Streetwise Professor

February 20, 2017

Trolling Brent

Filed under: Commodities,Derivatives,Economics,Energy,Regulation — The Professor @ 10:14 am

Platts has announced the first major change in the Brent crude assessment process in a decade, adding Troll crude to the “Brent” stream:

A decline in supply from North Sea fields has led to concerns that physical volumes could become too thin and hence at times could be accumulated in the hands of just a few players, making the benchmark vulnerable to manipulation.

Platts said on Monday it would add Norway’s Troll crude to the four British and Norwegian crudes it already uses to assess dated Brent from Jan 1. 2018. This will join Brent, Forties, Oseberg and Ekofisk, or BFOE as they are known.

This is likely a stopgap measure, and Platts is considering more radical moves in the future:

It is also investigating a more radical plan to account for a possible larger drop-off in North Sea output over the next decade that would allow oil delivered from as far afield as west Africa and Central Asia to contribute to setting North Sea prices.

But the move is controversial, as this from the FT article shows:

If this is not addressed first, one source at a big North Sea trader said, the introduction of another grade to BFOE could make “an assessment that is unhedgeable, hence not fit for purpose”. “We don’t see any urgency to add grades today,” he added. Changes to Brent shifts the balance of power in North Sea trading. The addition of Troll makes Statoil the biggest contributor of supplies to the grades supporting Brent, overtaking Shell. Some big North Sea traders had expressed concern Statoil would have an advantage in understanding the balance of supply and demand in the region as it sends a large amount of Troll crude to its Mongstad refinery, Norway’s largest.

The statement about “an assessment that is unhedgeable, hence not fit for purpose” is BS, and exactly the kind of thing one always hears when contracts are redesigned. The fact is that contract redesigns have distributive effects, even if they improve a contract’s functioning, and the losers always whinge. Part of the distributive effect relates to issues like giving a company like Statoil an edge . . . that previously Shell and the other big North Sea producers had. But part of the distributive effect is that a contract with inadequate deliverable supply is a playground for big traders, who can more easily corner, squeeze, and hug such a contract.

Insofar as hedging is concerned, the main issue is how well the Brent contract performs as a hedge (and a pricing benchmark) for out-of-position (i.e., non-North Sea) crude, which represents the main use of Brent paper trades. Reducing deliverable supply constraints which contribute to pricing anomalies (and notably, anomalous moves in the basis) unambiguously improves the functioning of the contract for out-of-position players. Yeah, those hedging BFOE get slightly worse hedging performance, but that is a trivial consideration given that the very reason for changing the benchmark is the decline in BFOE production–which now represents less than 1 percent of world output. Why should the hair on the end of the tail wag the dog?

Insofar as the competition with WTI is concerned, the combination of larger US supplies, the construction of pipelines to move supplies from the Midcon (PADDII) to the Gulf (PADDIII)  and the lifting of the export ban have restored and in fact strengthened the connection of WTI prices to seaborne crude prices. US barrels are now going to both Europe and Asia, and US crude has effectively become the marginal barrel in most major markets, meaning that it is determining price and that WTI is an effective hedge (especially for the lighter grades). And by the way, the WTI delivery mechanism is much more robust and transparent than the baroque (and at times broken) Brent pricing mechanism.

As if to add an exclamation point to the story, Bloomberg reports that in recent months Shell has been bigfooting–or would that be trolling?–the market with big trades that have arguably distorted spreads. It got to the point that even firms like Vitol (which are notoriously loath to call foul, lest someone point fingers at them) raised the issue with Shell:

While none of those interviewed said Shell did anything illegal, they said the company violated the unspoken rules governing the market, which is lightly regulated. Executives of several trading rivals, including Vitol Group BV, the world’s top independent oil merchant, raised objections with counterparts at Shell last year, according to market participants.

What are the odds that Mr. Fit for Purpose is a Shell trader?

All of this is as I predicted, almost six years ago, when everyone was shoveling dirt on WTI and declaring Brent the Benchmark of the Forever Future:

Which means that those who are crowing about Brent today, and heaping scorn on WTI, will be begging for WTI’s problems in a few years.  For by then, WTI’s issues will be fixed, and it will be sitting astride a robust flow of oil tightly interconnected with the nexus of world oil trading.  But the Brent contract will be an inverted paper pyramid, resting on a thinner and thinner point of crude production.  There will be gains from trade–large ones–from redesigning the contract, but the difficulties of negotiating an agreement among numerous big players will prove nigh on to impossible to surmount.  Moreover, there will be no single regulator in a single jurisdiction that can bang heads together (for yes, that is needed sometimes) and cajole the parties toward agreement.

