Streetwise Professor

March 14, 2012

Gazprom: Disconnected From Commercial Reality

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 9:06 am

Gazprom is having difficulty making inroads into Asia generally, and into the LNG market particularly.  Its problem?  Apparently so used to dealing with Europeans who have few outside options (yet), the company is incapable of operating in a competitive environment.  It is fixated on maintaining its traditional oil-linked pricing formula, despite the facts that (a) in the US natural gas prices on an energy equivalent basis have fallen to an all time record low vis-a-vis oil, and (b) US firms, notably the Cheniere Energy* mentioned in the Bloomberg piece, are gearing up to export LNG, particularly to Asia, making the US the likely supplier of the marginal mmbtu of gas, and hence making it the world price setter:

OAO Gazprom (GAZP), the world’s largest natural-gas exporter, is struggling to get a foothold in the Asian markets leading global economic growth.

The Russian company’s plan to supply liquefied natural gas to India from 2016, the year the U.S. is set to start gas exports, is faltering after buyers said they’re looking for cheaper fuel from North America. Last year, decade-long talks to supply pipeline gas to China foundered over price disagreements.

“Gazprom has a major problem of having a fixed view on what the price of gas should be, irrespective of market conditions,”Jonathan Stern, chairman and senior research fellow at the Oxford Institute for Energy Studies, said by e- mail. “If this continues, it will create increasing problems for Russian gas exports.”

“Irrespective of market conditions.”  Yup.  That’s the Gazprom way, and that way doesn’t work when it’s not the market.   In contrast, Cheniere is linking LNG prices to US natty gas prices:

GAIL India Ltd. (GAIL), the country’s largest gas supplier, became the first Asian buyer of U.S. natural gas in December when it signed a 20-year deal with Cheniere Energy Partners LP (CQP), which is planning the first U.S. export terminal. The contract, targeting 3.5 million tons a year starting in 2017, is linked to the day- to-day U.S. benchmark gas prices, which fell to a 10-year low of $2.21 a million British thermal units in January. It will also include a fixed component.

Note that this also permits companies like GAIL to lock in a fixed price fairly easily, given its ability to use derivatives to swap floating prices into fixed ones.  (The fixed component in the formula mentioned above covers liquification and transportation costs.)

Gazprom is a hidebound organization, grotesquely inefficient, notoriously corrupt, and unused to and arguably incapable of operating in truly competitive conditions.  It has a guaranteed monopsony at the upstream end (being the only company permitted to export Russian gas) and has traditionally sold in markets downstream where there is little, and often no, competition from other sellers.

Its disconnect from commercial reality grows with every widening of the difference between gas and oil prices.  It can insist on its self-serving formula, but as the US becomes a major exporter of gas-as fundamentals imply that it should be-its insistence will make it an also ran in the LNG market.

Right now, Gazprom’s biggest hope is that political resistance to gas exports in the US lead to bans or limitations on those exports, or the approvals and permitting for export terminals getting bogged down in the American bureaucracy.  Usual Suspect Ed Markey (D-MA) has introduced a bill to ban gas exports.  This will not go anywhere, but it does give edgy Asian buyers pause.  In the aftermath of Keystone XL, moreover, it is clear that failure to secure regulatory approvals can delay or derail altogether extremely beneficial energy initiatives.

Ironic, isn’t it, that Gazprom’s biggest hopes may be in DC: The White House, Capitol Hill, and FERC (which is responsible for permitting LNG export facilities)?

* Full disclosure: #1 daughter works for Cheniere. Any reader of this blog knows, however, that my criticism (ridicule, really) of Gazprom and my commitment to free trade long pre-date her employment there.

Pit Bull Bites Man

Filed under: Derivatives,Economics,Financial crisis,Financial Crisis II — The Professor @ 8:36 am

In a cri du coeur published in the New York Times, resigning Goldman executive director Greg Smith claims that the firm “sidelines” the interests of its clients “in the way it operates and thinks about making money“:

Integrity? It is eroding. I don’t know of any illegal behavior, but will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client’s goals? Absolutely. Every day, in fact.

Smith also claims that this wasn’t the case when he joined the firm 12 years ago, when apparently Goldman was all about helping little old ladies cross the street and rescuing kittens stuck in trees.  The firm’s dastardly turn is all the doing of Lloyd Blankfein and Gary Cohn.

