Streetwise Professor

January 24, 2017

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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December 11, 2016

Exxon’s Russian Dealings Are No Reason to Fret About Tillerson. If Anything, the Reverse is True

Filed under: Economics,Energy,Politics,Russia — The Professor @ 12:16 pm

Current reports suggest that Trump will select ExxonMobil CEO Rex Tillerson as his Secretary of State. Like many things Trump, this creates substantial uncertainty. For despite the fact that Tillerson has been a public figure for years, he has not been part of the foreign policy community, and hence his view on specific issues (China, the Middle East, and on and on), and his philosophical/ideological/doctrinal orientation are unknown.

As for the fact he has not been part of the FP community–good! It’s not as if it has covered itself in glory in the past couple of decades. Chin pullers moan that Tillerson’s appointment would represent the biggest discontinuity in US foreign policy in years. Again–good! We’re in a rut. Discontinuity has potential.

Others fret that as the mere CEO of one of the largest (if not the largest) corporations in the world, which invests in highly complex technology, operates in virtually every country on the globe, and which must navigate complex political issues in these myriad countries, is just not up to the job of managing the complexities of international diplomacy:

Some former officials said it was an open question whether Tillerson could make the transition from running Exxon, a vast company that explores for oil and gas on six continents, to the even greater complexity of being secretary of state.

“Negotiating a real estate deal or an oil contract with Saudi Arabia is not the same thing,” said Aaron David Miller, a former State Department Middle East specialist now at the Wilson Center think-tank in Washington.

“It’s not a complicated summit where you are trying to reconcile historical woundings, religious identities, sectarian tensions.”

“I’m not arguing that he can’t make this conversion. I just don’t think we know.”


Because ex-pols and career diplomats like John Kerry, Hillary Clinton, Warren Christopher, Cyrus Vance, James Baker, etc., are such towering geniuses that they are much better able to manage the complexities of foreign affairs.


In today’s hysteria over Russia, of course Exxon’s and Tillerson’s relationship with Russia and Putin has been the focus of much angst and criticism. He received the “Order of Friendship” from Putin! XOM was going to invest zillions in Russia but sanctions prevented that! Sanctions cost Exxon billions! He’ll go easy on Russia to help Exxon!

Tillerson ran an oil company. Oil companies look for oil. Russia has oil. Tillerson’s company looked for oil in Russia. Not that complicated.

Further, XOM was not nearly as dependent on Russia as other majors, such as BP or Shell. Consider the billion or so that Exxon had at risk in joint ventures with Rosneft, but which were scuppered by sanctions. Well, a billion is real money, it’s not nearly as big a deal for Exxon because, well, Exxon is so damn big. Even at the depressed values due to low oil prices, $1 billion is .25 percent of XOM’s market cap. The other numbers bandied about–$400-$500 billion in investments in the Arctic over decades–are highly speculative, and dependent on many contingencies. Indeed, the main source of these numbers is hype by Igor Sechin, and should be discounted accordingly.

But even going beyond that, oil exploration and development is a highly fraught and unpredictable endeavor, especially in harsh natural environments like the Arctic, and harsh political environments like Russia. Seemingly promising finds can turn out to be disappointing. Numerous technological hurdles must be overcome. Political difficulties must be surmounted. Take a look at the Shtokman saga to see how these things can bedevil big Arctic projects.

Most importantly, development economics depend on prices, and prices are highly volatile. The initial XOM-Rosneft deals were negotiated in 2011-2013 when oil prices were north of $100/bbl, and were expected to stay there for, well, pretty much forever. A mere year later, oil prices cratered, and now the conventional wisdom is that $100/bbl oil is not on the horizon, even the distant horizon. Even absent sanctions, there would have been a massive re-evaluation of the scale and scope of the Rosneft-XOM cooperation.

Look at Shell. The technological challenges and costs of the Arctic, plus low prices, have led it to pull the plug on its once vaunting ambitions there.

Here’s something else that should provide this perspective. One of Tillerson’s most important moves as CEO was the acquisition of shale operator XTO Energy, for which Exxon paid $31 billion. This dwarfs the commitment to Russia, and shows that Tillerson was investing bigger dollars  in a technology that actually reduced the need for access to Russian resources.