So Brent boosters, enjoy your laugh while it lasts.  It won’t last long, and remember, he who laughs last laughs best.

That’s exactly how things have worked out, even down to the point about the difficulties of getting the big boys to play together (a lesson gained through extensive personal experience, some of which is detailed in the post). Just call me Craignac the Magnificent. At least when it comes to commodity contract design 😉

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February 15, 2017

Never Argue From a Price Change, Oil Market Edition

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 9:19 pm

In the FT, Greg Meyer ponders a puzzle: “A mystery is confounding the US oil market: when inventories rise, prices rise, too.”

Yes, it is normally the case that inventories and prices, and inventories and the spot-deferred spread, move in opposite directions. But this does not have to be the case.

The typical case is based on the following economic logic. Inventories respond mainly to current, and temporary, supply and demand shocks. If current demand falls, and this demand shock is anticipated to be temporary, then current availability rises relative to expected future availability. The efficient way to respond to this is to store more today because the commodity is abundant today relative to what is expected in the future, and efficient allocations move resources from where they are relatively abundant to where they are relatively scarce. Storage increases expected future availability, which depresses expected future prices. The nearby price must fall relative to the expected future price in order to encourage storage, and together the fall in the expected future price and the fall in the nearby price relative to the expected future price causes the nearby price to fall.

A similar story holds with respect to a temporary increase in current supply.

Parenthetically, the temporary nature of the shock is important in driving the change in storage because this causes a change in relative availability that is necessary to make it optimal to store more. A shock that is anticipated to persist does not change current availability relative to expected future availability, so there is no benefit to shifting resources through time via storage. A persistent shock causes a parallel shift (roughly) in the forward curve, and no change in storage. In my academic research, I show that in a dynamic storage model supply/demand shocks with a very short half-life (on the order of 30 days) drive storage behavior, and that very persistent shocks drive the overall level of prices.

But there are other kinds of shocks. One kind of shock is to anticipated future demand or supply. Let’s say supply is expected to decline in the future. This increase in expected future scarcity can be mitigated by storing more today (i.e., reducing current consumption). This spreads the effect of the anticipated future supply loss over time, and thereby smooths consumption in an efficient way. The only way to reduce current consumption in order to increase inventories is to increase the spot price. So in this scenario, (a) inventories and prices move in the same direction, and (b) inventories and calendar spread (deferred minus nearby) move in opposite directions in order to reward the higher amount of storage.

Here’s a real world example. The Energy Policy Act of 2005 mandated increased use of renewable fuels–notably ethanol–in future years. This caused an increase in anticipated future demand for corn used to produce ethanol. When the act was passed, the supply of corn was basically fixed. One way of responding to the expected increase in future corn demand was to store more immediately (thereby carrying current supplies into the future when demand was going to be higher). Given the fixed supply, the only way to achieve this higher storage (and hence reduced current consumption) was for prices to rise.

Therefore, one explanation for the positive co-movement between prices and inventories is a shock to the expected future supply/demand balance. For example, an increased likelihood that OPEC will extend its supply cuts beyond April could produce this result.

Another kind of shock that can lead to a positive co-movement between spot prices and inventories is a shock to supply/demand volatility: I discussed this in an early blog post, and later analyzed this formally in my 2011 book. (A good example of the synergy between blogging and rigorous research, BTW.)

The intuition is this. Inventories are a way of insuring against uncertainty: putting something aside for a rainy day, as it were. If fundamental economic uncertainty goes up, it is efficient to hold more inventory. Since supply is fixed in the short run, the only way to increase inventory is to reduce current consumption. The only way to increase current consumption is for spot prices to rise. Moreover, to compensate increased inventory holding, futures prices must rise relative to spot prices. Therefore, for this kind of shock (like a shock to future demand) the forward curve rises and becomes steeper (i.e., increased contango).

So although the positive co-movement between spot prices and inventory may be unusual, it can occur in a rational, efficient market. It depends on the underlying driving shock. The typical case occurs when shocks to current supply/demand dominate. The more unusual case occurs when the shocks are to expected future supply and demand, or to fundamental volatility.

This relates directly to something I mentioned in the “kill the economists” post yesterday. Specifically: never argue from a price change. It is necessary to understand what is causing the price change. When there are multiple shocks that can affect prices (e.g., supply and demand shocks; current or future shocks; shocks to supply/demand volatility as well as to the level of supply/demand), just looking at the pice movement is not sufficient to draw conclusions about either its effect, or its cause. Indeed, it is even misleading to talk about the “effect” of the price change, because the price change is itself the endogenous effect of underlying causes/shocks.