Please. Goldman is, for the most part, what Goldman was. If you want a look at the firm’s “moral fiber” pre-2000, pre-Blankfein & Cohn, review the history of LTCM’s collapse.  The teetering hedge fund came to Goldman for help.  Goldman said it had to review LTCM’s books first, which LTCM in its desperation  permitted-only to have Goldman trade against every position in that book.

When dealing with any investment bank, and Goldman in particular, caveat emptor is the only rule to follow.  And it always has been.

My surmise is that Smith’s perception that things have changed is a very solipsistic one.  As he’s progressed up the organization-rapidly, to a very high position-he’s privy to things now that he wasn’t as a doe-eyed intern. What he’s seen has changed not because what is to be seen has changed: just that he wasn’t in a position to see it before.

What’s amazing is that an obviously very smart guy wouldn’t consider that possibility.  What’s even more amazing is the credulousness of the financial press in its reaction to Smith’s piece.  It’s obvious they haven’t thought of that possibility either.

March 12, 2012

CC Rider, Oh see, what you have done

Filed under: Uncategorized — The Professor @ 2:31 pm

People associated with Wikileaks appear to be very anxious about the prospect that Jules Assange will be implicated in the Stratfor criminal hack.  One example: Christiane Assange, Jules Assange’s mother tweeted me: “Perhaps u are unaware that the U.S.Doj will try to indict Julian using the term ‘hacker’ not ‘journalist’.”  This in response to her earlier tweet in which she said there was a difference between hacking and journalism, to which I asked about the Wikileaks-Stratfor connection.

The complaint against alleged Stratfor hacker Jeremy Hammond contains many tidbits that suggest, as I suspected as soon as the LulzSec bust was revealed, that anyone associated operationally with Wikileaks has a lot to worry about.

The highlights:

  • Hammond chatted with Sabu about a “new target”-apparently Stratfor-on 6 December, 2011.
  • The hack was evidently completed by 14 December.  Sabu asked Hammond whether the target was Stratfor, and Hammond acknowledged it.
  • Sabu provided Hammond access to servers thoughtfully paid for and monitored by the FBI onto which Hammond downloaded all the Stratfor material.
  • A “co-conspirator”-”CC-1″-upload all the information on 19 December. That was the only time the information was accessed.
  • Wikileaks announced that it had the Stratfor material on 27 February, 2012, and hyped an email that claimed that Stratfor’s Fred Burton knew that Assange had been indicted.
  • The FBI began physical and electronic surveillance on Hammond’s residence on 28 February.  Hammond made their lives easy by using wifi.
  • Although Hammond used Tor to conceal his tracks, a “Tor network expert” helped the FBI verify that Hammond was connecting to Tor.  Those operating Tor servers can identify the IP addresses connecting to them.  (“Tor sniffing.”)

It is clear that CC-1 has to be someone associated with Wikileaks.  So Wikileaks is a co-conspirator.  The entire transfer of the Stratfor information was monitored by the FBI, and even if the downloader [fixed-had said uploader] had used Tor, the FBI would presumably know the IP or IPs used to connect to the server on which the information was stored.

Some interesting issues.

  • The complaint is very hazy-certainly deliberately so-on the communications between Hammond and CC-1.  Presumably they have it all, or most of it. This raises the questions: when did the conversations start?  Was CC-1 in communication before the hack, or just afterwards? Who initiated the contact? In some respects, it’s moot whether CC-1 was an accessory/conspirator before or after the fact, but it is interesting nonetheless.
  • Even though the information in the Hammond complaint makes it quite clear that the FBI had sufficient information, based on Hammond’s revelations as early as July, 2011 about his various arrests in multiple cities, to identify Hammond as the hacker soon after they turned Sabu, they did not begin physical surveillance until 2/28/2012.  (The complaint does say it began “continuous physical surveillance” on that date, leaving open the possibility of intermittent surveillance earlier.)  Why the delay? And is it merely a coincidence that the continuous physical surveillance began the day after Wikileaks /Assange released the Stratfor emails?
  • Who is the “FBI Tor network expert” mentioned on p. 31 of the complaint?  Various Anonymous-types started asking Appelbaum whether he was involved.  Appelbaum went silent on twitter for a couple of days, returning today saying: “Huh? I’ve been announcing hack meetups at Noisebridge in the last few days. For you know, hacking, not twittering.” Whether or not Appelbaum (and recall that Tor gets virtually all its funding from the USG) is the expert, suspicions have been aroused, and those can take on a life of their own. (Generally, the relation between Tor-and Appelbaum-and the government is quite ambiguous, which is probably in the interests of all involved.  But as the LulzSec case shows, Tor could be just one big cyber Venus Flytrap.)