To some, any involvement in Russia inevitably makes one beholden to Putin. Consider this from one of the lead hysterics, Julia Ioffe:

What does that kind of friendship mean? Past experience suggests it is not a relationship of equals. It means that, at the drop of a hat, the Kremlin might discover serious environmental violations at your Sakhalin plant and drive you out of the country, as it did to Royal Dutch Shell, and then give the lucrative access to a better, domestic ally. It might decide to harass you with lawsuits to force you out, as it did to BP. And it might even throw you in jail, as it did to powerful Russian oligarch Vladimir Yevtushenkov in order to take a small oil company, Bashneft, away from you and give it to Sechin. Putin would even arrest his largely popular economics minister, as he did on November 15, to help Sechin retain it.

The lesson of Putin’s 16-year tenure is a lesson that all businesspeople, foreign and domestic, have learned: to do business in Russia, you have to be on good, personal terms with Putin and Sechin. And you have to understand that those two gatekeepers to Russia’s riches are fickle and sadistic, and, as former KGB operatives, know little of real friendship. To do business in Russia—both for Exxon Mobil and for Tillerson’s own massive retirement fund whose fortunes would rise significantly if a Trump White House lifted sanctions—you have to dance to Putin’s tune, and take whatever favors and humiliations he sends your wayPutin may act a friend and pin state medals on your breast, but he is, ultimately, a cynic. And to play ball with him, you have to be a cynic, too. Forget your honor, your rule of law, your independent judiciary, your human rights, your international law, and focus on the gold coins he throws to your feet. And forget looking dignified as you gather them up.

Note that none–NONE–of Ioffe’s examples involve ExxonMobil. Consider Shell’s travails in Sakhalin. ExxonMobil had a project in Sakhalin as well–Sakhalin I. Gazprom tried for years–years–to muscle its way in on that the way it muscled in on Shell’s Sakhalin II. It failed miserably. XOM swatted them away. And note that Gazprom and the Russian government didn’t pull the crap with Exxon that they pulled with Shell, or with BP in Kovytka or with TNK-BP. That’s a very big dog that didn’t bark. You think the Russians were just being nice to Exxon? Hardly. They respond to strength, and knew better than to confront Exxon.

When Rosneft and Exxon were negotiating their deals in the 2011-2013 time frame, Sechin wanted an arrangement similar to that he extracted/extorted from BP: an XOM investment in Rosneft combined with a big Rosneft equity stake in XOM. This went nowhere. Instead, Exxon negotiated a set of joint ventures that limited its exposure and gave it a lot of optionality and off-ramps, thereby limiting its vulnerability to Russian extortion. As further protection, it also exchanged hostages, namely JVs in the GOM. (These were ironically terminated last week, due to bad economics and unfavorable exploration results, thereby demonstrating the tenuous nature of these kinds of ventures.) Sachin was the supplicant, and was rejected.

All of this reveals that ExxonMobil, and Tillerson personally, were quite aware of the nature of the Putin regime, and the dangers in dealing with it. He hardly needs instruction from Julia Ioffe on these things. Indeed, he has more schooling in these matters that pretty much anyone alive, and has far fewer scars to show for it than pretty much anybody else who has tried to deal in Russia (Bob Dudley, for instance). He has fewer scars because he had more power to fight back than even behemoths like BP. Because Exxon is the behemoth among behemoths.

XOM/Tillerson were clearly aware of the lack of property rights in Russia, and the vulnerability to expropriation. They were the industry leaders at structuring contracts to reduce their risk to this. Further, they had the economic heft to stand up to Russia and Putin: Exxon’s market cap is almost equal to the market cap of the entire Russian market. What’s more, Exxon used this economic heft to get good deals out of Russia. If anything, Russia needed Exxon more than Exxon needed Russia–something that BP or even Shell could not say.

In other words, Tillerson is a man who understands Russia well, is intimately aware of its dysfunctions, understands relative power, and is willing to negotiate from a position of strength in order to obtain positive outcomes that limit the risk of exposure to these dysfunctions.

