Streetwise Professor

August 5, 2017

A Brief European Tour

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:46 pm

Emmanuel Macron’s popularity has come off considerably since his victory in May. This is to be expected. He was the beneficiary of metropolitan France’s giddiness at the vanquishing of Le Pen, and the perceived slap at Trump (more on this in a bit). That intoxication has passed, and France is still France, riven as it always has been by deep political divides even among the elite.

I must confess that I may have misjudged M. Macron. I pegged him as a cipher whom Merkel would dominate. But if anything, Macron is proving to lean more towards Napoleonic ambitions, labeling himself “Jupiter” who aims to overawe the petty squabbling political nation.

Macron left some angered, and others nonplused, by his bonhomie with Trump during the president’s visit to France on Bastille Day. This actually makes perfect sense, and is the best demonstration of his intent to be his own man, rather than a Merkel flunky. As Empress Angela’s pretensions continue to swell, Macron knows that he needs a counterweight. He further knows that Merkel disdains Trump, and Trump don’t think much of her either. So the clever thing to do is to build a relationship to Trump. It signals independence. It will aggravate Angela. And it will provide Macron with some muscle in his dealings with Germany, and with the EU.

Speaking of the Germans, they are in a lather over the recently passed, and grudgingly signed, US sanctions on Russia. (Socialist) Foreign Minister Sigmar Gabriel called the sanctions “more than problematic” and accused the US of using the sanctions to advance its economic interests.

Vats good for ze goose is good for ze gander, eh, Fritz? German policy is all about advancing the interests of Germany, Inc. (or more properly, Germany AG). So spare me the sanctimony.

And as a factual matter, Sigmar is full of it. He states the US position to be “we want to drive Russian gas out of the European market so we can sell American gas.” This takes a very narrow and distorted view of the effect of sanctions on US companies, and energy companies in particular. The gains to US LNG are speculative, and would not be realized for some time. Other US firms–notably the oil majors–will suffer more with certainty, and suffer now, as a result of the new sanctions. Consequently, US energy firms fought the sanctions bill aggressively, and won some concessions.  So the idea that the sanctions effort was a Trojan Horse intended to advance US commercial interests is laughable. Congress proceeded with sanctions in spite of US economic interests, rather than because of them.

I think psychologists refer to what Herr Gabriel did there as “projection.”

One other thing about the sanctions bill. After it became law, Putin responded by ordering a reduction of 755 in staff at US diplomatic missions in Russia, and kicked the American diplomats out of some dachas. This is a good a confession of his strategic weakness. He really had no retaliatory measure available that would have really hurt the US without hurting Russia substantially more. So he was forced to resort to a purely symbolic measure. Something to think about the next time that you read about Putin the Colossus. Yes, he can be a pain, but when it comes down to it, he is playing with a very weak hand.

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July 26, 2017

Europe Has Always Been at War With the Diesel Engine!

Filed under: China,Climate Change,Economics,Energy,Politics,Regulation — The Professor @ 7:26 pm

Europe is at war with the diesel engine. Paris, Madrid, and Athens will ban diesels starting in 2025. Even Stuttgart (home of Daimler and Porsche) and Munich (home of BMW) are following suit. France and Britain have pledged to eliminate internal combustion engine cars by 2040.   The cars–diesel in particular–are too polluting, you see. And so the Euros are intent on replacing them with electric vehicles.

Europe has always been at war with diesel!

Um, not really. Like Oceania and East Asia, Europe and diesel were once fast allies. In its early days of the fight against climate change, Europe figured that since diesel engines burn fuel more efficiently than gasoline ones, they could reduce carbon emissions by forcing or inducing people to switch to diesel. They gave tax breaks and incentives that led to 1/3 of the European car fleet being diesel.

Then reality crept in. Diesels create more particulates, which create nasty pollution, particularly in urban areas. The Euros thought they could address this by strict emissions standards. So strict, that auto companies couldn’t meet them economically. So they lied and cheated. Brace yourself: even morally superior German companies lied and cheated! So Europe bribed people to pollute their cities. Well played!

Further, even by its own objectives the policy was a failure. Even though diesel has lower CO2 emissions, it has higher soot emissions–and soot contributes to warming. Whoops! Further, the CO2 advantage of diesel has been narrowing over the years, due to improvements in gasoline engine technology. So at best the impact of diesel on warming has been a push, and maybe a net bad.