Right now there are more questions than answers, but there is more than enough to conclude that Wikileaks and Assange indeed have much to fear from the Stratfor/LulzSec events.  The FBI watched at least some of the transaction involving the transfer of stolen information to someone at Wikileaks.  As the “man in the middle” they presumably know very much indeed about those at either end-including Wikileaks-most of which has to be inferred right now.  But not for too long, I’m guessing: and if Christiane Assange’s tweet means anything, it means that people very close to Assange are guessing the same.

March 11, 2012

Sarko Whistles Past the Graveyard

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 3:39 pm

Nicholas Sarkozy said this about Greece: “”Today the problem is solved.”

Uhm, not so fast, Sarko.  The Greek economy is imploding.  The political situation there is still fraught.  The feasibility and credibility of the austerity pledges are highly questionable.  Realistic forecasts suggest that even with the 100 billion or so (largely coercive) writedown in government debt, Greece’s obligations are not sustainable.

The markets are already giving their verdict.  The new Greek debt (to be issued to private holders of the old debt) is trading on a when-issued basis at very high yields:

Markets showed investors have no faith that the bond swap will draw a line under the country’s troubles. Under Greece’s austerity and reform programme, its debt burden in 2020 should fall to where Portugal’s is now.

If investors believed Athens could succeed, yields on Greek and Portuguese bonds should be similar. But on the grey market, the new Greek bonds were yielding 17-21 percent, far above Portuguese levels around 11-14 percent.

And it’s not like Portugal’s yields are any great shakes.  Indeed, Portugal is itself at serious risk of default.

What do 17-21 percent yields mean? Here’s what they mean:

Initial quotes in the “when-issued” market for the new Greek 2042 government step-up bond range between 17% and 22% of face value, according to traders with knowledge of the matter. Small-sized trades are going through the broker market as dealers “test the water,” according to one trader.“We are quoting the new 2042 bond between 20 and 22 cents to a euro…there is some interest to trade these securities but volume is still quite small,” said a London-based market maker.

Sarkozy is whistling past the graveyard.  Official European entities, like the ECB, are Greece’s primary creditors.  All of Europe is on the hook for its debts: the effective subordination of the new debt in private hands is a main reason why the new debt is trading at such heavy discounts, but even given the senior status of Greek debt in official hands, it is unlikely those official creditors will receive full payment. Given the imploding economy and potential for political backlash in Greece, it is rather naive to think this is solved.  This may be the end of the beginning, but it is nowhere near the end.

Europe might have bought some time, but the key thing is what they do with it.  Sarkozy’s confident statement suggests they may well be wasting it.

This is Exactly Why I Don’t Give a Flyer About Contraception

Filed under: Economics,Politics — The Professor @ 2:57 pm

Rather than going away, the contraception carnival returned stronger than ever the past couple of weeks.  And although on the facts the whole Sandra Fluke thing is a farce, politically it has served its purpose.  In particular, having Rush Limbaugh go on a rant accusing Fluke of being a AAA girl (and no, that does refer to an auto club) allowed Obama to pose as the defender of oppressed womanhood, to the point of bringing his daughters into the debate.  (Uhm, whatever happened to how much he hated that his family was dragged into politics?  I guess the more accurate statement would be he likes to have the option to drag it in when it is politically expedient for him.)  More importantly, it again distracts attention from the crucial issues.  Spending. Obamacare. Iran. Obama is vulnerable on all these issues: he suffered bruising political defeats on these issues in 2010.  Hence the desperate need to change the subject.

The media, of course, will always oblige.  And so will the Stupid Party, and others on the right, who chased after the Sandra Fluke matter like a golden retriever bounding after a ball.

In politics, as in war, victory often depends on choosing the ground on which the battle is fought.  Social issues are Obama’s ground. The issues of 2010 are not. Will anybody get a clue?

Even academics have been swept into this debate, unfortunately.  The University of Rochester’s excellent, hyper-intelligent, and very articulate Steven Landsburg wrote a post defending Limbaugh, and followed it up with a typically incisive post on the inefficiency of subsidizing contraception. URochester President Joel Seligman (whom I know slightly from when we overlapped at Wash U)  just couldn’t permit such acts of speech-and analysis-pass.  He attacked Landsburg publicly, accusing the economist of “demean[ing] a student.”  Not Landsburg’s student.  Not even a Rochester student.  An adult student at another university whom Landsburg has no power over whatsoever, who is in no way Seligman’s responsibility, and who of her own volition inserted herself quite vocally as a partisan in a contentious political debate, but who apparently is immune from the ridicule that Landsburg heaped upon her.