This is a problem why, exactly? That sounds like the perfect skill set. I know those still in shock after losing an election want to blame Russia for all their misfortunes and are (insanely) seeking open confrontation. That’s idiocy. He will have the resources of the most powerful nation in the world at his disposal, and he will know that American power vastly exceeds Russia’s. Tillerson has taken Putin’s measure, knows the players, and knows how to deploy power to reach mutually beneficial outcomes. Sounds good to me.

Also, incentives matter. As CEO, Tillerson was accountable to shareholders, and his compensation largely aligned his incentives accordingly. He was not (directly) accountable to the US government or the American people, and therefore it is expected that he would sometimes make decisions that benefited Exxon but which were not necessarily aligned with American policy or even American interests. (Though no one has provided a compelling example of that.*)

As Secretary of State, however, his incentives will be far different, and his interests will be far less aligned (if aligned at all) with his former employer. However imperfectly, the incentive structure of democratic politics will lead him to make choices that will differ substantially from those he would have made as CEO of Exxon. I would note that there are many, many instances where what people do in office is very different from what they did or said previously. This is because they face very different incentives. To go out on a limb, I would not be surprised if Tillerson becomes a Strange New Respect winner.

I have no idea how Tillerson will perform as Secretary of State. But I am highly confident that his long experience in Russia does not represent a serious concern: in fact, I would venture that it is his greatest attribute.  He dealt with the Russians for years, and didn’t get run over, and indeed, negotiated some pretty favorable deals with them. That speaks volumes.

Further, I would note that Russia is obviously an important policy challenge, but as a declining power that faces some rather daunting geopolitical and economic handicaps, I do not consider it our primary policy threat. The political class’ recent obsession with Russia, to the exclusion of more important countries–China, most notably–reflects the narcissistic rage of a part of the political class that was thwarted in its ambitions, and which is casting about for a scapegoat. These people didn’t give a damn about Russia before last summer, and indeed, to the extent they mentioned it at all it was to scorn those (e.g., Romney) who raised alarms about it. These are not serious people and their hysterics should not be taken seriously. Fixating on Tillerson’s Russian experience and dealings will distract attention from inquiries about his policy thinking on more important issues.

*In the comments Tim Newman mentions ExxonMobil’s dealings with Kurdistan in defiance of US government policy. That’s a good example, though I do find American policy in this regard problematic. Another example that comes to mind is Tilleson’s decision to terminate drilling in Ukrainian waters around the time of the Crimean crisis.

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December 10, 2016

The Glencore/QIA/Rosneft Deal: A Little Clearer Than Mud

Filed under: Commodities,Derivatives,Economics,Energy,Russia — The Professor @ 8:28 pm

Rosneft and Glencore have released some additional information on the three way involving these two firms and the Qatar Investment Authority. These releases answer some of the questions about the deal–and evidently there is now a deal–but not all of them.

The new information indicates that I got some things wrong and some things right in my snap take. What I got wrong was the amount of equity, and hence the amount of leverage in the deal. My original conclusion that the equity investment was €600 million was based on (a) the announcement that Glencore would invest €300 million, and (b) Sechin’s statement that Glencore and QIA would be “equal partners.” (Silly me for believing Igor!) As it turns out, the QIA will invest €2.5 billion, making the deal leveraged a mere 3.6 to 1.

Where I got it right was my surmise that there was a lot of financial engineering going on. We still don’t know the full extent of such machinations, but the Glencore statement gives a glimpse. The key tipoff is the fact that although the Glencore-QIA consortium is 50:50, Glencore is at great pains to emphasize that its “economic exposure” to Rosneft represents a mere .54 percent share of the Russian company, and that “Glencore will not have any economic exposure to its interests in the Shares.”

Well, if the consortium is buying 19.5 percent of Roseneft, and Glencore is 50 percent of the consortium, that’s a wee bit bigger than .54 percent, isn’t it? So there must be some structure or structures that effectively shift the risk to other parties.

The Glencore statement provides a hint of at least one of these structures. It describes this feature:

  • Limited liability structure fully ring-fenced and non-recourse to Glencore apart from its €300 million equity contribution and the provision of margin guarantees of up to €1.4 billion, for which Glencore has obtained full indemnification from appropriate Russian banks.