The usual way to sort out what is going on is to look at quantities as well as prices. For instance, in a simple supply-demand model if you see prices go down, that could be because supply rose or demand fell. You can figure out which only by observing quantity: if you see quantity fall, for instance, you know that a demand decline caused the movements.

This means that the recent co-movements in oil inventories and prices reflects market participants’ assessment that the supply/demand balance is expected to tighten in the future, or that fundamental uncertainty is going up, or both.

 

 

 

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February 4, 2017

The Regulatory Road to Hell

One of the most encouraging aspects of the new administration is its apparent commitment to rollback a good deal of regulation. Pretty much the entire gamut of regulation is under examination, and even Trump’s nominee for the Supreme Court, Neil Gorsuch, represents a threat to the administrative state due to his criticism of Chevron Deference (under which federal courts are loath to question the substance of regulations issued by US agencies).

The coverage of the impending regulatory rollback is less that informative, however. Virtually every story about a regulation under threat frames the issue around the regulation’s intent. The Fiduciary Rule “requires financial advisers to act in the best interests of their clients.” The Stream Protection Rule prevents companies from “dumping mining waste into streams and waterways.” The SEC rule on reporting of payments to foreign governments by energy and minerals firms “aim[s] to address the ‘resource curse,’ in which oil and mineral wealth in resource-rich countries flows to government officials and the upper classes, rather than to low-income people.” Dodd-Frank is intended prevent another financial crisis. And on and on.

Who could be against any of these things, right? This sort of framing therefore makes those questioning the regulations out to be ogres, or worse, favoring financial skullduggery, rampant pollution, bribery and corruption, and reckless behavior that threatens the entire economy.

But as the old saying goes, the road to hell is paved with good intentions, and that is definitely true of regulation. Regulations often have unintended consequences–many of which are directly contrary to the stated intent. Furthermore, regulations entail costs as well as benefits, and just focusing on the benefits gives a completely warped understanding of the desirability of a regulation.

Take Frankendodd. It is bursting with unintended consequences. Most notably, quite predictably (and predicted here, early and often) the huge increase in regulatory overhead actually favors consolidation in the financial sector, and reinforces the TBTF problem. It also has been devastating to smaller community banks.

DFA also works at cross purposes. Consider the interaction between the leverage ratio, which is intended to insure that banks are sufficiently capitalized, and the clearing mandate, which is intended to reduce systemic risk arising from the derivatives markets. The interpretation of the leverage ratio (notably, treating customer margins held by FCMs as an FCM asset which increases the amount of capital it must hold due to the leverage ratio) makes offering clearing services more expensive. This is exacerbating the marked consolidation among FCMs, which is contrary to the stated purpose of Dodd-Frank. Moreover, it means that some customers will not be able to find clearing firms, or will find using derivatives to manage risk prohibitively expensive. This undermines the ability of the derivatives markets to allocate risk efficiently.

Therefore, to describe regulations by their intentions, rather than their effects, is highly misleading. Many of the effects are unintended, and directly contrary to the explicit intent.

One of the effects of regulation is that they impose costs, both direct and indirect.  A realistic appraisal of regulation requires a thorough evaluation of both benefits and costs. Such evaluations are almost completely lacking in the media coverage, except to cite some industry source complaining about the cost burden. But in the context of most articles, this comes off as special pleading, and therefore suspect.

Unfortunately, much cost benefit analysis–especially that carried out by the regulatory agencies themselves–is a bad joke. Indeed, since the agencies in question often have an institutional or ideological interest in their regulations, their “analyses” should be treated as a form of special pleading of little more reliability than the complaints of the regulated. The proposed position limits regulation provides one good example of this. Costs are defined extremely narrowly, benefits very broadly. Indirect impacts are almost completely ignored.

As another example, Tyler Cowen takes a look into the risible cost benefit analysis behind the Stream Protection Rule, and finds it seriously wanting. Even though he is sympathetic to the goals of the regulation, and even to the largely tacit but very real meta-intent (reducing the use of coal in order to advance  the climate change agenda), he is repelled by the shoddiness of the analysis.

Most agency cost benefit analysis is analogous to asking pupils to grade their own work, and gosh darn it, wouldn’t you know, everybody’s an A student!

This is particularly problematic under Chevron Deference, because courts seldom evaluate the substance of the regulations or the regulators’ analyses. There is no real judicial check and balance on regulators.