But never fear! The same geniuses who forced diesel down Europe’s throat have a solution to the evils of diesel: they will force electric cars down people’s throats.

What could possibly go wrong?

Well, off the top of my head.

First, in the near term, a good portion of electric cars will be powered by electricity generated by coal. This is especially true if China goes Europe’s way.

Second, the green wet dream is for renewables to replace coal. Don’t even get me started. Renewables are diffuse and intermittent–they don’t scale well. They have caused problems in the power grid wherever (e.g., Europe, California) they have accounted for over 10 percent or so of generation. They consume vast amounts of land: air pollution (if you believe CO2 is a pollutant) is replaced by sight pollution and the destruction of natural habitat and foodstuff producing land. Renewables are a static technology (e.g., the amount of wind generation is limited by physical laws), whereas internal combustion technology has been improving continuously since its introduction in the 19th century. Really economic renewables generation will require a revolution in large-scale storage technology–a revolution that people have been waiting for for decades, but which hasn’t appeared.

Third, disposal of batteries is an environmental nightmare.

Fourth, mining the materials to produce batteries is an environmental nightmare–and is likely to benefit many kleptocrats around the world. Are greens really all that excited about massive mines for rare earths (notoriously polluting) and copper springing up to provide the materials for their dream machines? Will they pass laws against, say, blood cobalt? (And when they do, will they acknowledge–even to themselves–their culpability? Put me down as a “no.”)

Fifth, depending on the fuel mix, carbon emissions over an EV’s lifetime are not that much lower than those of an internal combustion car using existing technology–and that technology (as noted above) will improve.

Like I say, top of my head. But there’s an even bigger reason:

Sixth, unintended consequences, or more prosaically, shit happens. Just like the diesel box of chocolates was full of things the Euro better thans didn’t expect, and didn’t like upon consuming, the EV craze will also present unintended and unexpected effects, and in this type of circumstance, these effects are usually negative.

But they know better! How do we know? Because they keep telling us so! And because they keep telling us what to do!  Despite the fact that their actual record of performance is a litany of failures. (I cleaned that up. My initial draft had a word starting with “cluster.”)

Given such a track record, people with any decency would exercise some restraint and have some humility before embarking on another attempt to dictate technology. But no, that’s not the elite’s way. That’s not the bureaucrats’ way. They have learned nothing and forgotten nothing and will continue to prove that until someone stops them. Sadly, short of revolution it’s hard to see how that can happen.

Almost all attempts by states to dictate technology are utter fiascos. The knowledge problem is bigger here than anywhere, and the feedbacks are devilishly complex and hard to predict. Look at something seemingly as prosaic and well-understood as the production of oil and gas. Ten or twelve years ago, only a few visionaries glimpsed the potential of fracking, and I doubt that even they would admit that they foresaw the transformation that has occurred. Trying to dictate a technology that is dependent on myriad other technologies, and which may be rendered obsolete by technologies not yet developed, is something that only fools do.

But alas, there are many fools in high places.

The Orwellian switch from Europe and Diesel Have Always Been Allies to Europe Has Always Been at War With Diesel is particularly revealing because rather than recognize that the experience of Europe’s pro-diesel policy makes a mockery of policymakers pretenses of foresight, the failure of that policy is spurring them to embark on an even more speculative binge of coercion!

If you think CO2 is an issue, tax CO2 and let the market figure out the optimal way of reducing emissions: there are many margins on which to adjust, including technical innovation, fuel substitution, changes in lifestyle. Yet these madmen (and women) and fools insist on dictating technology right after their past dictates have proved failures. Worse than that: they are issuing new ukases because their old ones were crashing failures.

We are in the best of hands.

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July 20, 2017

Hyperloop Hype. What Else Do You Expect From Elon?

Filed under: Energy,Politics — The Professor @ 6:59 pm

The classic sign of a con man is that he always responds to information or developments that undermine his previous promises with new!, better! promises. Elon Musk fits this template to a T.

Most of the news from Tesla lately has been less than favorable, and all of it contradicts previous pronouncements. Vehicle shipments have failed to make forecast, and it is  trying to manage expectations about Model 3 production and sales. It is becoming clear that Tesla will face considerable competition in electric cars, and from companies that have a proven ability to build automobiles in quantity with quality–both of which Tesla has yet to do. As a result, the price has cracked considerably in the past few weeks.

