European solidarity. It’s all for one, all right: that one being Germany. That one for all . . . not so much.

It gets better! Merkel and other Euros are fond of saying “more Europe.” Well, that’s exactly what the dispute and the sanctions are about, isn’t it? The economics of NordStream 2 are dubious, but it presents a nearly existential threat to Ukraine. The entire reason for the conflict in Donbas and the seizure of Crimea (conflicts that Merkel is allegedly attempting to mediate) were Ukraine’s attempt to move closer to Europe.

That is: (1) Ukraine takes “more Europe” seriously, and enters into an agreement with the EU that would open up trade with an eye on Ukraine joining the union in the future, (2) Putin takes exception to this, and initiates a series of actions that culminate with the ouster of Yanukovych followed by the seizure of Crimea, and a hot war in Donbas, (3) the US Senate attempts to penalize Russian actions by sanctions, and (4) the Europeans scream bloody murder at US intrusion into their policy domain.

In other words, when forced to put their money (and their gas) where their mouths are, the Europeans jettison “more Europe”. And then turn around and slag the US for taking them at their word.

Hey, they can do what they want. And the US can do what it wants. Just spare me the sanctimonious bullshit about standing up to Russia, European solidarity, more Europe, and on and on. It’s all about the Euros, baby–€–and German € in particular. Every “principle” that supposedly earned Merkel the designation as Leader of the Free World went out the window in a nanosecond, once some big German companies were going to have to pay a price for those principles.

We can now bound from above the price of German principles. The upper bound is in the billions of Euros. I am sure that the true price is far lower than that.

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June 8, 2017

Rosneft Follies, Redux

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 1:16 pm

Sarah Mcfarlane dropped a long piece in the WSJ claiming that the already sketchy Rosneft-QIA-Glencore deal was even sketchier than it appeared at the time, hard as that is to believe. Specifically, according to Sarah (and Summer Said), Putin and the emir of Qatar, Sheikh Tamim bin Hamad Al Thani, agreed in that Russia would repurchase the stake at a future date:

Moscow agreed with Qatar that Russia would buy back at least a portion of the stake from the rich Persian Gulf emirate, the people said. The Qatar Investment Authority and Glencore, the Swiss-based commodities giant, formed a partnership to buy the 19.5% stake in Russia’s energy jewel at a time when Mr. Putin’s government needed cash.

The people with knowledge of the deal say the buyback arrangement was negotiated with involvement from Mr. Putin and the emir of Qatar, Sheikh Tamim bin Hamad Al Thani. Russia and Qatar saw it as an opportunity to build a bridge between countries that had taken up opposite sides in the Syrian civil war, the people said. One of the people said the buyback would happen in the next 10 years.

Color me skeptical. For one thing, Glencore is a principal in the deal, and it would have to sign off too: the story does not assert, claim, suggest, or imply that Glencore did so. Both Glencore and QIA vigorously deny the story, for whatever that’s worth, as do the Russians. (As an aside, a source in Russia tells me that Ivan Glasenberg refused to discuss anything about the deal recently. Why the UK authorities and the LSE are so willing to accept the extremely deficient disclosure by a major UK issuer relating to a major transaction is beyond me. Maybe they are trying to convince Saudi Aramco that if it lists in London, it can do pretty much anything anywhere, no questions asked! BP’s silence is also curious.)

For another thing, Putin saying “I’ll buy it back later” without a mechanism to determine price is meaningless. I smile when I think about the number of times going back to at least 2006 the Russians announced that they had almost completed a gas deal with China: all that remained to determine was the price! And this went on year, after year, after year.  In other words, no agreement on pricing means no real agreement.

This is pretty funny:

Qatar wanted its Rosneft stake to be temporary, the people said. The emirate believes it will profit from selling the shares back to Russia at a later date, the people said, betting that oil prices will rise and push up Rosneft’s share price. Qatar saw the political benefits of giving Russia access to quick cash as a sort of loan to address a budget deficit that had widened due to lower oil prices, the people said.

In the 7 months (to the day) since the deal was announced, this has turned out to be a bad bet: Rosneft’s stock is down about 12 percent in Euros. (It’s down about 18 percent in rubles.)

This raises some other crucial issues. The €2.8 billion that QIA and Glencore put down represents about 26 percent of the value of the deal. Meaning that about one-half of the equity cushion is gone. Thus, the indemnities and guarantees that the Russian banks provided Glencore (there is no clarity on whether they similarly indemnified the QIA portion of the loan, but its non-recourse nature suggests they did) are getting pretty close to being in the money. Given the recent bloodbath in the oil market there is a decent probability that the loan will be underwater in the near to medium term.

Intesa’s statement suggests that QIA is indemnified/guaranteed too:

An Intesa spokesman said the loan to the Qatar/Glencore partnership “is covered by a robust package of guarantees.” Intesa is trying to spread the risk of its loan by syndicating it to other banks, but a person familiar with the matter said the bank hasn’t yet found willing banks.

The syndication part makes me laugh. Um, you’re kinda supposed to arrange the syndication at the front end, either before the deal or shortly (I mean days) afterwards. Seven months later, when you have zero negotiating leverage because you already are wearing the entire loan? With about half the equity cushion gone? With the loans being backed by Russian banks that are (a) not in the most robust health, and (b) under a cloud due to Russian sins real, and recently, feverishly imagined? Yeah, that will be an easy sell! I’m sure other banks are just lining up for a piece of that!