The metastasizing regulatory and administrative state is a very real threat to economic prosperity and growth, and to individual freedom. The lazy habit of describing regulations and regulators by their intent, rather than their effects, shields them from the skeptical scrutiny that they deserve, and facilitates this dangerous growth. If the Trump administration and Congress proceed with their stated plans to pare back the Obama administration’s myriad and massive regulatory expansion, this intent-focused coverage will be one of the biggest obstacles that they will face.  The media is the regulators’ most reliable paving contractor  for the highway to hell.

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January 25, 2017

Live From Moscow! Rosneft Kabuki!

Filed under: Commodities,Derivatives,Economics,Energy,Russia — The Professor @ 3:31 pm

Today it was announced that Putin will indeed meet with Glencore’s Ivan Glasenberg,  QIA’s Sheikh Abdullah Bin Hamad Al Thani, and  Intesa Sanpaolo SpA Managing Director Carlo Messina. According to Bloomberg,

Putin will talk about “the investment climate, the reliability of Russia for foreign investors and prospects for expanding cooperation,” Peskov said on a conference call. The Kremlin said Jan. 23 that Sechin was keen to underline the significance of the deal with Glencore and Qatar and to outline new projects.

Yes, this is all about portraying the Rosneft stake sale as a normal deal, and as an indication that Russia presents a normal investment climate.

In fact, the deal does nothing of the sort. The bizarreness of what is known, that the curtain of secrecy that prevents so much from being known, show that the deal is highly abnormal by the standards of the US, Europe, Japan, and other major investment regions.

A Russian analyst puts his finger on it: this is PR, not reality:

The deal meant Rosneft avoided buying back the 19.5 percent stake itself. That would have been seen as “Russia’s demise” in the search for investors, according to Ivan Mazalov, a director at Prosperity Capital Management Ltd., which has $3.5 billion under management.

“It was important for Russia to win a PR battle that Russia is open to do business and that investors consider Russia as a good destination for their capital,” Mazalov said by e-mail.

But that’s the thing. We don’t know for sure that Rosneft avoided buying back the 19.5 percent stake. It apparently did not buy all 19.5 percent, but there is the matter of that missing 2.2 billion Euros. Further, who knows how the complex structure of shell companies involved the deal parses out actual economic ownership? And even if Rosneft isn’t putting up money or taking economic exposure to the stake, it’s pretty clear that some Russian entity or entities are.

But the show must go on! This Frankenstein’s monster of a deal must be made to look like the epitome of commercial normalcy: Since henchman Igor (Sechin, that is) is obviously not up to the task, Herr Doktor Putin himself must make an appearance to calm the agitated villagers.  Ivan Glasenberg is no doubt quite happy to play his part, because Glencore apparently made out very well in the deal, due in large part to the offtake agreement that went along with it. And il Signor Messina has stumped up Euros 4.5b, so he is certainly going to chew the scenery.

So who you gonna believe, Putin and his troupe, or your lyin’ eyes?

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January 24, 2017

Rosneft & Glencore & QIA & ???: More Kabuki

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 7:58 pm

Today Reuters ran a long article summarizing all of the holes in the official Russian story about the sale of the Rosneft stake. Nice of them to catch up: there is nothing in the article that wasn’t discussed here, or in RBC reports, from six weeks to two weeks ago.

The main question is who is covering the €2.2 billion hole. My leading candidates: (1) a Russian state bank (likely VTB) providing debt financing, or (2) Rosneft buying its own equity from Rosneftgaz (perhaps using funding from a Russian state bank directly, or indirectly via proceeds from its recent bond sale). One factor in favor of (2) is the web of shell companies involved in the deal: these could be used to conceal the faux nature of the “privatization” and the supposed transfer of foreign money to the budget in an amount equal to the announced purchase price. The money could be used to launder Russian money, making it look like it was coming from a foreign source.

Recall that when it was doubted Rosneft would find a foreign buyer, the fallback plan was to have the firm purchase its shares from Rosneftgaz, and then sell them to a foreign buyer later. Option (2) would be a variant on that.

Regardless, even if the details are not known, it is abundantly clear that the privatization was not the clean, blockbuster deal originally announced. It is a stitched up job intended to obscure the failure to make a straight, uncomplicated sale to foreign buyers.

Interestingly, Rosneft has allegedly paid $40 million in legal fees. (H/T @leenur.) In 2017. That’s about $2 million/day, and if the deal was done in 2016, that’s when the legal expenses would be expected to be incurred. This is consistent with this being very much a work in progress. Or maybe, a work in regress.