So Elon needs a distraction, and another fantastical statement about Tesla would probably be ill-advised. So what to do? Tweet tantalizing trash about Hyperloop, of course! (I have to rely on press reports, because Elon blocked me long, long ago. I’m so proud.)

Musk stated that he had received “verbal govt approval” to build the NY-DC Hyperloop.

Approval from whom, exactly? Elon didn’t say. Approval to do what, exactly? Elon didn’t say.

Forget the what: the whom question is amusing enough. I can imagine a conversation between Elon and an alderman in say, Applegarth, NJ. “Hey. I’d like to drill a tunnel under your town and run high speed capsules carrying passengers underneath it. What do you think?” “COOL! Go for it!” Then Elon whips out his iPhone and tweets that he got “verbal govt approval.”

Just think how many jurisdictions there are between New York and DC. (And how many of those are corrupt as hell.)  This is also the Land of NIMBY. So unless there is some supersecret Regional Subterranean Construction Authority that can approve–verbally, no less–the building of something like Hyperloop, can override local government in NY, NJ, PA, DE, and the Federal government as well, there is no single body to give the approval that Elon claims he has.

But reality doesn’t matter in ElonWorld. He needed something to feed the fanboyz, and he did. And non-fanboyz (e.g., the WSJ) actually treat these utterances seriously.

Note that Elon’s Hyperloop Tweet gets wall-to-wall coverage, but the fact that his brother-in-law Peter Rive has left Tesla to–wait for it–“spend more time with his family” has barely registered in the news.

Rive was a co-founder of Solar City, and was in charge of one of the projects that Elon had hyped earlier–the Solar Roof, which was supposedly about ready to be installed en masse.  Has anyone actually seen such a roof? I thought not. Yet more hype, the failure to deliver on which requires hyping Hyperloop.

Musk has gone through execs like Kleenex during a bad cold. And now he can’t even keep his relatives.

But Elon always has rent-seeking to fall back on. Of all his bullshit, the biggest is his claim that the company does not depend on government largesse: “And I should perhaps touch again on this whole notion of – it’s almost like over the years there’s been all these sort of irritating articles like Tesla survives because of government subsidies and tax credits. It drives me crazy.”

So I presume you sent back those CA ZEV and US subsidy checks, right Elon? For the sake of your sanity.

Thought not.

Take Elon’s pronouncements at face value (I know, I know) and you would think that the impending phase out of Federal subsidies would be great news for his mental health. But given the fact that EV sales have this tendency to collapse when subsidies go away (recent examples being Hong Kong, China, and Denmark), the loss of this revenue stream is a grave threat to the company. But never fear, California, which hasn’t met an idiotic green technology that it won’t throw money at, is getting ready to throw large green Elon’s way:

The California state Assembly passed a $3-billion subsidy program for electric vehicles, dwarfing the existing program. The bill is now in the state Senate. If passed, it will head to Governor Jerry Brown, who has not yet indicated if he’d sign what is ostensibly an effort to put EV sales into high gear, but below the surface appears to be a Tesla bailout.

. . . .

This is how the taxpayer-funded rebates in the “California Electric Vehicle Initiative” (AB1184) would work, according to the Mercury News:

The [California Air Resources Board] would determine the size of a rebate based on equalizing the cost of an EV and a comparable gas-powered car. For example, a new, $40,000 electric vehicle might have the same features as a $25,000 gas-powered car. The EV buyer would receive a $7,500 federal rebate, and the state would kick in an additional $7,500 to even out the bottom line.

And for instance, a $100,000 Tesla might be deemed to have the same features as a $65,000 gas-powered car. The rebate would cover the difference, minus the federal rebate (so $27,500). Because rebates for Teslas will soon be gone, the program would cover the entire difference – $35,000. This is where Senator Vidak got his “$30,000 to $40,000.”

The Tesla Model 3 would be tough to sell without the federal $7,500. But this new bill would push Californian taxpayers into filling the void. It would be a godsend for Tesla.

AB1184 would be a huge expansion of the current Clean Vehicle Rebate Project which has doled out 115,000 rebates for $295 million to buyers of EVs and hybrids since 2010, averaging about $2,550 per rebate.