In bocca al lupo, signori!

The story suggests that Putin pressured Sechin to stitch together this Frankenstein’s monster to address pressing budget issues. I have no doubt that this was done under duress, but less because of budget than because of prestige and reputation. Putin had said that a stake in the company would be privatized in 2016, and to a non-Russian buyer. So Putin put his reputation on the line, and Sechin had to come through.

But virtually all the downside risk resides in Russia (something I pointed out early). So although the deal (a) generated some cash inflow that did address some budget issues, and (b) provided some reputational benefits (for a few weeks, anyway), it did nothing to mitigate the Russian government’s exposure to Rosneft’s downside, but did give away the upside. In essence, Putin and Sechin got their PR play by giving away a put on Rosneft. That’s what enticed QIA and Glencore.

In other news from the bizarre world of Russian–and Rosneft specifically–transactions, the Rosneft/Sechin-Sistema litigation rolls on. Indeed, Sechin increased his demands by more than 50 percent, from $1.9b to $3b. My same Russian source says all of Russia is mystified by this, but he did provide a valuable tidbit.

What had mystified me was how Rosneft could go after Sistema when it bought Bashneft from the state. Well, apparently Igor was in such a hurry to complete the deal that Rosneft didn’t begin the audit/due diligence until after the deal was completed! 

Why was Igor in a hurry? My guess is that Putin had opposed Rosneft’s purchase in August, and changed his mind in September, and Sechin wanted to move before Putin changed his mind again.

Perhaps Igor was thinking that if the audit uncovered irregularities, he could get a Russian court to give him a mulligan and claw back the money. In which case, the current litigation might have been part of the plan (at least as a contingency) all along.

I’m still puzzled, though, because some of the things Sechin goes on about (e.g., the sale of Bashneft’s oilfield services business to a Sistema entity, and the subsequent contract between Bashneft and that entity for said services) was known about before. So maybe Igor is just throwing everything into the litigation claim, even when it doesn’t make any sense. After all, this isn’t being heard in a London court or arbitration in a European country: although this is an intra-Russian dispute, Sechin definitely has home field advantage.

Keep this all in mind whenever anyone (and now it seems that means pretty much everyone) tries to scare you about the Russian bogeyman. The follies of one of Russia’s premier companies, a so-called national champion, illustrate just what a ramshackle, and at times clownish, contraption the Russian state is. Putin does a great Wizard of Oz imitation, but when Toto pulls back the curtain as has happened with the Rosneft/Glencore/QIA deal, you’ll see that there’s a little man blowing a lot of smoke.

 

 

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June 2, 2017

Trump Rejects the Climate Gateway Drug: Global Progressives Go All Spanish Inquisition

Filed under: China,Climate Change,Economics,Energy,Politics — The Professor @ 7:00 am

The wailing, gnashing of teeth, and rending of garments that has followed Trump’s widely expected decision to withdraw the US from the Paris Climate Accord is truly amazing to witness. It is virtue signaling taken to a new extreme. Indeed, since so many people want to signal simultaneously, each apparently feels obliged to outdo the other in hysterics in order to attract the attention their precious egos crave. Hence the apocalyptic paroxysms of rage that started the moment Trump spoke.

Truth be told, even if one believes the predictions of standard climate models, and even if one believes there will be compliance with the commitments of the Accord (which is slightly less likely than my becoming Pope), it would have a trivial impact on global temperatures: on the order of .2 degrees. The impact of the US withdrawal alone, given its declining CO2 emissions relatively (especially compared to China and India) and even absolutely (something the pious Europeans have not been able to manage despite their moribund economy and costly—and insane–commitment to renewables), means that Trump’s action by itself will have an immeasurable effect on climate in any time frame.

So despite all of the screeching that Trump has doomed—doomed I say!—life on earth, in reality the accord is not a practical agreement, but a ritual. And like all rituals, its primary purpose is to provide an opportunity to display obeisance to a creed, theology, doctrine, or dogma.

Which explains the overwrought reaction: those rejecting creeds, theologies, doctrines, and dogmas are heretics, and heretics must be attacked, ostracized, ridiculed, and in the dreams of some, burned. Trump is accused of heresy on three counts — heresy by thought, heresy by word, heresy by deed, and heresy by action — four counts! Yet he does not confess, and indeed revels in his heresy, only infuriating his inquisitors all the more.

There is much dispute over the concrete effects of Paris qua Paris. Some claim it is merely symbolic. Others claim that it will lead to real policy changes. Whatever the practical effects, there is no doubt about the ambitions of those pushing Paris, and Trump rejected them all. He rejected the delegation of authority over the United States to an unelected and unaccountable (self-perceived but actually utterly failed) elite. He rejected the exploitation of climate concerns to implement a vast scheme of international wealth redistribution.