My interpretation of this is term is that the loan funding the bulk of the purchase includes a margining feature, as in a stock margin loan. That is, the borrower is obligated to put up additional cash if the collateral value of the shares declines. In this case, Glencore has apparently promised to pay up to €1.4 billion. But apparently Glencore has passed this risk to “appropriate Russian banks.” (What’s an “appropriate bank”, anyways?) That is, the Russian banks will stump up the cash in the event of a stock price decline. Sounds to me like the banks have written a put on Rosneft shares (which is one of the structures that I had originally guessed at).

Well, puts aren’t free. Neither of the documents indicates the price of the put, or who is paying the premium.

If Glencore’s downside is limited to €300 million, certainly it doesn’t have a claim to 50 percent of the upside. One possibility is that it is paying for the put by writing a call. If so, the deal basically embeds a swap between Glencore and “appropriate banks” via which the risk of Rosneft shares are essentially transferred to the banks (with Glencore being short the swap and the banks long). If so, this would be a backdoor way for the Russian banks to buy Rosneft shares. To a first approximation their exposure is on the order of 9 percent (19.5 x .5 minus a little to reflect Glencore’s exposure).

This interpretation would square with Glencore’s assertion that “Glencore will not have any economic exposure to its interests in the Shares.” That means neither upside nor downside exposure. Where did the upside exposure go? Most likely to the Russian banks.

The QIA has been totally silent on the deal. It has not issued a press release. (Its web page looks like it was designed by a 15 year old in 1999, and is remarkably uninformative. Go figure.) Therefore, it is unknown if Qatar also has posted “margin guarantees.” If so, it would make calling the debt “non-recourse” highly misleading. It’s not as if QIA could put the keys in the mail and walk away with no additional liability in the event of a large decline in the value of Rosneft stock. Such a margin guarantee feature would effectively make a good portion of the debt recourse, rather than non-recourse, and convert its position into a conventional leveraged equity purchase. (This is because the lenders would have a claim on QIA assets beyond the initial investment.)

Another way to look at this is to ask: where does the risk go? The candidates are: QIA, Glencore, Intesa Sanpaolo and other funding banks, Russian banks “providing financing and credit support,” and even Rosneft (there would be Enronesque ways of passing the risk of an SPV back to Rosneft). Even with the additional disclosure, we only have a limited understanding of where the risk is going. Glencore is insisting its downside risk is very limited: €300 million. Its upside potential is unclear, but it is highly likely that has been transferred elsewhere, mainly to pay for Glencore’s limiting its downside exposure. We know some of the downside exposure has gone to Russian banks. The exact division is unclear.

If I had to guess, I would surmise that the exposure of Intesa and other banks providing funding is limited: margin guarantees limit their risk to a stock price decline. Due to the indemnification, Intesa et al have a rather complex exposure to the credit of Russian banks and Glencore, where this credit exposure also depends on the price of Rosneft stock. Good luck modeling that correlation risk and (implicit) tranching!

As I noted earlier, my guess is that Qatar has a fairly standard leveraged long position in Rosneft.

The Russian banks have a long position too, through the indemnification feature, and likely through the way that is paid for (e.g., a call). If this is the case, and if the “appropriate banks” are state banks like VTB, that makes the privatization something of a sham, or at least only half of what Sechin and Putin are trumpeting, because Russian state entities would have an long equity exposure to Rosneft.

A couple of asides on how this story evolved–or should I say is evolving. First, Rosneft evidently made its initial announcement without clearing it with Glencore. I have been told that the first Glencore’s corporate affairs people heard of the news was when reporters contacted them. Glencore then made a rather bizarre statement, the first sentence of which was: “Glencore notes the announcement released by the Russian government regarding the privatization of shares in Rosneft.” (Emphasis added.) Notes the announcement. Doesn’t confirm the truth of it, just notes it. Glencore then proceeded to say that negotiations were still ongoing and that no deal was finalized, though it anticipated such a result. Methinks that Rosneft made the announcement to pressure Glencore into finalizing the transaction.