Under AB1184, hybrids and hydrogen powered cars are not included, and rebates for plug-in hybrids are slashed – perhaps to keep Toyota’s technologies at bay.

Even the current, relatively small Clean Vehicle Rebate Project has been lambasted as a subsidy for the wealthy who can afford to spend $100,000 on a set of wheels. A study, cited by the Mercury News, showed that of nearly 100,000 rebates, over 80% went to Californians with incomes over $100,000. This notion of a subsidy for the wealthy also applies to the federal rebate.

So of course Elon threw himself across the Assembly door in Sacramento, right? He’s bombarding Jerry Brown with calls begging him to veto right?

Yeah, sure. No this smells for all the world like California doing a solid for a local company (and the wealthy Californians that buy its cars). And we know how Elon can work governments to get him to shovel money his way.

In some ways, you can’t blame Elon. As transparent as his shtick is, it seems to work. P.T. Barnum’s dictum about a sucker being born every minute seems to be a low-ball estimate when it comes to Musk’s con. So until it doesn’t work, he’ll keep doing it. Given that reality isn’t an option, what else is he going to do?

If Elon fools you once, shame on him. If he fools you twice, three times, four times . . . shame on you.

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July 6, 2017

The Qatar LNG Expansion Announcement: Vaporware Meets LNG?

Filed under: Commodities,Economics,Energy,Politics — The Professor @ 4:04 pm

Qatar sent shock waves through the LNG market by announcing plans to increase output by 30 percent. Although large energy firms (including Rex Tillerson’s old outfit) expressed interest in working with Qatar on this, color me skeptical.

I can think of two other explanations for the announcement, particularly at this time.

The first is that this may be akin to a vaporware announcement. Back in the day, it was common for software firms to announce a new product or a big update of an existing product in order to try to deter others from entering that market. If entry in fact did not occur, the product announced with such fanfare would never appear. Similar to this strategy, I think it is very plausible that Qatar is trying to deter entry or expansion by North American, Australian, and African producers by threatening to add a big slug of capacity in a few years. Perhaps the developers won’t be scared off, but their bankers may be.

The surge in LNG capacity around the world has severely undercut Qatar’s competitive position, and forced it to make contractual concessions. It also threatens to erode prices for a considerable period. Even more entry would exacerbate these problems. This gives Qatar a strong incentive to try to scare off some of that capacity, and a vaporware strategy is worth a try in order to achieve that.

The second is based on the current set-to between Qatar and the Saudis and the rest of the GCC. They are all but blockading Qatar, and have made demands that bring to mind Austria-Hungary’s demands against Serbia in July, 1914: the ultimatum is designed to be rejected to give a pretext for escalation. Qatar needs to demonstrate that it is immune to the pressure. An announcement of grandiose expansion plans is a good way to signal that it is immune to pressure and not only plans to continue business as usual, but to go further. In a part of the world where showing weakness is an invitation for the wolves to pounce, putting on a bold front is almost a necessity when the wolves are already circling.

So we’ll see where this goes. But I think there’s a good likelihood that this is a big bluff.

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July 4, 2017

Donald Trump, LNG Impressario: Demolishing the Putin Puppet Narrative

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 9:50 am

If Trump has a signature policy issue, it is promoting US energy to achieve what he calls “energy dominance.” The leading edge of this initiative is the promotion of LNG. Immediately prior to his appearance at the G20 Summit (where ironically he will be tediously hectored on trade by the increasing insufferable Angela Merkel), he will speak Thursday at the “Three Seas Summit” in Poland, where he will tout American LNG exports as both an economic and security fillip to Europe, and in particular eastern Europe.

“I think the United States can show itself as a benevolent country by exporting energy and by helping countries that don’t have adequate supplies become more self-sufficient and less dependent and less threatened,” he said.

This strikes at the foundation of Putin’s economic and geopolitical strategy. Export revenues from gas and oil keep his country afloat and his cronies flush. He uses gas in particular as a knout to bludgeon recalcitrant eastern Europeans (Ukraine in particular) and as a lever to exercise influence in western Europe, Germany in particular.