Seligman of course issued the disclaimer that he fully respected Landsburg’s right to exercise his academic freedom, and couched his criticism as a mere statement of his views.  But that’s all weaseling.  When a university president makes a public statement criticizing a faculty member (an apparently unprecedented act insofar as Seligman is concerned), it carries an implicit threat to utilize the powers of the president’s office to punish those with the temerity to voice politically incorrect views. Moreover, it is a signal to others in the university that attacks or retaliation directed against the transgressive faculty member not only will not be discouraged, but actually have official sanction.

Landsburg is perfectly capable of defending himself, as he did here and elsewhere. Seligman picked the wrong target, and Landsburg is unlikely to be deterred in the future from speaking his rather impressive mind.  But other faculty members, less accomplished, less secure professionally and economically (and perhaps personally), and less renowned will almost certainly be far more reluctant to offend the Gods of Political Correctness knowing that such offenses may bring down the wrath of the university president, and may be interpreted as an invitation to other faculty to rid him of this troublesome faculty member.

Seligman gave lip service to academic freedom, but he would have given it genuine service had he kept his lip zipped.  Or, his statement should have ended after acknowledging Landsburg’s academic freedom to make controversial statements.  Seligman’s attempt to suggest a symmetry between his statement and Landsburg’s-that both were merely exercises of academic freedom-is belied by the fundamental asymmetry in power and authority between his position and Landsburg’s.  An asymmetry that leftist academics are quick to point out in other circumstances.

Oh, would this all go away so that it would be possible to focus on things that really matter.  Big things.  But it is in the interest of too many to keep this kind of distraction going.

March 8, 2012

Can’t Have It Both Ways, Bart

Filed under: Commodities,Derivatives,Energy,Politics,Regulation — The Professor @ 9:37 pm

Bart Chilton has been fairly quiet recently, but today he made news twice, with two completely contradictory statements.

First, he bemoaned the lawsuits challenging the CFTC’s ability to quantify the costs and benefits of its regulations-as required by Congress:

“Some regulators live in constant fear and are virtually paralyzed by the threat” that they will face “spuriously” filed suits alleging that the costs and benefits of their rules weren’t adequately considered, Chilton said in a speech prepared for the Trade Tech 2012 conference today in New York. “It is a bastardization of the conduct and use of cost-benefit analyses in regulatory rulemaking.”

. . . .

Chilton, a supporter of the speculation limits, said banks and others should be required to provide cost analyses to rebut regulators’ conclusions.

“We put out a proposal, ask for comments and ask what the costs might be,” Chilton said. “Then we either aren’t provided with costs of the regulation, or what we get from the commenters isn’t very helpful.”

Well, if the CFTC could accurately quantify costs and benefits, (a) it wouldn’t need help from the banks to provide cost/benefit analyses, and (b) it wouldn’t have to fear lawsuits claiming it hadn’t performed an adequate analysis.  Eliding over the issue of burden of proof-which Congress has clearly placed on the agency by statute, not on those subject to the rules as Chilton would like it-this is a clear confession that the CFTC is incapable of performing a rigorous analysis that would persuade a court: if it was confident in its ability to do so, why the paralysis.

But on the same day (and I think the same event) Chilton quantified the effects of “excessive speculation” on energy prices to the penny.  Seriously:

Today, Chilton is expected to tell the traders that the “speculative premium” on oil adds 56 cents to every gallon of gas, which he calls “an enormous drain” on businesses. Chilton has previously said oil speculation costs every consumer up to $757 extra a year.

Not 55 cents.  Not 54 cents.  56.  Not $756 dollars/year.  Not $758.  $757.

And Bart can give very precise industry breakdowns of the impact:

Runaway oil speculation is costing the airline and trucking industries $39 billion a year in added expenses, according to new data to be released today.

The airline sector alone could save as much as $9.8 billion annually if Wall Street speculation is curbed, Commissioner Bart Chilton of the Commodity Futures Trading Commission is expected to announce today.

The trucking industry stands to save even more, as much as $29.1 billion a year, according to Chilton, who will reveal the data in a speech before a group of traders at the Javits Center.