And perhaps most importantly, he called out, confronted, and rejected the role of Paris as a gateway drug to even more intrusive supranational elite control and power:

The risks grow as historically these agreements only tend to become more and more ambitious over time.  In other words, the Paris framework is a starting point — as bad as it is — not an end point.  And exiting the agreement protects the United States from future intrusions on the United States’ sovereignty and massive future legal liability.  Believe me, we have massive legal liability if we stay in.

Absolutely. Climate concerns (hysteria, really) have become an engine for rent seeking and power grabbing on a global scale never seen before, and it needs to be throttled in the crib. For it is evident from years of experience how the leftist-statist-dirigiste march through the institutions works. Stake out a modest set of policies to achieve a lofty goal. When the policies fall short, impose more draconian ones. When those policies in turn fail, unleash more bureaucratic dragoons to intrude on every aspect of institutional life. And in this case, the institution at stake is the world. Better to stop it now, then to watch it metastasize later.

The reaction has been predictable. Corporate rent seekers—Goldman Sachs’ Lloyd Blackfein, GE’s Jeffrey Immelt, and our favorite among them Elon Musk—have expressed their rage and dismay. Political power seekers, the Euros most notable among them, are beside themselves.

The Euros are particularly amusing. After Trump spurned them, they are now looking to China’s Xie for climate policy leadership, just as they did on “free trade” at Davos. Daddy didn’t give them what they wanted, so they are throwing themselves into the arms of the leader of a biker gang. That will show that meanie, harrumph!

That won’t end well, and don’t bother come crying to us when it doesn’t! China is a mercantilist environmental disaster that will pump out increasing quantities of CO2 for the foreseeable future. China is in this for China, and will exploit climate policy to advance its economic interests while paying lip service to green pieties. Only the willfully self-deluded refuse to see otherwise.

The economic costs of any actual implementation of Paris promises would have dwarfed any benefits accruing to its effects on climate. Force-feeding of renewables will increase energy costs, thereby impairing growth—which will have a disproportionate effect on the poor. Taxes to fund global wealth transfers will have similar effects: and if you think that money transferred to poor countries is going to go to the poor, rather than sticky-fingered elites, you are truly a fool.

So Donald Trump has said we’ll never have Paris. And that’s a damn good thing. Arguably the best thing he’s done—and the shrieking of global progressives is about the best proof of that I can think of.

 

 

 

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May 25, 2017

OPEC and Inventories: An Exercise in Game Theoretic Futility

Filed under: Commodities,Economics,Energy — The Professor @ 11:37 am

OPEC met today, and agreed to extend its output cuts for another nine months. OPEC’s focus is on “rebalancing the market,” that is, on inducing a decline in world oil stocks to a level well below their current inflated value. This is far easier said than done, and indeed may be impossible because of the inability of OPEC to commit to a path of future output. This is because inventory changes result from changes in the temporal supply and demand balance.

In a competitive market, stocks accumulate when there are unexpected increases in supply or declines in demand, and crucially, these shocks are expected to be highly transitory. Similarly, market participants draw down on stocks when there are unexpected declines in supply or increases in demand that are expected to be highly transitory.

The “transitory” part of the story is very important. It makes sense to store when expected future supply is less than current supply, i.e., when future scarcity is greater than current scarcity. It makes sense to draw down on storage when future scarcity is expected to be low relative to today: why carry inventory to a time of greater abundance? Markets move things from where/when they are abundant to where/when they are scarce. Highly persistent shocks to supply and demand don’t affect the temporal balance, and hence to don’t lead to temporal reallocations. Temporary shocks (or shocks to future supply/demand) also change the temporal balance, and lead to inventory changes.

In my empirical work on the copper market (where inventory data is pretty good), I document that a net supply shock with a half-life of about 1 month drives inventory changes. Much more persistent shocks (e.g., those with a half-life of a year) have virtually no impact on inventory.

Inventories can also decline if expected future supply rises, or expected future demand declines. An increase in expected future supply reduces the future value of oil, and makes it less valuable to hold oil today for future use. Or to put it another way, it is desirable to smooth consumption, so if expected future supply (and hence future consumption) goes up, it makes sense to increase consumption today. This can only be done by drawing down on inventory. (Time travel that would allow bringing the abundant future supply back to the present would do the same thing, but alas, that’s impossible.)

OPEC’s desire to cause a drawdown in inventory would therefore require it to commit to a path of output. Further, this path would involve bigger cuts today than in the future in order to cause a temporal imbalance involving an increase in future supply relative to current supply.

But it is unlikely that this commitment could be credible, precisely because of the reason that OPEC gives for fretting about inventories: that they constrain its pricing power. Assume that inventories do drop substantially. According to its own logic, OPEC would feel less constrained about cutting output even further because non-OPEC supplies (in the form of stocks) have declined. Thus, if inventories indeed fall, OPEC’s logic implies that it would cut output further in the future.

But this path is inconsistent with the path that would be necessary to induce the inventory decline in the first place. Indeed, market participants, looking forward to what OPEC would do in the event that stocks were to decline substantially, would choose to hold on to inventories rather than consume them. Meaning that OPEC would fail in its objective of reducing stocks. In the game between OPEC and other market participants, OPEC’s own rhetoric about inventories and supply/demand balance severely undercuts its ability to cause others to consume inventories rather than continue to hold them.