Gazprom routinely sniffs that LNG is more costly than Russian gas, and that LNG will not appreciable erode its market share. That’s true, but illustrates perfectly the limitations of market share as a measure of economic impact. The increased availability of LNG, particularly from the US, increases substantially the elasticity of supply into Europe. This, in turn, substantially increases the elasticity of demand. As the low cost producer (pipeline gas being cheaper), Russia/Gazprom will continue to be the source of the bulk of the methane molecules burned in Europe, but this increased elasticity of demand will reduce Gazprom’s pricing power and hence its revenues.

Furthermore, the effect on short-run elasticities will be particularly acute. Pre-LNG, there were few sources of additional supply available in a period of days or weeks that could substitute for Russian gas cutoff during some geopolitical power play. With LNG, the threat of shutting off the gas has lost much of its sting: especially as LNG evolves towards a traded market, supplies can swing quickly to offset any regional supply disruption, including one engineered by Putin for political purposes. So LNG arguably reduces Putin’s political leverage even more than it reduces his economic leverage. This is particularly true given complementary European policy changes that permit the flow of gas to regions not serviced by LNG directly.

Trump is getting some pushback from domestic interests in the US (notably the chemical industry) because greater exports would support prices and deprive these industries of the cheap fuel and feedstock that has powered their growth (something totally unpredictable a decade ago, when the demise of the US petrochemical industry was a real possibility). But (a) Trump seems totally committed to his pro-export course, and (b) complementary efforts to reduce restrictions on supply will mitigate the price impact. So I expect the opposition of the likes of the Industrial Energy Consumers of America to be little more than a speed bump in his race to promoting energy exports.

This all reveals Trump for the mercantilist he is: imports bad, exports good. This is economically illiterate and incoherent, but it’s Trump trade policy in a nutshell. Economic coherence aside, however, Donald Trump, LNG Impressario totally demolishes the Putin puppet narrative. Not that you’d notice–the hysteria continues unabated, because reality doesn’t matter to the soi disant reality-based community.

Here we have Trump devoting the bulk of his non-Twitter-directed energies (and he is high energy!) to promoting an economic policy that hits Putin at his most vulnerable spot, economically and geopolitically. Whatever his Russia-related rhetoric, pace Orwell, he is objectively anti-Putin.

Not that this causes neo-McCarthyites even to experience cognitive dissonance, let alone to engage in a serious re-evaluation. To them, Trump is literally a Kremlin operative in Putin’s thrall. And nothing–not even Trump venturing to the heart of the area Putin and his ilk believe to be in Russia’s sphere of influence and loudly (very loudly) proclaiming that he is offering American gas to free Europe from its energy thralldom–will divert them from their non-stop narrative.

As an aside, I do Joseph McCarthy a grave disservice by comparing today’s mainstream media, the Democratic Party, Neocons, and large swathes of the Republican establishment to him. There was actually a far more substantial factual basis for his paranoia than there is for that of the anti-Trump brigades.

There is an irony here, though. I have often sneered at Putin (and when he was president, Medvedev), for acting like a glorified Secretary of Commerce, going around being the pitchman for Russian economic interests, in energy in particular. Stylistically, Trump is doing somewhat the same. But substantively, in Making American Energy (LNG particularly) Great, Trump is giving Putin a good swift kick in the stones.

Not that the promoters of the New Red Scare are paying the slightest heed. Which demonstrates that theirs is a completely partisan and grotesquely intellectually dishonest campaign.

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July 1, 2017

All Flaws Great and Small, Frankendodd Edition

On Wednesday I had the privilege to deliver the keynote at the FOW Trading Chicago event. My theme was the fundamental flaws in Frankendodd–you’re shocked, I’m sure.

What I attempted to do was to categorize the errors. I identified four basic types.

Unintended consequences contrary to the objectives of DFA. This could also be called “counter-intended consequences”–not just unintended, but the precise opposite of the stated intent. The biggest example is, well, related to bigness. If you wanted to summarize a primary objective of DFA, it would be “to reduce the too big to fail problem.” Well, the very nature of DFA means that in some ways it exacerbates TBTF. Most notably, the resulting regulatory burdens actually favor scale, because they impose largely fixed costs. I didn’t mention this in my talk, but a related effect is that increasing regulation leads to greater influence activities by the regulated, and for a variety of reasons this tends to favor the big over the medium and small.