Second, just how the official announcement would read was a  matter of contention up to the last minute. Rosneft told several wire services that they would receive a briefing at 11PM Moscow time on Friday (!). But that was delayed hours, apparently because Glencore and Rosneft (and their lawyers) were fighting over how Glencore’s participation would be described. My conjecture is that Rosneft wanted it to appear that Glencore was a full equity participant, thereby putting its imprimatur on Rosneft as a great investment: this would also conceal the risk being passed onto Russian banks. Glencore, as we’ve already seen, is intent on conveying that its exposure to Rosneft is minimal. This would no doubt allay its creditors concerns–but it would also undermine Sechin’s narrative. Hence the battle. Reading the releases, it looks like Glencore won. The sense I get is that Glencore is signaling that it gained significant trading benefits (a big offtake agreement, and potential for future commercial ventures with Rosneft) without having to expose itself all that much to Rosneft’s embedded price, operational, and political risks.

Perhaps some additional details will come out. But I doubt much more will. If I’m right, Rosneft and the Russian banks have little interest in disclosing how much risk Glencore is passing along to them. Glencore will be happy as long as it is convinced its creditors and investors believe that it has little exposure to Rosneft but has gained significant commercial advantages. And QIA don’t need to tell nobody nothing.

So as it stands, things are clearer than mud, but not much. Like the Brazos River or somesuch.


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December 7, 2016

Ivan Glasenberg’s Shock and Awe: But There Has to Be More Than Meets the Eye

Filed under: Commodities,Derivatives,Economics,Energy,Russia — The Professor @ 8:25 pm

Today saw a major surprise. I mean a major surprise. The Russian government announced that a consortium consisting of Glencore and the Qatar Investment Authority had purchased a 19.5 percent stake in Rosneft for €10.5 billion. (Glencore said the price was €10.2 billion.)

The major surprise was that outside investors were involved at all at this time. For weeks the story had been that Rosneft itself would buy back the shares from the Rosneftgaz holding company, and then sell them to a private investor at a later date. This looked like a sham privatization, which fit in with the idea that Igor Sechin was less than enamored with the idea of selling equity to outsiders.

Also a surprise was Glencore’s participation. Qatar’s name had been floated as a possible buyer, but not Glencore’s. And no wonder. The firm is just recovering from a near death experience, has been feverishly de-leveraging, and only a few days ago announced it would pay $1 billion in dividends next year. So it hardly looked like a firm that would have the cash to pay out of pocket, and was not a candidate to borrow a lot.

But it appears there is some financial engineering going on here. A Glencore-QIA joint venture will buy the Rosneft shares, and the two investors will put up a mere €300 million each in equity. The remainder will be financed (according to Putin) by one of “the largest European banks.” Furthermore, the debt is supposedly non-recourse to Glencore or QIA. This means that the loan is essentially secured by the Rosneft shares.

This would allow Glencore to keep the debt off its balance sheet, and skirt sanctions by not having an equity stake in Rosneft.

If those numbers are right, the deal will be leveraged 17.5-to-1. That reminds me of a real estate boom SPV–except that the underlying asset here is even riskier than subprime. Given the riskiness of the underlying asset (Rosneft shares) that gearing seems unsustainable to me. What bank would take that risk?: the bank owns all the downside, and the JV partners get all the upside.

You can bet that any bank wouldn’t let you buy Rosneft shares on that geared a margin loan–and a non-recourse one no less. So I am guessing that there is some other part of the deal that passes the equity price risk back to Glencore and QIA. For instance, a total return swap between the JV and its owners. Or a put (which would make it unnecessary for the JV to make payments to the investors in the event Rosneft stock rises in value, as would be the case in a TRS.) If that, or something like it, is going on here, this is a cute way to keep investment off Glencore’s balance sheet, and also may be a way to work around sanctions, because derivatives on Rosneft debt (e.g., CDS) and equity are not subject to the sanctions. I cannot believe that any bank would lend so heavily based only on the security of Rosneft stock. So there must be a part of the deal that hasn’t been disclosed yet. (This may also involve an arrangement between Qatar and Glencore that limits the latter’s exposure.) There is more here than meets the eye, at least from the initial reporting.