I have no clue how Bart calculated these numbers.  (I suspect he has no clue either.  A little more than “suspect”, actually.)  But apparently he believes he can calculate the impacts of speculation with considerable precision, and since there is no way the costs of complying with the regulation could run into the mid-11 figure per year range, it follows immediately that Bart should have no problem convincing any court in the land that the benefits of the regulation exceed the cost.

So why doesn’t he?  So why are he and his fellow commissioners “paralyzed” by the prospect of providing the cost benefit analysis?

The easy answer is that Chilton is almost certainly MSU (making stuff up–trying to keep it clean tonight, folks) regarding the impact of speculation.  I am very familiar with the literature, and the available methods.  Such accurate quantification is impossible, and no reputable method has produced such numbers.

So when is Bart BS-ing? When he says it is impossible to quantify the benefits and costs of the position limit rule?  Or when he says he can–to the penny?

The answer cannot be “neither.” It’s one or the other.  Smart money answer: he can’t really quantify, which is why he doesn’t want the CFTC to be forced to do so.

Which raises another point.  The CFTC position limit rule’s cost benefit analysis, such as it is, repeatedly says that Congress has decided that position limits are necessary, and that as a result the benefits of the rule are presumed to exist.  But Congress has also decided that cost-benefit analysis is required.  The commission doesn’t really have the ability to choose which Congressional directives it must follow, does it? And wouldn’t the cost-benefit analysis requirement be superfluous if Congress had already decided that the benefits exceeded the costs, as the position limit rule repeatedly argues?  So doesn’t that undermine the commission’s argument?

Full disclosure: I filed a declaration on behalf of ISDA  and SIFMA in what Chilton believes to be the “spurious” lawsuit challenging the position limit rule. But as anyone who has read this blog knows, or who has read some of my other writing knows, I have long been critical of claims that speculation distorts prices, and of position limits.

March 7, 2012

More Timeless Smithian Wisdom on Speculation

The material from Book IV, Chapter 5 of Wealth of Nations is quite interesting, and applicable to today’s debate over speculation.  In this regard it is useful to distinguish between financial speculation and what is sometimes referred to as “speculative storage.”  Financial speculation is what often gets people’s jockeys in a bunch, but unless these financial speculators are somehow affecting quantities produced or consumed–by distorting prices in ways that induce distortions in storage, for instance–this activity will not affect the prices that consumers pay or producers receive.  Financial speculators deal in price risk, and affect the price of that risk first and foremost. (These statements are a little overbroad: I refine the analysis a bit below.)

What Smith discusses in IV.5 is speculative storage.  People holding inventories of commodities in anticipation of future market conditions.

Such storage decisions are inherently speculative, in the sense that they are based on expectations about future market conditions.  That’s what storage is all about-and what my book on structural models of commodity prices is all about.  Based on noisy signals, market participants try to determine whether the commodity is going to be more scarce in the future than it is at the present.  If so, it is optimal to add to inventories because the commodity is going to be more valuable in the future.  If not, it is optimal to draw down on inventories.

Since these decisions are necessarily based on conjectures about future fundamental conditions, there is a natural role for speculation: taking risky positions in the expectation of earning a profit, based on current information.

If a speculator is correct, he can make large profits.  A speculator who anticipates that the next crop will be small will add to inventory, and if he is right, can sell that inventory at a high price when the crop is harvested and the shortage revealed.  And note that his actions are beneficial: yes, he sells at a high price, but the price would have been higher still had he not added to the speculative inventory in anticipation of the future shortage.  Further note that his actions do raise prices at the time he adds to inventory: if he doesn’t those bushels would be sold and consumed, and the price today (prior to the harvest) would be lower than they are when he holds them off the market (in Smith’s terms, “forestalls” or “engrosses’.)

Of course the speculators are not always right.  They are working on limited information, and things can change over time-think of how decisions made in June of 2008 looked in October of that year.  But this means that speculators have an incentive to collect information to allow them to make better decisions.  Moreover, purely financial speculators that collect information and trade on it (such as by trading calendar spreads) can contribute to price discovery that leads to better inventory decisions.  And as I’ve shown in some of my academic work (some currently in progress) financial speculators can reduce the cost of inventory by absorbing price risk from inventory holders, leading to an efficient unbundling of the functions of making inventory decisions and holding inventory on the one hand, and bearing the price risk of inventory on the other.  (Smith makes a similar point, related to the allocation of capital rather than risk, at IV.5.55-56.)