In sum, OPEC is likely to have little if any ability to influence inventories. To influence inventories, it would have to commit to an output path, but that commitment is not subgame perfect/time consistent.

Instead, inventories will be driven by factors outside of OPEC’s control, namely, unexpected transitory changes in supply and demand. But the effect of even those shocks will depend on how market participants believe OPEC will behave when inventories are low. The supply changes will mainly result from shocks to non-OPEC producers (e.g., US shale producers) and to politically unstable OPEC nations like Libya, Nigeria, and Venezuela. Inventory changes may also result from information about the durability of output cut agreements and cheating: a surprise increase in the estimates of future cheating would tend to cause inventories to decline today. Thus, perversely from OPEC’s perspective, its wish of lower inventories may come true only when it is widely believed that OPEC output discipline will soon collapse.

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May 8, 2017

Whatever Igor Wants, Igor Gets: Primitive Capital Accumulation, a la Sechin

Filed under: Economics,Energy,Politics,Russia — The Professor @ 7:34 pm

Apparently winning the “auction” for Bashneft (after it was widely claimed by Putin, and others, that a sale of the company to Rosneft would be a sham privatization) wasn’t enough for Igor Sechin. Igor is now after MOAR, and is using the “legal” process to get it. Rosneft has filed suit against the former owner of Bashneft, Vladimir Evtushenkov’s holding company Sistema, and is asking for a cool $1.9 billion. News of the suit knocked almost 40 percent off of Sistema’s stock price.

The grounds of the lawsuit are unclear.

In the past Sechin has complained about a sale of a Bashneft asset, oil services company Targin, to Sistema at an allegedly knock-down price. He has also criticized contracts between Targin and Bashneft entered into after the sale as unduly favorable to Sistema.

Both of these allegations are plausible. This is Russia, after all, and related-party transactions and Credit Mobilier-like contracting scams are classic ways of tunneling assets.

Recently Rosneft has had to spend $100 million to address safety problems at Bashneft refineries. Rosneft claims that it has found “irregularities.”

If commercial and legal logic mattered (a big if, I know), the alleged shenanigans involving Targin would not be grounds for a suit, and it would be hard to imagine how Rosneft would have standing. Recall that Bashneft was seized by the state in 2014, and Rosneft bought it from the government. So any uneconomic transactions in 2014 or earlier would not harm Rosneft: it would have known that Targin was not included, and what the contracts were. So Rosneft was not harmed by what happened before the company was nationalized.

Failure to detect “irregularities” at the refineries would suggest a lack of due diligence if these were not discovered prior to buying from the state, or if they were known, they would have been reflected in the price. Again, it is hard to see how Rosneft could have been defrauded. Further, there’s a big difference between a $100 million repair bill and a $1.9 billion legal claim.

But does it matter, really? Any legal claim is almost surely a pretext to expropriate a politically vulnerable oligarch who is, shall we say, Без крыши. And this strategy is in Rosneft’s DNA. After all, the company was built primarily on the assets seized from Yukos, and another big asset–TNK-BP–was obtained only after a campaign of pressure against BP (although the Russian AAR consortium held their own and were paid in cash). Put differently, Rosneft was built by  what Marxists called primitive capital accumulation–force and fraud, sometimes operating under the color of legal authority.

But there is a price to be paid for this. It shows that Russia remains a fraught place for investors with assets that come under the covetous eyes of Sechin, or others like him. This depresses valuations for Russian companies, and is a serious drag on investment. No wonder year in and year out Russia is notable for the small share of investment, which runs about 18 percent of GDP, very low for a country in its stage of development. (The world rate is about 24 percent.)

But whatever Igor wants, Igor gets, evidently. Even though what’s good for Igor isn’t good for Russia.

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April 21, 2017

The Left Loses Its Mind (Again!) Over Citgo and Trump

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 5:23 pm

Donald Trump is the left’s Theory of Everything. To be more precise, it is the left’s Theory of Everything Bad.

Latest (nut) case in point: Rachel Maddow is blaming Trump for the riots in Venezuela. No-really!

The theory: the Federal Election Commission revealed that Citgo, a US subsidiary of Venezuela’s national oil company/basketcase PDVSA had donated $500,000 to Trump’s inauguration. According to Maddow, this sent Venezuela’s citizenry, which is reeling under an economic catastrophe wrought by Chavez, Maduro, and “Bolivarian Socialism”–a cause that the left from Bernie Sanders to Danny Glover to many others has swooned over for years–into paroxysms of rage at the thought that their national patrimony was paying to honor the evil Trump.

To start with, there have been violent protests in Venezuela for years. The country is facing economic collapse. PDVSA has been looted by the Chavistas for going on 15 years now, and is a complete wreck. $500K is chump change compared to what the leftist darlings have stolen from the company, or destroyed through their grotesque mismanagement–would that the left shown equal concern over THAT. The country is on the verge of hyperinflation. There are food lines. There is no toilet paper–unless you count the currency the Venezuelan central bank is cranking out like nobody’s business. I could go on and on.

So no, Rachel. The Citgo contribution to the inaugural fund–which represents less than .5 percent of the total raised–is not even a piece of dust on the straw on the camels back: the camel’s back was broken long ago, by the vanguard of socialism that Rachel Maddow and her crowd lionized for years. The rage of the Venezuelan people is directed precisely where it should be: at Maduro, the Bolivarian revolution, and the dirt-napping Chavez.