Perhaps the most telling example of the perverse effects of DFA is that it has dramatically increased concentration among FCMs. This exacerbates a variety of sources of systemic risk, including concentration risk at CCPs; difficulties in managing defaulted positions and porting the positions of the customers of troubled FCMs; and greater interconnections across CCPs. Concentration also fundamentally undermines the ability of CCPs to mutualize default risk. It can also create wrong-way risks as the big FCMs are in some cases also sources of liquidity support to CCPs.

I could go on.

Creation of new risks due to misdiagnoses of old risks. The most telling example here is the clearing and collateral mandates, which were predicated on the view that too much credit was extended via OTC derivatives transactions. Collateral and netting were expected to reduce this credit risk.

This is a category error. For one thing, it embodies a fallacy of composition: reducing credit in one piece of an interconnected financial system that possesses numerous ways to create credit exposures does not necessarily reduce credit risk in the system as a whole. For another, even to the extent that reducing credit extended via derivatives transactions reduces overall credit exposures in the financial system, it does so by creating another risk–liquidity risk. This risk is in my view more pernicious for many reasons. One reason is that it is inherently wrong-way in nature: the mandates increase demands for liquidity precisely during those periods in which liquidity supply typically contracts. Another is that it increases the tightness of coupling in the financial system. Tight coupling increases the risk of catastrophic failure, and makes the system more vulnerable to a variety of different disruptions (e.g., operational risks such as the temporary failure of a part of the payments system).

As the Clearing Cassandra I warned about this early and often, to little avail–and indeed, often to derision and scorn. Belatedly regulators are coming to an understanding of the importance of this issue. Fed governor Jerome Powell recently emphasized this issue in a speech, and recommended CCPs engage in liquidity stress testing. In a scathing report, the CFTC Inspector General criticized the agency’s cost-benefit analysis of its margin rules for non-cleared swaps, based largely on its failure to consider liquidity effects. (The IG report generously cited my work several times.

But these are at best palliatives. The fundamental problem is inherent in the super-sizing of clearing and margining, and that problem is here to stay.

Imposition of “solutions” to non-existent problems. The best examples of this are the SEF mandate and position limits. The mode of execution of OTC swaps was not a source of systemic risk, and was not problematic even for reasons unrelated to systemic risk. Mandating a change to the freely-chosen modes of transaction execution has imposed compliance costs, and has also resulted in a fragmented swaps market: those who can escape the mandate (e.g., European banks trading € swaps) have done so, leading to bifurcation of the market for € swaps, which (a) reduces competition (another counter-intended consequence), and (b) reduces liquidity (also counter-intended).

The non-existence of a problem that position limits could solve is best illustrated by the pathetically flimsy justification for the rule set out in the CFTC’s proposal: the main example the CFTC mentioned is the Hunt silver episode. As I said during my talk, this is ancient history: when do we get to the Trojan War? If anything, the Hunts are the exception that proves the rule. The CFTC also pointed to Amaranth, but (a) failed to show that Amaranth’s activities caused “unreasonable and unwarranted price fluctuations,” and (b) did not demonstrate that (unlike the Hunt case) that Amaranth’s financial distress posed any threat to the broader market or any systemic risk.

It is sickly amusing that the CFTC touts that based on historical data, the proposed limits would constrain few, if any market participants. In other words, an entire industry must bear the burden of complying with a rule that the CFTC itself says would seldom be binding. Makes total sense, and surely passes a rigorous cost-benefit test! Constraining positions is unlikely to affect materially the likelihood of “unreasonable and unwarranted price fluctuations”. Regardless, positions are not likely to be constrained. Meaning that the probability that the regulation reduces such price fluctuations is close to zero, if not exactly equal to zero. Yet there would be an onerous, and ongoing cost to compliance. Not to mention that when the regulation would in fact bind, it would potentially constrain efficient risk transfer.

The “comma and footnote” problem. Such a long and dense piece of legislation, and the long and detailed regulations that it has spawned, inevitably contain problems that can lead to protracted disputes, and/or unpleasant surprises. The comma I refer to is in the position limit language of the DFA itself: as noted in the court decision that stymied the original CFTC position limit rule, the placement of the comma affects whether the language in the statute requires the CFTC to impose limits, or merely gives it the discretionary authority to do so in the even that it makes an explicit finding that the limits are required to reduce unwarranted and unreasonable price fluctuations. The footnotes I am thinking of were in the SEF rule: footnote 88 dramatically increased the scope of the rule, while footnote 513 circumscribed it.