But the Kabuki play must go on! Sechin is inviting Putin to meet with Glencore, QIA, and Intesa:

The chief executive of Russia’s biggest oil firm Rosneft on Monday asked President Vladimir Putin to receive the company’s partners Glencore, Intesa and the Qatar Investment Authority (QIA), the Kremlin said.

Trading house Glencore and the QIA recently became Rosneft shareholders in a multi-billion-dollar deal partly funded by Italian bank Intesa.

Rosneft boss Igor Sechin said at a meeting with Putin on Monday that Rosneft was planning new projects with the three partners and they wanted to tell Putin about the prospects for those projects, the Kremlin said in a statement on its website.

This is clearly intended to lend Putin’s authority to the deal (as he already did in his end of year Q&A). Bringing in Putin and the alleged principals for a Sovok PR gimmick is pathetic, and amusing–and amusing because it’s so pathetic!

Any such act will not end the questions. It will just bring attention to the deal, and any attention will only bring the questions to the fore.

Not that we can expect to get any answers from the Russians, or from QIA. But why the UK authorities and the LSE seem so complacent about the participation of a UK/LSE-listed company in such a dodgy deal, with such little disclosure, is beyond me. Glencore may argue that it has disclosed the basics of its involvement, but without knowing about the structure of the entire deal it is evaluate the accuracy of those disclosures, in particular relating to what Glencore’s real economic exposure is. The relevant parties in the UK should be pressing hard for much greater disclosure from Glencore.

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Two Contracts With No Future

Filed under: China,Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 7:14 pm

Over the past couple of days two major futures exchanges have pulled the plug on contracts. I predicted these outcomes when the contracts were first announced, and the reasons I gave turned out to be the reasons given for the decisions.

First, the CME announced that it is suspending trading in its new cocoa contract, due to lack of volume/liquidity. I analyzed that contract here. This is just another example of failed entry by a futures contract. Not really news.

Second, the Shanghai Futures Exchange has quietly shelved plans to launch a China-based oil contract. When it was first mooted, I expressed extreme skepticism, due mainly to China’s overwhelming tendency to intervene in markets sending the wrong signal–wrong from the government’s perspective that is:

Then the crash happened, and China thrashed around looking for scapegoats, and rounded up the usual suspects: Speculators! And it suspected that the CSI 300 Index and CSI 500 Index futures contracts were the speculators’ weapons of mass destruction of choice. So it labeled trades of bigger than 10 (!) contracts “abnormal”–and we know what happens to people in China who engage in unnatural financial practices! It also increased fees four-fold, and bumped up margin requirements.

The end result? Success! Trading volumes declined 99 percent. You read that right. 99 percent. Speculation problem solved! I’m guessing that the fear of prosecution for financial crimes was by far the biggest contributor to that drop.

. . . .

And the crushing of the CSI300 and CSI500 contracts will impede development of a robust oil futures market. The brutal killing of these contracts will make market participants think twice about entering positions in a new oil futures contract, especially long dated ones (which are an important part of the CME/NYMEX and ICE markets). Who wants to get into a position in a market that may be all but shut down when the market sends the wrong message? This could be the ultimate roach motel: traders can check in, but they can’t check out. Or the Chinese equivalent of Hotel California: traders can check in, but they can never leave. So traders will be reluctant to check in in the first place. Ironically, moreover, this will encourage the in-and-out day trading that the Chinese authorities say that they condemn: you can’t get stuck in a position if you don’t hold a position.

In other words, China has a choice. It can choose to allow markets to operate in fair economic weather or foul, and thereby encourage the growth of robust contracts in oil or equities. Or it can choose to squash markets during economic storms, and impede their development even in good times.

I do not see how, given the absence of the rule of law and the just-demonstrated willingness to intervene ruthlessly, that China can credibly commit to a policy of non-intervention going forward. And because of this, it will stunt the development of its financial markets, and its economic growth. Unfettered power and control have a price. [Emphasis added.]

And that’s exactly what has happened. Per Reuters’ Clyde Russell:

The quiet demise of China’s plans to launch a new crude oil futures contract shows the innate conflict of wanting the financial clout that comes with being the world’s biggest commodity buyer, but also seeking to control the market.

. . . .

The main issues were concerns by international players about trading in yuan, given issues surrounding convertibility back to dollars, and also the risks associated with regulation in China.

The authorities in Beijing have established a track record of clamping down on commodity trading when they feel the market pricing is driven by speculation and has become divorced from supply and demand fundamentals.

On several occasions last year, the authorities took steps to crack down on trading in then hot commodities such as iron ore, steel and coal.

While these measures did have some success in cooling markets, they are generally anathema to international traders, who prefer to accept the risk of rapid reversals in order to enjoy the benefits of strong rallies.