Maddow’s attempt to lay Venezuela’s social explosion at Trump’s feet is very revealing. She and her ilk think that everything is about us–the US that is. Everything. And now in the minds of her and her ilk, everything in the US is all about Trump. So everything everywhere is all about Trump, and supposedly everyone in the world is as obsessed with Trump as they are, and blame him for all that is bad in the world, like they do.

This is clinical solipsism, broadcast live on MSNBC and CNN daily.

And in fact, Rachel should be ecstatic at Citgo’s donation. The company wasn’t spending the money of the Venezuelan people–it was spending Igor Sechin’s money! Rosneft brilliantly–brilliantly I say!–lent PDVSA $5 billion, and negotiated a 50 percent stake in Citgo as partial security. (Rosneft’s brilliance is only surpassed by the Chinese, who lent Venezuela $55 billion. Hahahaha. Good luck collecting on that one Xi! Well played.) Given PDVSA’s parlous condition, it is highly likely that Rosneft will get control of Citgo, meaning that every dollar it spends now is a dollar less in Igor’s pocket.

So the left should be happy! Trump has picked Russia’s pocket!

But no, they are also obsessing about the possibility that Rosneft will get control of Citgo’s US refineries (which represent a whopping ~2.5 percent of US refining capacity) and its gas stations (who cares?). The refineries ain’t going anywhere, so the impact on the US market will be nil. Anything Rosneft would do in operating these refineries that could hurt the US would hurt Rosneft even more. So don’t count on it happening, and if it does, it would be another own goal that weakens Russia.

Again, the left should be experiencing schadenfreude, not panic. Rosneft lent large money to a deadbeat. It’s not going to get paid back so it is seizing assets, and will end up losing money. Playing repo man is hardly the road to riches. It just mitigates the losses from making a bad loan, and it is the bad loan that is the real story here.

But to figure that out would require actual thinking, which is not exactly the strong point of Rachel, et al. Because they have everything figured out. Trump did it! And if Trump is connected, it’s bad!

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March 11, 2017

One Degree of Idiocy: Michael Weiss Expounds on Trump-Putin Connections

Filed under: Energy,Politics,Russia — The Professor @ 9:59 pm

Some years ago, “Six Degrees of Kevin Bacon” was somewhat popular. The object of the game was to connect any randomly chosen actor to Kevin Bacon in six movies or less.

Today, the game that is all the range in DC and the media is Six Degrees of Donald Trump. The main difference is that the starting point is not any randomly chosen individual, but one very specific individual: Vladimir Putin.

Not surprisingly, the most  demented and absurd entry in this game was submitted by Michael Weiss of the Daily Beast. Here’s how it goes. Putin is connected to Gazprom. Gazprom was a participant in a consortium (which also included European energy giants Shell, ENGIE, Winterhall, OMV, and Uniper) to build the Nordstream 2 pipeline. This consortium hired McClarty Associates as a lobbyist. McClarty employs ex-US diplomat Richard Burt. Burt made suggestions about Russia policy that a third party passed on to Trump. As a bonus connection, Burt attended two dinners hosted by Jeff Sessions, and wrote white papers for him.

Burt has never met Trump. Like many in the foreign policy establishment, Burt advocates a pragmatic approach to Russia. He was engaged in diplomacy with the USSR while in the Reagan administration (hardly a hotbed of commsymps and Russophiles), and shockingly, has continued to do business in Russia in the past 30 years. But apparently under the Oceania Has Always Been at War With Eastasia mindset that dominates DC at present, this is tantamount to Burt being a Russian puppet (a view that requires the consignment of most of the history of that period, not least of all that of the Obama administration 2009-2014, to the Memory Hole).

As far as connections are concerned, this is about as tenuous as one can get. The headline (“The Kremlin’s Gas Company Has a Man in Trumpland”) is a vast overstatement. For one thing, Burt is barely in Trumpland. Indeed, although the article says that the connection offers “Republican bona fides,” it is almost certain that was not the reason for hiring McClarty. Astoundingly, the article fails to note that said McClarty himself is a Clintonoid: Mack McClarty is from an old-time Arkansas political family, was closely connected to Bill Clinton in Arkansas, and was Clinton’s first chief of staff. Weiss ominously starts his piece with a recounting of the importance of having a krysha (“roof”, i.e., political protection) and insinuates that hiring Burt was intended to obtain a roof in the Trump administration. But if anything, it would have been an entree into a Clinton administration–which, of course, everybody figured was an inevitability.

Furthermore, perhaps Weiss hasn’t noticed, but “Republican bona fides” are hardly a ticket into Trumpland. Trump’s relationship with the party establishment varies between the hostile and the transactional.

And the timing is all wrong: the contract was signed before Trump was even the Republican nominee, and at a time when no one figured he would be the party’s candidate, let alone president. Talk about a deep out-of-the-money option.

It’s also rather bizarre that the connection between Burt and Gazprom also involves several very large European companies, and a purely European issue. There is nary an American company involved, and the matter is an intramural European spat pitting eastern vs. western EU countries. Wouldn’t you think that if you are trying to buy influence in the United States, you’d engage McClarty/Burt on an issue that would allow them to interact with US officials and politicians?