Speaking of sanctions, the fact that a European bank (who?–reportedly Intesa Sanpaolo) is stepping up suggests that they believe the structure is sanctions-proof. This may also be a Trump effect: banks may have less concern about aggressive sanctions interpretation and enforcement in a Trump administration.

If it is Intesa Sanpaolo–that’s also rather interesting. Italian banks aren’t exactly in great shape these days, and are particularly shaky in the aftermath of the rejection of the referendum on Sunday. It is one of Italy’s healthier banks, but like saying someone is one of the healthier patients in the oncology ward. (Its equity is about 7 percent of assets.) Normally a loan of this size would be syndicated to spread the risk. If it isn’t, the loan represents more than 20 percent of Intesa’s equity and almost a quarter of its market cap. That’s insane.

All the more reasons to think that the bank has to find a way to lay off the price risk in the deal. (All the ways I can think of would expose it to the credit risk of Glencore and QIA. The latter isn’t an issue . . . the former could be. All the more reason to consider the possibility of QIA providing some credit support in the deal even if it is formally non-recourse.)

Another interesting aspect to the deal. Trafigura has been an important bulwark for Rosneft in the last two plus years. It dramatically stepped up its pre-pay deals with Rosneft, thereby providing vital (though very short-term sanctions compliant) funding when the Russian company was cut off from the capital markets. Moreover, Trafigura’s participation was a linchpin in Rosneft’s acquisition of Indian refiner Essar. As a result of these deals, Trafigura had nudged out Glencore as Rosneft’s biggest Russian partner. Now Glencore owns a major equity stake, and as part of the deal gets a 220,000 barrel-per-day off-take agreement with Rosneft. This gives Glencore 11.5 million tons/year of oil. Trafigura has been doing about 20 million tons of crude and 20 million tons of product from Rosneft. (Glencore also has off-take volume stemming from a 2013 pre-pay deal.)

Perhaps Trafigura did not have an appetite or capacity for doing much more volume with Rosneft, but it must be disconcerting to see Glencore take such a large equity stake. That undoubtedly has implications for Rosneft’s future dealings.

This transaction says a lot about Ivan Glasenberg. Given the experience of the last two years, one could have understood if he had been risk averse. This shows that his legendary appetite for risk remains. (And the more of the equity risk that is passed back to Glencore through financial engineering, the bigger that appetite will be shown to be.) This was shock and awe.

This deal is a boon for Russia and Putin, who can really use the money, and outside money especially. I wonder if Sechin is all that pleased, though. As noted earlier, he has been dragging his feet on privatization. Earlier this year a Rosneft analysis said the company would only be able to raise $1-$2 billion: obviously this was intended to convince Putin that a privatization would be a giveaway that he should take a pass on. But I’m sticking with my earlier guess that going through with the privatization was the quid pro quo for Putin allowing Rosneft to buy Bashneft. And again, Vlad really needs the money.

One last thing to put this all in perspective. Yes, €10 billion seems like a lot, but that values Rosneft at around $55 billion. The company’s reserves are about 34.5 billion barrels of oil equivalent (BOE). Its output is around 1.75 billion BOE per annum. For comparison, ExxonMobil is worth ~$350 billion. Its reserves are a third smaller than Rosneft’s: 24.8b BOE. Its output of 1.43 billion BOEPA is about 80 percent of Rosneft’s. So on a dollars per unit of reserves or output basis, XOM is about 8-9 times as valuable as Rosneft. That speaks volumes about Rosneft’s inefficiency, and the political risks that go along with the normal commercial risks inherent in an oil company. Keep that in mind when evaluating Putinism.


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December 2, 2016

Lucy Putin?

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 12:53 pm

I was somewhat surprised that OPEC came to an agreement. I will be more surprised if they live up to it: that would be not just going against history, but against basic economics. The incentives to cheat are omnipresent (as the Saudi’s ex-Minister of Petroleum of Petroleum Naimi acknowledged in the aftermath of the announcement). Further, what is the enforcement mechanism? Retaliatory output increases/price cuts (i.e., price wars)? Moreover, given that many OPEC nations are facing acute budgetary strains, the present looms and the future looks very, very far away: consequently, getting some additional revenue today at the risk of losing some revenue a year or two from now when a price war breaks out looks pretty attractive.