It’s likely that while the INE could design a crude futures contract that would on paper tick all the right boxes, it would battle to overcome the trust deficit that exists between the global financial community and China.

What international banks and trading houses will want to see before they throw their weight behind a new futures contract is evidence that Beijing won’t interfere in the market to achieve outcomes in line with its policy goals.

It will be hard, but not impossible, to guarantee this, with the most plausible solution being the establishment of some sort of free trade zone in which the futures contract could be legally housed.

Don’t hold your breath.

It is also quite interesting to contemplate this after all the slobbering over Xi’s Davos speech. China is protectionist and has an overwhelming predilection to intervene in markets when they don’t give the outcomes desired by the government/Party. It is not going to be a leader in openness and markets. Anybody whose obsession with Trump leads them to ignore this fundamental fact is truly a moron.

 

 

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January 5, 2017

Rosneft/Glencore/QIA: More Answers Mean More Questions

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 8:01 am

Soon after I posted yesterday, news stories reported that the Rosneft-Glencore-QIA deal had closed. But questions still remain.

Here’s the Rosneft statement:

“As part of the previously agreed privatization deal all sides in the project, including Rosneftegaz and the consortium of foreign investors – one of the world’s largest sovereign funds, Qatar Investment Authority, and a leading Swiss commodity producer and trader Glencore – as well as financial and legal consultants, financial institutions and creditors, have finalized all corporate and technical closure and payment procedures,” the statement read.

I had to take that from Sputnik, because, curiously, there is no statement on Rosneft’s website. Yes, I know it’s the holidays in Russia, but still.

Also, look at this part: “have finalized all corporate and technical closure and payment procedures.” But on December 16, it was reported that Sechin had told Putin that the funds had been transferred to the Russian budget. Putin said so during his end-of-year gabfest. But the release says that only payment procedures have been finalized. So, whence the money that appeared in the Russian budget?

There is still the open question of the arithmetic. The moneys supposedly pledged by Glencore, QIA, and Intesa don’t add up to the purchase price. Close to 20 pct is pretty big for rounding error. So where’s that coming from?

I found this interesting:

“The technical procedures for closing (the deal) required the preparation and signing of more than 50 documents and agreements,” Rosneft said in a statement. “All this reflects the unprecedented complexity of the deal.”

Why so complex? Indeed, unprecedentedly so? What are the complexities? Many players who have not been named publicly? A complicated set of indemnities, collateralization agreements, guarantees and cross guarantees?

Another intriguing fact. Glencore announced the closing on Tuesday, 3 January. This is the sum and substance of the statement:

The Company announces that final settlement has been completed and closing achieved for the transaction described in its release of 10 December 2016.

I know Glencore is still a Swiss trading company at heart, but it is a public company now and such firms are usually somewhat more forthcoming about large transactions. Some even brag a little. Or a lot. Glencore’s statement is like a legal notice in a newspaper.

So the deal is done. Apparently, beyond that, we know little. And the principals are quite obviously very happy to keep it that way. Which is revealing in its own way.

Update. A Russian reporter kindly tells me that the Rosneft press release is available on its website. On the Russian language site, go to: “Shareholders and Investors” section > Disclosure of information > Main shareholder Rosneftegaz and open the first from the top pdf-release. It’s a PDF in Russian, moreover, meaning that you just can’t translate it in Chrome. How could I possibly have missed that?

Meanwhile, English language version of the home page of the Rosneft website tells you that “Rosneft launches Italian Cafe Chain A-Cafe in Moscow.” So we know what’s really important.

 

 

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January 4, 2017

The Rosneft Deal: One Step Closer to Reality

Filed under: Commodities,Derivatives,Economics,Energy,Russia — The Professor @ 4:51 pm

After-a thinking-a about it-a for almost a month-a, Italian bank Intesa Sanpaolo has apparently decided to stump up €5.2 billion to fund the Rosneft-QIA-Glenocre transaction.

A few interesting aspects to this, beyond that it took so long to commit after Rosneft said it was a done deal in the first week of December.

First, by my arithmetic, the deal is still short about €1.9 billion short. Intesa is putting up €5.2 billion, QIA €2.8 billion, Glencore €.3 billion. That’s €8.3 billion. The deal is for €10.2 billion. So where’s the other money coming from?

Second, Intesa is saying they will lend now, and syndicate the loan later. That’s not unheard of, but it’s not typical. Not least because Intesa’s bargaining position is weak now: potential syndicate members will know that Intesa has to unload the risk, and be patient in the hope of getting better terms.