Further, if you are going to buy a krysha in the Trump administration, dontcha think you’d want to hire somebody who, you know, actually knows Trump?

But our Mikey is not deterred by such pesky details. He has a connection between Putin and Trump, and he is going to flog it for all it’s worth. Which isn’t much.

Of course the details of the Burt-Trump (non-) connection alone wouldn’t make for much of an article, especially for Weiss, who typically drones on paragraph after endless paragraph. So he adds gratuitous ad hominem attacks on Burt, such as comparing him to the late Russian UN ambassador Vitaly Churkin (career diplomats are a type–who knew?), and trotting out Bill Browder, who snarked about how gauche the Russian influence efforts were back in the bad old days (you know, when he was on the make in Russia) and yet again drags out the corpse of his lawyer, Sergei Magnitsky, in order to score political points.

Weiss also notes that McClarty has been retained by a Mikhail Fridman company in the UK, but fails to point out that Fridman is hardly a Putin pet. Indeed, Fridman took on Sechin, and came out the winner. But in Weiss’ worldview–which makes that of a 1950s John Bircher look nuanced by comparison–all them Russkies are Putin pawns.

And the anti-Trump establishment should at least get its story straight. On the same day that Weiss’ article appeared, Foreign Policy ran a piece claiming that Tillerson is a weak Secretary of State (the weakest ever, in fact!) because he doesn’t have Trump’s ear. So Trump ignores his own Secretary of State but somehow a guy whom he has never met and who has no position in the administration exerts some great influence over him? And weren’t we told a month ago that Tillerson was going to be Putin’s cat’s paw in the Trump administration because of his extensive dealings there (including with Gazprom in Sakhalin I)? But now he’s a nobody? Damn, that Memory Hole is getting a helluva workout.

Indeed, if the Burt connection (such as it is) and the like are the best that these people can come up with, they are doing a great job of showing how limited and tenuous Trump’s ties to Russia are. And remember the whole point of the Kevin Bacon game: it was a cutesy way of illustrating the “six degrees of association” theory, which posits that any two people in the world are separated by no more than six acquaintances. Any two people, no matter how obscure. Play Six Degrees of Vladimir Putin using yourself as the terminal connection: I bet you could connect with Vlad in six steps or less. I know I can. And does make me some sort of Putinoid? Hardly, as anyone who has read this blog knows.

When major international figures are involved, moreover, there are inevitably multiple such connections, often involving less than six steps. So finding a connection is about as earth shattering as finding sand on a beach. Furthermore, when considering a figure like Trump, he has myriad connections to other figures, many of whom may have interests and views contrary to Putin’s/Russia’s, or orthogonal thereto. Ignoring all these other contrary connections and focusing monomaniacally on ties to Putin and Russia when attempting to predict or explain Trump’s motivations is beyond asinine. In econometrics, this is called omitted variable bias–if you omit relevant variables, you get a very biased estimate of the influence of the ones you include.

But this is what passes for journalism in the United States right now: parlor games posing as deep analysis, latent with dark meanings.

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March 10, 2017

US Shale Puts the Saudis and OPEC in Zugzwang

Filed under: Commodities,Derivatives,Economics,Energy,Politics — The Professor @ 2:55 pm

This was CERA Week in Houston, and the Saudis and OPEC provided the comedic entertainment for the assembled oil industry luminaries.

It is quite evident that the speed and intensity of the U-turn in US oil production has unsettled the Saudis, and they don’t know quite what to do about it. So they were left with making empty threats.

My favorite was when Saudi Energy Minister Khalid al-Falih said there would be no “free rides” for US shale producers (and non-OPEC producers generally). Further, he said OPEC “will not bear the burden of free riders,” and “[w]e can’t do what we did in the ’80s and ’90s by swinging millions of barrels in response to market condition.”

Um, what is OPEC going to do about US free riders? Bomb the Permian? If it cuts output, and prices rise as a result, US E&P activity will pick up, and damn quick. The resulting replacement of a good deal of the OPEC output cut will limit the price impact thereof. The best place to be is outside a cartel that cuts output: you can get the benefit of the higher prices, and produce to the max. That’s what is happening in the US right now. OPEC has no credible way of showing off, or threatening to show off, free riders.

As for not doing what they did in the ’80s, well that’s exactly OPEC’s problem. It’s not the ’80s anymore. Now if it tries to “swing millions of barrels” to raise price, there is a fairly elastic and rapidly responding source of supply that can replace a large fraction of those barrels, thereby limiting the price impact of the OPEC swingers, baby.

Falih’s advisers were also trying to scare the US producers. Or something:

“One of the advisors said that OPEC would not take the hit for the rise in U.S. shale production,” a U.S. executive who was at the meeting told Reuters. “He said we and other shale producers should not automatically assume OPEC will extend the cuts.”

Presumably they are threatening a return to their predatory pricing strategy (euphemistically referred to as “defending market share”) that worked out so well for them the last time. Or perhaps it is just a concession that US supply is so elastic that it makes the demand for OPEC oil so elastic that output cuts are a losing proposition and will not endure. Either way, it means that OPEC is coming to the realization that continuing output cuts are unlikely to work. Meaning they won’t happen.