The breathless TigerBeat-style reporting of the meeting states that Russia’s last-minute intervention rescued the deal. A few things to keep in mind. Russian oil output has surged in the last few months, meaning that its promise to cut 300,000 bbl/day basically puts its output back to where it was in March. This is in fact pretty much true of the OPEC members too: the deal very much as the feel of simply taking two steps back to reverse the two steps forward that major producers took in the past 9 months (and the two steps forward were no doubt driven in large part to improve bargaining positions in anticipation of the November OPEC meeting).

Moreover, the timing of the Russian commitment is rather hazy. Energy Minister Alexander Novak said Russia would cut “gradually.” That can mean almost anything, meaning that the Russians can say “the cuts are coming! Trust us! We said it would be ‘gradual!'” and that there will be no hard evidence to contradict them.

The most amusing part of this to me is that many are interpreting Putin’s personal involvement as proof that the Russians will indeed cut. “If Putin tells Russian oil companies to cut, they’ll ask ‘how deeply’?”


Call me cynical (yeah, I know), but I find this scenario far more plausible: Putin sweet-talked the Saudis and Iranians to overcome their differences to cut output in order to raise prices, all the while planning to sell as much as possible at the (now 10 percent) higher prices. Breezy promises cost nothing, and even if eventually OPEC members wise up to being duped, in the meantime Russia will be able to sell to capacity at these higher prices. Yes, the OPEC members will be less likely to believe him next time, but Putin’s time horizon is also very short, for a variety of reasons. He’s not getting any younger. And more immediately, the Russian recession is dragging into its third year, and budgetary pressures are mounting (especially since he is committed to maintaining a high level of military spending). The Russian Wealth Fund (one of its two sovereign wealth funds) has been declining inexorably: the rainy day fund is almost empty, and the skies still haven’t cleared. And the presidential election looms in 2018. For Putin, the future is now. The future consequences of making and breaking a promise are not of great importance in such circumstances. But more money in the door today is very, very important.

Russia isn’t like other OPEC producers, which have national oil companies that respond to government orders. Although government-controlled Rosneft is the biggest producer in Russia, there are others, and even Rosneft and Gazpromneft have more autonomy than, say, Saudi Aramco. Yes, Putin could, er, persuade them, but a far more effective (and credible) tool would be to adjust taxes (especially export taxes on both crude and fuels) to give Russia’s producers an incentive to cut output (and especially exports, which is what OPEC members really care about). A tax boost would be a very public signal–and reversing it would be too, making it harder to cheat/renege. (Harder, but not impossible. The government could give stealth tax cuts or rebates. This is Russia, after all.) But I have not seen the possibility of a tax rise even be discussed. That makes me all the more skeptical of Putin’s sincerity.

So my belief is that Putin is stepping into the role that Sechin played in 2009, that is, he is being Lucy beckoning Charlie Brown/OPEC with the football. And Charlie Brown is attempting a mighty boot. We know how that works out.

Even if Putin lives up to his pinky-swear to cut output, Russia has cut a much better deal than the Saudis. The promised Russian cut is about 60 percent of the Saudi cut, yet both get the same (roughly 10 percent) higher price, meaning that (roughly speaking) Russian revenues will rise 40 percent more than than Saudi revenues do–assuming that both adhere to the cuts. The disparity will be greater, to the extent that Russia cheats more than the Saudis.

Time will tell, but what I am predicting is that (a) Russia will not cut anything near 300kbbl/d, and (b) cheating by OPEC members will snowball, meaning that next November’s OPEC meeting will likely be another rancorous effort dedicated to repairing a badly tattered deal, rather than a celebration of the anniversary of a successful and enduring bargain.

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November 15, 2016

Igor Sechin Takes His Revenge

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

The Bashneft sale to Rosneft (which I wrote several posts about) is a done deal, but apparently there was some unfinished business. Namely, the business of  revenge.