Third is this gem at the end: “The underwriting, to be syndicated, has strong protection in terms of collateral and guarantees.” So who is providing the guarantees? What is the substance of the guarantees?

We have Glencore’s statement about indemnity, and some basis to believe that Gazprombank is the provider. But does QIA have a guarantee as well?

In any event, the deal looks more real than it did last month. But there are still open questions.

 

 

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December 30, 2016

For Whom the (Trading) Bell Tolls

Filed under: Clearing,Commodities,Derivatives,Economics,Energy,Exchanges,History — The Professor @ 7:40 pm

It tolls for the NYMEX floor, which went dark for the final time with the close of trading today. It follows all the other New York futures exchange floors which ICE closed in 2012. This leaves the CME and CBOE floors in Chicago, and the NYSE floor, all of which are shadows of shadows of their former selves.

Next week I will participate in a conference in Chicago. I’ll be talking about clearing, but one of the other speakers will discuss regulating latency arbitrage in the electronic markets that displaced the floors. In some ways, all the hyperventilating over latency arbitrages due to speed advantages measured in microseconds and milliseconds in computerized markets is amusing, because the floors were all about latency arbitrage. Latency arbitrage basically means that some traders have a time and space advantage, and that’s what the floors provided to those who traded there. Why else would traders pay hundreds of thousands of dollars to buy a membership? Because that price capitalized the rent that the marginal trader obtained by being on the floor, and seeing prices and order flow before anybody off the floor did. That was the price of the time and space advantage of being on the floor.  It’s no different than co-location. Not in the least. It’s just meatware co-lo, rather than hardware co-lo.

In a paper written around 2001 or 2002, “Upstairs, Downstairs”, I presented a model predicting that electronic trading would largely annihilate time and space advantages, and that liquidity would improve as a result because it would reduce the cost of off-floor traders to offer liquidity. The latter implication has certainly been borne out. And although time and space differences still exist, I would argue that they pale in comparison to those that existed in the floor era. Ironically, however, complaints about fairness seem more heated and pronounced now than they did during the heyday of the floors.  Perhaps that’s because machines and quant geeks are less sympathetic figures than colorful floor traders. Perhaps it’s because being beaten by a sliver of a second is more infuriating than being pipped by many seconds by some guy screaming and waving on the CBT or NYMEX. Dunno for sure, but I do find the obsessing over HFT time and space advantages today to be somewhat amusing, given the differences that existed in the “good old days” of floor trading.

This is not to say that no one complained about the advantages of floor traders, and how they exploited them. I vividly recall a very famous trader (one of the most famous, actually) telling me that he welcomed electronic trading because he was “tired of being fucked by the floor.” (He had made his reputation, and his first many millions on the floor, by the way.) A few years later he bemoaned how unfair the electronic markets were, because HFT firms could react faster than he could.

It will always be so, regardless of the technology.

All that said, the passing of the floors does deserve a moment of silence–another irony, given their cacophony.

I first saw the NYMEX floor in 1992, when it was still at the World Trade Center, along with the floors of the other NY exchanges (COMEX; Coffee, Sugar & Cocoa; Cotton). That space was the location for the climax of the plot of the iconic futures market movie, Trading Places. Serendipitously, that was the movie that Izabella Kaminska of FT Alphaville featured in the most recent Alphachat movie review episode. I was a guest on the show, and discussed the economic, sociological, and anthropological aspects of the floor, as well as some of the broader social issues lurking behind the film’s comedy. You can listen here.

 

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December 25, 2016

A Christmas Miracle in Moscow?

Filed under: Economics,Energy,Politics,Russia — The Professor @ 12:27 pm

Putin gave his annual marathon address a few days ago. As usual, some of the things he said were quite sensible. Some things were more debatable. And some things were just codswallop:

Speaking at an annual press conference on Friday, Mr Putin said that “foreigners” had “transferred the money into the Russian budget in full.” The [Rosneft-Glencore-QIA] deal is worth Rbs700bn ($11.5bn).

This echoes a Sechin statement from 9 days ago:

Rosneft CEO Igor Sechin reported to Russian President Vladimir Putin that the federal received all proceeds from privatization of a 19.5% stake in Rosneft, according to Presidential spokesman Dmitry Peskov.

“Sechin told Putin that all funds from Rosneftegas were transferred to the budget,” Peskov said.