OPEC also floated cooperation with US producers on output. Mr. al-Falih, meet Senator Sherman! And if the antitrust laws didn’t make US participation in an agreement a non-starter, it would be almost impossible to cartelize the US industry given the largely free entry into E&P and the fungibility of technology, human capital, land, services, and labor. Maybe OPEC should hold talks with the Texas Railroad Commission instead.

Finally, in another laugh riot, OPEC canoodled with hedge funds. Apparently under the delusion that financial players play a material role in setting the price of physical barrels, rather than the price of risk. Disabling speculation could materially help OPEC only by raising the cost of hedging, which would tend to raise the costs of E&P firms, especially the more financially stretched ones. (Along these lines, I would argue that the big increase in net long speculative positions in recent months is not due to speculators pushing themselves into the market, but instead they have been pulled into the market by increased hedging activity that has occurred due to the increase in drilling activity in the US.)

Oil prices were down hard this week, from a $53 handle to a (at the time of this writing) $49.50 price. The first down-leg was due to the surprise spike in US inventories, but the continued weakness could well reflect the OPEC and Saudi messaging at CERA Week. The pathetic performance signaled deep strategic weakness, and suggests that the Saudis et al realize they are in zugzwang: regardless of what they do with regards to output, they are going to regret doing it.

My heart bleeds. Bleeds, I tells ya!

 

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March 3, 2017

The Rocks Didn’t Go Anywhere. Go Figure.

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 2:58 pm

The conventional wisdom during the oil price collapse that started in mid-2014 and which accelerated starting in November of that year when the Saudis decided not to cut output was that the Kingdom was engaged in a predatory pricing strategy intended to drive out US shale producers. I mocked this in real time. Nothing really special about that analysis: economists have known for a long time that predatory strategies are almost never rational. They are irrational because the predator has to incur losses to cause its competitors to reduce production, but the competitors’ resources are unlikely to leave the industry permanently: they can come flooding back in when the predator attempts to restrict output to raise prices. Thus, the predator suffers all the pain at selling at low prices, but cannot recoup these losses by selling at higher prices later.

In the case of shale, the rocks weren’t going anywhere. Obviously. When prices fell, companies just drilled fewer wells–a lot fewer wells–but the rocks remained. The knowledge of where the right rocks were remained too. The knowledge of how to drill the rocks didn’t disappear. Idled rigs went into storage. Yes, some labor (including some skilled labor left), but this resource is pretty flexible and can come back quickly when demand goes up. E&P companies incurred financial losses, and some experienced financial distress and even bankruptcy, but this did not drive them out of the industry permanently, and did not drive out the human and physical capital that these firms employed. New capital required to drill new wells is available to E&P firms based on future prospects, not past failures. Indeed, one of the functions of bankruptcy and restructuring of distressed firms is to clean up balance sheets so that old debt doesn’t impede the ability of firms to take on positive NPV projects.

In sum, even though drilling activity plummeted along with prices, the resources needed to ramp up production weren’t destroyed or driven out of the industry. They were only waiting for more favorable prices. The industry went into hibernation: it didn’t die.

OPEC’s decision to cut output to raise prices–and the Saudis going beyond their share of output cuts to strengthen OPEC’s effect–provided the opportunity the industry had been waiting for. It rapidly awoke from its slumbers. Rig counts did a U-turn, up 90 percent in 9 months. And so has output. John Kemp reports:

U.S. crude oil production appears to be rising strongly thanks to increased shale drilling as well as rising offshore output from the Gulf of Mexico.

Production averaged almost 9 million barrels per day (bpd) in the four weeks to Feb. 24, according to the latest weekly estimates published by the Energy Information Administration.

Production has been on an upward trend since hitting a cyclical low of 8.5 million bpd in September (“Weekly Petroleum Status Report”, EIA, March 1).

Javier Blas chimes in:

“North American oil companies are going to increase their spending by 25 percent in 2017 compared to last year,” said Daniel Yergin, the oil historian-cum-consultant who hosts the CERAWeek. “The increase reflects the magnetism of U.S. shale.”

U.S. benchmark West Texas Intermediate traded at $52.79 a barrel on Friday. Futures bounced between $51.22 and $54.94 in February.

So far this year, U.S. energy companies have raised $10.5 billion in fresh equity, with shale and oil service groups drawing the most investment, the best start of the year since at least 1999 and equal to a third of what the sector raised in the whole of 2015. [A clear indication that “debt overhang” is not constraining the ability to access capital to fund drilling programs, which would have been the only way the Saudi strategy had a prayer of working.]

In Midland, the Texas city at the center of the Permian basin, the activity rush is palpable, as is the threat of higher costs for shale companies. The county’s active-rig total ranks second in the U.S., behind only Reeves County further to the west.

“You could see the town’s energy is back,” said Alan Means, founder of Cambrian Management Ltd., a Midland-based firm that operates more than 200 oil wells in the Permian across Texas and New Mexico. “The rigs are up again, the fracking crews are busier and the highway traffic is increasing.”