Smith recognizes the benefits of this intertemporal trade, undertaken by speculators:

Secondly, it supposes that there is a certain price at which corn is likely to be forestalled, that is, bought up in order to be sold again soon after in the same market, so as to hurt the people. But if a merchant ever buys up corn, either going to a particular market or in a particular market, in order to sell it again soon after in the same market, it must be because he judges that the market cannot be so liberally supplied through the whole season as upon that particular occasion, and that the price, therefore, must soon rise. If he judges wrong in this, and if the price does not rise, he not only loses the whole profit of the stock which he employs in this manner, but a part of the stock itself, by the expence and loss which necessarily attend*79 the storing and keeping of corn. He hurts himself, therefore, much more essentially than he can hurt even the particular people whom he may hinder from supplying themselves upon that particular market day, because they may afterwards supply themselves just as cheap upon any other market day. If he judges right, instead of hurting the great body of the people, he renders them a most important service. By making them feel the inconveniencies of a dearth somewhat earlier than they otherwise might do, he prevents their feeling them afterwards so severely as they certainly would do, if the cheapness of price encouraged them to consume faster than suited the real scarcity of the season. When the scarcity is real, the best thing that can be done for the people is to divide the inconveniencies of it as equally as possible through all the different months, and weeks, and days of the year. The interest of the corn merchant makes him study to do this as exactly as he can: and as no other person can have either the same interest, or the same knowledge, or the same abilities to do it so exactly as he, this most important operation of commerce ought to be trusted entirely to him; or, in other words, the corn trade, so far at least as concerns the supply of the home market, ought to be left perfectly free.

Let me emphasize this part:

When the scarcity is real, the best thing that can be done for the people is to divide the inconveniencies of it as equally as possible through all the different months, and weeks, and days of the year. The interest of the corn merchant makes him study to do this as exactly as he can: and as no other person can have either the same interest, or the same knowledge, or the same abilities to do it so exactly as he, this most important operation of commerce ought to be trusted entirely to him; or, in other words, the corn trade, so far at least as concerns the supply of the home market, ought to be left perfectly free.

Exactly. (See also IV.5.42.)

Smith also understood that attempts to control this type of speculation, in particular by limiting price increases during times of dearth, were extremely counterproductive:

When the government, in order to remedy the inconveniences of a dearth, orders all the dealers to sell their corn at what it supposes a reasonable price, it either hinders them from bringing it to market, which may sometimes produce a famine even in the beginning of the season; or if they bring it thither, it enables the people, and thereby encourages them to consume it so fast as must necessarily produce a famine before the end of the season. The unlimited, unrestrained freedom of the corn trade, as it is the only effectual preventative of the miseries of a famine, so it is the best palliative of the inconveniences of a dearth; for the inconveniences of a real scarcity cannot be remedied, they can only be palliated. No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium.

But Smith also understood the political economy of the situation:

In years of scarcity the inferior ranks of people impute their distress to the avarice of the corn merchant, who becomes the object of their hatred and indignation. Instead of making profit upon such occasions, therefore, he is often in danger of being utterly ruined, and of having his magazines plundered and destroyed by their violence. It is in years of scarcity, however, when prices are high, that the corn merchant expects to make his principal profit. He is generally in contract with some farmers to furnish him for a certain number of years with a certain quantity of corn at a certain price. This contract price is settled according to what is supposed to be the moderate and reasonable, that is, the ordinary or average price, which before the late years of scarcity was commonly about eight-and-twenty shillings for the quarter of wheat, and for that of other grain in proportion. In years of scarcity, therefore, the corn merchant buys a great part of his corn for the ordinary price, and sells it for a much higher. That this extraordinary profit, however, is no more than sufficient to put his trade upon a fair level with other trades, and to compensate the many losses which he sustains upon other occasions, both from the perishable nature of the commodity itself, and from the frequent and unforeseen fluctuations of its price, seems evident enough, from this single circumstance, that great fortunes are as seldom made in this as in any other trade. The popular odium, however, which attends it in years of scarcity, the only years in which it can be very profitable, renders people of character and fortune averse to enter into it. It is abandoned to an inferior set of dealers; and millers, bakers, mealmen, and meal factors, together with a number of wretched hucksters, are almost the only middle people that, in the home market, come between the grower and the consumer.

The ancient policy of Europe, instead of discountenancing this popular odium against a trade so beneficial to the public, seems, on the contrary, to have authorized and encouraged it.