And new issues of this sort crop up regularly, almost 7 years after the passage of Dodd-Frank. Recently Risk highlighted the fact that in its proposal for capital requirements on swap dealers, the CFTC (inadvertently?) potentially made it far more costly for companies like BP and Shell to become swap dealers. Specifically, whereas the Fed defines a financial company as one in which more than 85 percent of its activities are financial in nature, the CFTC proposes that a company can take advantage of more favorable capital requirements if its financial activities are less than 15 percent of its overall activities. Meaning, for example, a company with 80 percent financial activity would not count as a financial company under Fed rules, but would under the proposed CFTC rule. This basically makes it impossible for predominately commodity companies like BP and Shell to take advantage of preferential capital treatment specifically included for them and their ilk in DFA. To the extent that these firms decide to incur costs (higher capital costs, or the cost of reorganizing their businesses to escape the rule’s bite) and become swap dealers nonetheless, that cost will not generate any benefit. To the extent that they decide that it is not worth the cost, the swaps market will be more concentrated and less competitive (more counter-intended effects).

The position limits proposed regs provide a further example of this devil-in-the-details problem. The idea of a hedging carveout is eminently sensible, but the specifics of the CFTC’s hedging exemptions were unduly restrictive.

I could probably add more categories to the list. Different taxonomies are possible. But I think the foregoing is a useful way of thinking about the fundamental flaws in Frankendodd.

I’ll close with something that could make you feel better–or worse! For all the flaws in Frankendodd, MiFID II and EMIR make it look like a model of legislative and regulatory wisdom. The Europeans have managed to make errors in all of these categories–only more of them, and more egregious ones. For instance, as bad as the the US position limit proposal is, it pales in comparison to the position limit regulations that the Europeans are poised to inflict on their firms and their markets.

 

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June 28, 2017

Puzzling Statements From Rosneft and Russneft

Filed under: Commodities,Derivatives,Energy,Russia — The Professor @ 6:21 pm

Yesterday Rosneft was the target of a cyberattack (ransomware to be specific). The company ominously tweeted:

Screen Shot 2017-06-28 at 6.58.23 PM

So the first thing that came to mind was that some legal adversary (presumably Sistema) was hacking Rosneft in retaliation for Rosneft’s lawsuit?

How weird is that? Paranoid? A threat? A paranoid threat?

This is even more bizarre because multiple companies–including Russian companies like Evraz and several banks, Ukrainian companies, and major international firms like Maersk–were hit simultaneously and the news spread rapidly. But apparently those running Rosneft’s social media live in a bubble and think (a) everything is about them, and (b) their commercial enemies are out to get them (which could well be a clinical case of projection). The Tweet certainly suggests that the Sistema litigation is a huge deal at Rosneft, which is telling in its own way.

Regardless of the explanation, this has to be the most bizarre corporate Tweet I have ever seen. And I’ve read some of Elon’s (before he blocked me!)

In other news that makes me question the competence of the management of Russian oil companies, consider this gem from Russneft:

Russneft, Russia’s mid-sized oil producer, is looking to clinch an oil hedging deal with VTB, Russia’s second biggest bank, Russneft Senior Vice President Olga Prozorovskaya said on Tuesday.

Mikhail Gutseriyev, a Russneft co-owner, told an annual shareholders meeting separately that he had earned $700 million on a previous oil hedge deal. Sources told Reuters earlier that Gutseriyev had been hedging at Sberbank.

“We are waiting for (the right) moment … and we will do (oil) hedging in the nearest future. We will hedge in such a way that we will get a couple of hundreds of million dollars in profit,” Gutseriyev said. [Emphasis added.]

Perhaps something was lost in translation, but on its face the statement makes no sense: hedging is not a profit making activity, but is a risk reduction activity. Indeed, in most markets a short hedger (which an oil producer would be) lowers average profits by hedging (because hedging pressure generally depresses the forward price below the expected spot price), but may choose to hedge nonetheless because of the benefits of lower profit variability (which arise from factors such as financial distress costs, agency costs, and taxes).

So methinks Gospodin Gutseriyev is unclear on the concept of hedging.

Attempting to be charitable here, perhaps what he means is that by selling forward its anticipated output Russneft will lock in a profit in the hundreds of millions. Dunno, but read literally the statement suggests that Russneft needs some schooling on what hedging can actually achieve.

 

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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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