As activity rises, the man-camps in the town outskirts are flush again, with workers arriving from the Bakken in Montana and North Dakota, and from as far way as Canada. The 1,000-bed Permian Lodging camp is now 100 percent full, up from 65 percent in July, according to camp owner Ralph McIngvale. [See how quickly labor resources can return?]

Shale firms have also become more efficient.

In sum, the predatory strategy hasn’t made shale go away. Now, the longer the Saudis and the rest of OPEC (and the non-OPEC countries that have joined in) hold down output, the larger the fraction of that output loss will be redeemed by resurgent shale production in the US.

In other words, shale makes the the demand for OPEC (and non-OPEC cooperators’) oil pretty elastic. This raises serious questions about the rationality of the output cuts from the perspective of the cutters, especially the big countries like Saudi Arabia (which has cut substantially–more than it promised) and Russia (whose cooperation is more equivocal). This, in turn, makes the durability of the cuts problematic.

The quick turnaround in US shale provides a new data point for the Saudis, Russians, et al. Their dreams that they could make rocks disappear–or that they could make it permanently unattractive to extract oil from their rocks–have proved chimerical. Persisting in output cuts will become progressively less profitable, and indeed, is likely to be downright unprofitable soon. What’s the over-under on how long until they figure that rocks will outlast them, and give up the output cut game?

Teaser: I am currently slogging through oil well data (tens of thousands of wells in all the major basins) in a study of the sources of productivity gains in shale production. Hopefully I will be able to report some results soon. Initial results are particularly ominous for OPEC. I am finding evidence of learning-by-doing in both oil and gas. That is, drilling wells today generates knowledge that enhances future productivity and lowers future costs. This means that the increased shale output resulting from OPEC’s current attempt to prop up prices will increase the US shale industry’s future productivity, making it even harder for OPEC to keep prices high months or years from now.

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March 1, 2017

Ivan Glasenberg: Mistaking Luck for Genius?

Filed under: China,Commodities,Economics,Energy — The Professor @ 8:58 pm

Glencore is back from the brink, posting a $1.4 billion profit for 2016. When I first read about the 2016 results, I wondered aloud to a friend whether Ivan Glasenberg would have learned something from the company’s near death experience, or instead would consider the fall someone else’s fault, and the resurrection the result of his genius. I should have known it would be the latter.

Glasenberg has been gloating about the 2016 results, and flaunting them as some sort of vindication. He is openly musing about paying a $20 billion dividend to the company’s “long suffering shareholders,” and is looking for acquisitions, including in North American grain trading.

The fact is that Glencore and Ivan Glasenberg were (and are) just along for a ride on the commodity price roller coaster, which is located at a Chinese amusement park. When the roller coaster plunged as the Chinese economy shuddered in 2015, Glencore plunged along with it. Now, in large part due to Chinese policy moves that have caused the prices of coal and other raw materials to climb again, Glencore has rebounded. Management genius had nothing to do with it.

Well, that’s not completely true. Glasenberg made the conscious choice to transform Glencore from a trading firm that was basically flat price neutral to a mining firm with a big exposure to the flat prices of coal and copper in particular. So the big drop and the rebound are the result of his choice.

When Glencore was in peril in 2015, I said that its fate was dependent on commodity prices, and hence on Chinese policy, rather than any decision that management can make. I said that Glencore was along for the ride. That turned out to be true. It remains true going forward. That was the fundamental strategic choice that has shaped and will continue to shape its performance. Management can at best optimize performance over the cycle, but the cycle will dominate.

Prior to 2015, Glencore management did not optimize. The firm was over-leveraged: it continued to operate with trading-firm like leverage levels even though it faced bigger commodity price risks. Glasenberg/Glencore have cut down on debt in the past year, and this reduces the likelihood of a repeat of 2015–if they stick to a lower leverage policy going forward. But the fact is that the biggest driver of Glencore’s fate is not decisions made in Baar, but the whims of policymakers in Beijing.

It is interesting to compare Glasenberg’s crowing to the more muted tones of other mining firms which have also profited from the rebound. The managements of these other firms apparently realize that what the cycle giveth, the cycle can taketh away. Is Peabody Coal’s management preening over the company’s rebound? No. They are silently grateful that factors outside of their control have turned their way. Similarly, Noble eked out a profit, but its management isn’t breaking their arms patting themselves on the back.

Traders typically make deals of relatively short duration, and it is possible to evaluate trading decisions and trading acumen based on P/L. But by transforming Glencore into a mining company with a  supersized trading arm, Glasenberg purposefully made a very long term trade with a duration of years (decades, even): quarterly or even annual fluctuations in P/L tell you little about the wisdom of such a trade. It is therefore rather disturbing to watch Glasenberg gloat on the basis of a profitable year driven by a cyclical turn with which he had exactly zero to do with.

And let’s put this in perspective. Glencore lost $5 billion in 2015. 2016 made up less than 30 percent of that loss. There is still a long way to go to determine whether the big, multi-year trade that Glencore made a few years ago was a smart play or not.

Perhaps Glasenberg still has a trader’s mindset, and a trader’s time horizon, suited for a transaction cycle measured in weeks or months, not years or decades. If so, the company might be in for a big future fall, because its guiding light is apt to mistake luck for skill.

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