On Monday Economic Development Minister Alexei Ulyukayev was detained for corruption. He allegedly took a $2 million bribe to “allow” the sale. Indeed, Bloomberg claims he was caught in the act:

Ulyukayev, 60, was detained on Monday “in the act” of receiving the cash, said Russia’s Investigative Committee. He was later charged with demanding the money from Rosneft PJSC to allow its purchase last month of the government’s 50 percent stake in regional oil producer Bashneft PJSC, the agency said in a statement. The economy minister denies any wrongdoing, his lawyer Timofei Gridnev told Business FM radio. Investigators moved that he be held under house arrest before he arrived for arraignment Tuesday at Moscow’s Basmanny Court.

Ah, Basmanny justice. Gotta love it.

This all seems quite bizarre. The Bashneft acquisition was clearly a source of intense conflict with the Russian government, with the government ministries–including Ulyukayev–initially expressing opposition. Then there was temporizing, with Putin seeming to come down on both sides of the issue. Then it was decided in Rosneft’s–that is, Igor Sechin’s–favor.

Presumably, Putin was the ultimate decider here. If so, Ulyukayev was in no position to “allow” anything. Maybe he had a chance to make his case, either directly to Putin, or indirectly via Medvedev. But once he lost, he would have been delusional to think he had any leverage over whether the deal would proceed.

Further, the timing is beyond strange. The deal was decided in September, and finalized on October 12, more than a month ago. So, did Ulyukayev give net 30 terms on the bribe? Net 60? Was it half now, half later? Is bribery really done on credit in Russia?

I would also venture that attempting to shake down Sechin and Rosneft is tantamount to suicide. Did Ulyukayev attempt such a risky thing? Did Sechin play along and then facilitate a sting by the Investigative Committee? Or was this a set-up job from the start?

One thing that is almost certainly true is that this is Sechin taking his revenge, and sending a message to others: look at what happens to those who cross me.

The Energy Ministry, under Novak, also opposed the deal initially. I wonder if he is sleeping well.

There are some comic elements to the story. Several stories breathlessly report a law enforcement leak saying that Ulyukayev’s phone had been tapped “for months.” Um, pretty sure it was tapped like forever.

Ulyukayev has a reputation as a “liberal” in Russia, and assorted Western dimwits expressed Shock! Shock! at his arrest. Prominent among these were Anders Aslund and my fellow professor and buddy Michael McFaul. I say dimwits for several reasons. First, is it news to them that the “liberals” in the Russian government are marginalized, and exist at the sufferance of people like Sechin who are in Putin’s inner circle? Second, are they so credulous as to believe that these liberals are untainted by corruption? Puh-lease. Ulyukayev appeared in the Panama Papers. Further, the “liberals” and “reformers” mainly go back to the Yeltsin period, and remember that  Yeltsin elevated Putin in exchange for foregoing any investigation or prosecution of the rife corruption of the Yeltsin administration. Ulyukayev was associated with Gaidar, who was also tied to corruption (although the publicly revealed instances were small beer by Russian standards).

There are no clean hands in Russia. This very fact is what usually keeps people in line, for they know the adage “for my friends, everything: for my enemies, the law!” Everybody is vulnerable to prosecution, because everybody is corrupt: actual prosecution is used sparingly, however, to punish those who have committed a political transgression.

Ulyukayev clearly committed such a transgression, and hence he finds himself in the dock.

There is no reason to be shocked by this. It merely confirms that people like Sechin are the real power. But this is apparently a revelation to alleged Russia experts.

Bashneft is the Hope Diamond of oil companies: it seems to bring bad luck to anyone who touches it. Ural Rakhimov, the son of the boss of Bashkortostan (where the company is located), who profited from the corruptly done privatization of the company in 2002, but who apparently fled Russia when the privatization and subsequent sale came under government scrutiny. Vladimir P. Yevtushenkov, who bought Bashneft from Rakhimov, but then wound up under house arrest for 92 days for allegations related to the privatization: he walked only after the government seized Bashneft shares from Yevtushenkov’s holding company before performing the re-privatization Kabuki that ended with the company being bought by Rosneft. And now Ulyukayev.

Will the skein of bad luck end with Rosneft and Sechin? That’s a good bet, but not a lock. Who knows what changes in power are in store, especially as Putin ages, or if there is some economic or political shock?

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