There is some ambiguity here: Putin could have been referring to “the foreigners'” equity stakes. But that would leave open the question of where the balance of the money came from, and there is no way that Russia has received the entire $11.5b from “foreign” sources. Note that the bank (Intesa Sanpaolo) that had been named–by Rosneft–as leading the funding for the purchase has said that it’s still thinking about it:

Intesa said earlier this week that its “potential involvement” in the deal was “still under evaluation.” Financial regulators in Rome are examining whether Intesa Sanpaolo’s financing of a €10.2bn investment in Russian oil group Rosneft complies with sanctions

No other foreign bank or banks have stepped up to provide funding.

Maybe Glencore and QIA would have made their equity investment without financing for the balance of the purchase price. But I doubt it. There is no way Rosneftgaz would have parted with ownership of the 19.5 percent stake in Rosneft without being paid in full. So where did the money come from? Either it came from Russian sources, or the deal is not done–both which would be contrary to what Putin asserts. And if it’s from Russian sources, that would give to lie to Sechin’s and Putin’s original claims that all the money would come from foreign sources.

So where did it come from (assuming that it came from anywhere at all)? Some possibilities:

  • Rosneftgaz. Note Sechin’s statement that “all funds from Rosneftegas were transferred.” Rosneftgaz owned (owns?) the shares. Perhaps it made a payment to the budget from its own funds, and retained ownership of shares in anticipation of selling them to the Glencore-QIA consortium at a later date. (This was the common belief as to how the “privatization” would occur prior to the announcement of the Glencore-QIA consortium.) But there is no way that Rosneftgaz transferred $11.5b received from foreigners.
  • Rosneft. It is interesting that on December 5 Rosneft announced plans to issue about $9b of bonds. Add that $9b to the amount allegedly being invested by the consortium, and you get pretty close to the purchase price for the 19.5 percent stake. (Coincidence?) The bonds haven’t been issued yet (apparently), but Rosneft could borrow from Russian banks in anticipation of repaying the loan with the proceeds from the bond issue. More speculatively, the Russian banks could have turned around and used a loan extended to Rosneft as collateral to a loan from the Central Bank of Russia, making the CBR the ultimate funding source. (John Helmer asserts that this is the case.)
  • Russian banks. Russian banks could have lent the money to the consortium. Alternatively, Russian banks could have lent to Rosneft, Rosneftgaz, or both.

But it is incontestable that either (a) the deal isn’t really done, or that (b) contrary to the statements trumpeted at the start of the deal, it was primarily funded by Russian banks, rather than western ones.

We now do have some idea of what an “appropriate Russian bank” is. (That was the mysterious phrase used in Glencore’s release to refer to a Russian bank providing an indemnity to Glencore.). RBC reports that Gazprombank is involved in the transaction. The Russian government operates under the fiction that Gazprombank is not a state bank. Putin had said that Russian state banks would not be involved, because that would not be a true privatization. The obvious inference is that an “appropriate” bank is a non-state one.

Even looking beyond whether Gazprombank is reasonably considered a non-state bank, (a) it was supposed to be indemnifying Glencore’s borrowing from western banks to fund the purchase, not providing the funding itself, and (b) on its own, it wouldn’t have the scratch to finance the entire purchase. Putting all this together, it means that either (a) the money is coming from other banks–which have to be Russian state banks (most likely Sberbank and VTB), or (b) the deal ain’t done.

It is interesting to note that neither Glencore nor QIA have made an announcement that the deal has closed. Indeed, they declined comment when asked about Putin’s statement. If the deal has closed, Glencore would have said something. Western banks funding the deal would have said something. The silence speaks volumes.

What accounts for the reticence of Intesa, and other western banks? Perhaps it’s coincidence, but Intesa was just fined $235 million for “anti-money laundering failures and violations of bank privacy laws.” The fine was levied by New York state regulators, not the Feds. Furthermore, lending to fund the transaction would not appear to violate sanctions, because it does not involve the purchase of new equity. However, Intesa and other western banks (and others have to get involved, because Intesa could not afford to finance it itself) know that there are many ways that the US government could express its displeasure at doing a deal that adhered to the letter of sanctions, but violated the spirit (as interpreted by the Treasury Department). The fine may have have gotten Intesa’s (and other banks’) minds right–and that may have been the point.

In sum, there is no way that $11.5b of western money has been transferred to the Russian budget to pay for a 19.5 percent stake in Rosneft. Thus, Putin was telling a stretcher at his presser.

Or perhaps it was a Christmas miracle. Money magically appeared in Rosneftgaz’s kitty, which it then generously transferred to the Russian government budget, out of the goodness of its heart in the spirit of the season. That would make as much sense as the story Putin spun.

And speaking of Christmas miracles, I hope that all my loyal readers are favored with one as well. Have a Merry Christmas, and a Happy New Year.

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