And as we see over and over again, it is not just the ancient policy of Europe, but the modern policy of the US-or at least it would be if many politicians were to get their way.

This discussion is useful in making a valuable distinction.  It is wrong to say that speculators don’t affect prices: competitive, efficient speculation does affect prices by ensuring that information about future and current fundamental conditions is reflected in inventory decisions, and hence consumption and production decisions: this necessarily affects prices.  But as Smith notes, these price effects lead to a more efficient utilization of the commodity over time, in a way that actually alleviates the most acute shortages-shortages that would be even worse if speculative storage were constrained in some way.

That’s different from saying that speculation distorts prices: affecting prices and distorting them are two very different things.

Moreover, these price effects can be different from those of purely financial speculation, e.g., spread trading by hedge funds, although this trading can (as noted above) affect in a beneficial way inventory decisions through both an information channel and a risk allocation channel.

Finally, since speculative storage requires financing of inventory, it is often efficient for banks or other financial institutions to engage in it as they are often incur the lowest cost of financing: witness the large speculative storage of oil by big banks (e.g., Morgan Stanley) at the depths of the financial crisis.  Financial/capital markets and financial institutions are all about the movement of resources over time: storage is just the movement of resources over time too, so there can be a natural complementarity between finance and storage. This last issue is evidently a source of policy controversy involving the Federal Reserve and large banks that it regulates.  More on this soon.  It is fascinating on many levels.

One other policy issue.  Smith’s concern  about the perverse effects of price ceilings during periods of shortage is the most defensible rationale of government storage programs, like the SPR.  If the government cannot precommit to let prices clear the market during periods of shortage, there will be an insufficient incentive for private, speculative storage, especially since as Smith notes it is selling into these spikes that is most remunerative to inventory holders.  Government storage programs can be a second best response to its inability to precommit not to screw things up.  This raises questions about how the government storage program should operate: again, I hope to post on that soon.  Hint: SPR doesn’t appear to be operated in the efficient way.

March 6, 2012

Popular Terrors and Fears: Adam Smith on Speculation as Witchcraft

Filed under: Commodities,Derivatives,Economics,History,Politics,Regulation — The Professor @ 10:45 pm

In a post earlier this evening, I said that anti-speculation frenzies dated from the 19th century.  But they in fact date back much further. In Book IV, Ch. 5 of Wealth of Nations, Adam Smith analyzed the irrational attacks on commodity speculation:

The popular fear of engrossing and forestalling [types of speculative activity outlawed in England] may be compared to the popular terrors and suspicions of witchcraft. The unfortunate wretches accused of this latter crime were not more innocent of the misfortunes imputed to them than those who have been accused of the former. The law which put an end to all prosecutions against witchcraft, which put it out of any man’s power to gratify his own malice by accusing his neighbour of that imaginary crime, seems effectually to have put an end to those fears and suspicions by taking away the great cause which encouraged and supported them. The law which should restore entire freedom to the inland trade of corn would probably prove as effectual to put an end to the popular fears of engrossing and forestalling.

Sadly, I think that Smith’s belief that legalizing speculation would end attacks against it is quaint, but wrong.  Indeed, it appears that the reverse is true: popular terrors and fears-stoked by opportunistic politicians eager to divert blame for high prices to others-lead to attempts to restrict speculation.

But Smith’s analysis of the counterproductive effects of these restrictions does stand the test of time.  It is worth a read.

They Ain’t Anonymous No More

Filed under: Politics — The Professor @ 9:18 pm

The FBI has indicted 6 Anonymous/LulzSec hackers, including the infamous @anonymousabu.  The Feds apprehended Sabu in August of last year, and the pathetic unemployed welfare recipient has been an informant ever since.

A couple of interesting tidbits from the FBI announcement.

First, it confirms my suspicion that the vaunted hack of the FBI phone call was due to an egregious security lapse by a foreign cop who participated in the call:

The Hack of International Law Enforcement

In January 2012, O’CEARRBHAIL hacked into the personal e-mail account of an officer with Ireland’s national police service, the An Garda Siochana (the “Garda”). Because the Garda officer had forwarded work e-mails to a personal account, O’CEARRBHAIL learned information about how to access a conference call that the Garda, the FBI, and other law enforcement agencies were planning to hold on January 17, 2012 regarding international investigations of Anonymous and other hacking groups. O’CEARRBHAIL then accessed and secretly recorded the January 17 international law enforcement conference call, and then disseminated the illegally-obtained recording to others.

It is appalling that a law enforcement officer engaged in cybercrime efforts would be so sloppy in his own security.

Second, one of the hackers arrested was responsible for the Stratfor hack:

The Stratfor Hack

In December 2011, HAMMOND conspired to hack into computer systems used by Stratfor, a private firm that provides governments and others with independent geopolitical analysis. HAMMOND and his co-conspirators, as members of AntiSec, stole confidential information from those computer systems, including Stratfor employees’ e-mails as well as account information for approximately 860,000 Stratfor subscribers or clients. HAMMOND and his co-conspirators stole credit card information for approximately 60,000 credit card users and used some of the stolen data to make unauthorized charges exceeding $700,000. HAMMOND and his co-conspirators also publicly disclosed some of the confidential information they had stolen.

Hammond is a real winner. (h/t R) The scary part: there are TWO of them (he’s a twin-and it doesn’t appear one’s the good twin and the other evil: they are both criminals).  BTW, Hammond is from Chicago, and associated with Occupy and anarchist movements.  Does this have anything to do with the otherwise mysterious decision to move the G8 meeting from Chicago? (Something the Occupy types are claiming credit for.)

Some theorizing.  The question arises: why roll up these people now?  Let’s examine some interesting coincidences. 1. Julian Assange of Wikileaks was apparently obsessed with Stratfor because he believed it had information about the existence of a sealed indictment against him.  2. In his typical drama queen fashion, Assange highlighted the revelation in the leaked Stratfor emails that company VP Fred Burton had claimed that a Federal Grand Jury had indicted Assange.  3. There had been rumors that Assange had arranged the Stratfor hack to get information about the indictment. 4. A week after Wikileaks publishes the Stratfor emails, and Assange makes a huge deal about the emails regarding his indictment, the Stratfor hacker is arrested–and the entire operation to roll up this group is made public.  Given these facts, it does not stretch credulity to believe that Assange arranged the hack to get at the information, and the FBI is going to go after Assange next.

This suggests to me that Assange is the real target here.  He’s a far bigger target than dreadlocked basement dwellers like Hammond.  Once the stolen Stratfor material was definitively in Wikileaks’s-and Assange’s-hands it makes perfect sense to arrest Hammond to make a connection between Assange and the theft.  It may well be the case, due to Sabu’s participation, that the FBI was aware of a nexus between Assange and Hammond either before, or sometime after the hack, and were just waiting until the stolen goods were delivered to close the trap.  Or the delivery of the stolen material to Assange suggested to the FBI that Hammond and Assange had collaborated, giving the Bureau a motive to nab Hammond in order to pressure him to turn on Assange.

If I am right, in short order the least that Julian Assange will have to worry about is extradition to Sweden.

Shocked! Shocked!

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 8:50 pm

Reprising his role as Captain Renault, Obama has order Attorney General Holder to “reconstitute” the oil and gas task force in order to round up the usual suspects: oil speculators.  You know, the one he constituted (I guess) last April.  Yeah. That one.  The one that found so much evidence that speculation had distorted prices.  Just like the numerous other FTC investigations that had turned up zero, zip, nada during previous gasoline price spikes.

In other stunning news, 70 nitwit senators and representatives (but I repeat myself) sent off a letter demanding the CFTC “immediately enact strong position limits to eliminate excessive oil speculation.” Apparently they don’t have newspapers, TV, or internet in DC, because these Einsteins and their myriad staffers overlook the fact that the CFTC passed a position limit rule almost 5 months ago-18 October, 2011, to be exact.  But never let the facts get in the way of an opportunity to strike an indignant pose. (I won’t even bother to ask these geniuses to present a coherent explanation of how speculation distorts prices, or how position limits will eliminate these putative distortions. To them, limits are some sort of talisman.)

As I’ve said repeatedly, these anti-speculator frenzies are a hardy perennial, dating well back into the 19th century.  Prices go up, prices go down-blame it on the speculators. They are a convenient whipping boy for poseur politicians (again, apologies for the redundancy).

And as I’ve also said before: no theory, and no evidence. (And no, Bernie, quoting the Saudis doesn’t count as “evidence”.) But I’ve long since given up any expectation of seriousness about energy.  Demonizing speculators is all to easy, and all to successful, and hence appeals to the lazy demagogues who infest DC.

Well, at least Claude Rains was acting.  I sometimes wonder whether Obama, Sanders, Levin, Pelosi, and on and on are. And I honestly don’t know whether it would be worse if they were, or if they weren’t.

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