Streetwise Professor

July 8, 2015

Monkeys Fly in China

Filed under: China,Economics,Exchanges,Regulation — The Professor @ 5:56 pm

In the very early days of this blog, I told the story about what Chief Economic Advisor Beryl Sprinkel said on Black Monday, 1987, when a panicked Treasury Secretary James Baker wanted to close the stock market: “We’ll close these markets when monkeys fly out of my ass.” No monkeys flew, and the markets stayed open, eventually stabilized, and then recovered.

But many monkeys are flying out of many asses in China. Although the authorities have not closed the stock markets, individual companies have halted trading in their stocks: trading in more than one-half of the listings in China is currently suspended.

Halting trading more than for a short interval in order to resolve information asymmetries and permit the flow of liquidity to stocks that have just experienced an information event (as during a temporary stock halt in the US) is in general a bad idea. (Post-87, Greenwald and Stein wrote a paper published in the JOB laying out this argument.) An uncoordinated and extended halt of many stocks is a really horrible idea, because of the negative externalities. That is, uncoordinated flying monkeys wreak even more havoc than coordinated ones.

Halting trading in a large number of stocks increases selling pressure on stocks that are still trading. This happens for at least a couple of reasons. First, individuals who need to raise cash (e.g., to meet margin calls) are forced to concentrate their sales in the stocks that keep trading. This tends to concentrate selling pressure, rather than diffuse it. Second, individuals who want to rebalance their portfolios away from equity into cash or bonds have to concentrate their sales in the stocks that continue to trade. Again, this concentrates selling pressure.

This creates a vicious feedback loop. A number of companies halt trading, which forces selling pressure to spill over with greater force on other stocks, which leads some of these companies to halt trading, which intensifies selling pressure on other companies, and so on. The ultimate likely outcome is a protracted lockdown of the entire market. Protracted because who is going to be the firm to restart trading first, and risk having everyone sell the hell out of them?

The vaunted Chinese economic managers (ha!) have well and truly bungled this one. They should have prevented open-ended trading halts, or had a coordinated stoppage and restarting of trading. The coordination failure at work now is manifest.

Again, I believe that the sharp selloff is more of a symptom of a deeper economic problem than a potential direct cause of such a problem. The main adverse spillover that the stock selloff could cause is through the margin debt channel. Margin calls could lead to fire sales of illiquid assets. Again, the more stocks that are not trading, the more severe these fire sales in non-equity assets will be: this is another adverse consequence of uncoordinated monkey launches. Moreover, failures to meet margin calls will saddle the lenders (themselves often highly leveraged) with losses. Both of these channels could have adverse consequences in the brokerage, banking and shadow banking sectors. Their balance sheets are not that hale and hearty to begin with, and this kind of shock could spark broader financial distress throughout the sector.*

In other words, the stock market decline is less of a crisis in itself, than a potential catalyst to a crisis via informational and fire sale channels. And perversely, uncoordinated trading halts in the stock market are more likely to intensify than mitigate any such catalytic effect.

But the Mandarins know everything, so I’m sure it will turn out swell.

In the meantime, the Mandarins have a message for all investors in China. Good luck with that!

* Perhaps one could argue, as Michael Brennan did when trying to explain price limits in futures markets in the JFE in 1986, that halting trading could ease pressure on margin credit. I am skeptical though. Even if stocks stop trading, margin lenders are likely to demand additional security in current conditions. Indeed, trading halts that reduce the informational content of stock prices create a source of uncertainty to margin lenders which they are likely to compensate for by demanding additional margin based on their estimate of the stock price once trading recommences, plus a premium to compensate for the uncertainty.

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July 6, 2015

China: Catching a Falling Knife

Filed under: China,Economics — The Professor @ 6:13 pm

The People’s Bank of China is effectively funding an effort by a group of brokers to buy equity (to the tune of about $20 billion) in an attempt to stem the massive selloff in Chinese stocks. The news barely checked the relentless decline, which I will expect will resume with a vengeance.

In other words, China is panicking, and attempting to catch a falling knife, as the phrase goes. And that almost never works out well.

Actually, I don’t think that the equity market decline is China’s big problem, except to the extent that it is a harbinger of a dramatic slowing of the growth in the economy, or perhaps an absolute decline in the economy. Countries survive equity market meltdowns. It is the leveraged sector that is the concern. In China, that includes not just banks, but the plethora of shadow banks, trusts, and local government funding vehicles, all with murky interconnections with the banks.

There are pronounced signs of economic stagnation besides the shuddering equity market. The lack of growth in electricity generation is one. The sharp declines in China-sensitive commodities, notably oil, iron ore, and copper are another: oil was down 8 plus percent today. (Cheers, Vlad!) If it was oil alone, one could write it off to the market deciding that a generous Iran deal was imminent. The broad fall suggests that it is China, China, China.

The equity market, and the government’s response to it, is therefore a symptom of this broader economic problem. What the Chinese (and those long energy and metals production) need to be especially concerned about is if a decline in growth sets off a banking or shadow banking crisis. Then the Chinese central bank and government will be in the unenviable position of catching a barrage of plummeting arrows.

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Greece Quick Hits

Filed under: Economics,Financial Crisis II — The Professor @ 6:00 pm

Hit Number 1. One of Krugman’s stock arguments to defend deficit spending and the accumulation of massive amounts of debt is “don’t worry!: we owe it to ourselves.” (I will pass over in silence at the Ricardian implications of that statement, which undermine Krugman’s argument that deficits are expansionary.) Krugman is also cheerleading for a Grexit.

It is therefore beyond ironic that a major reason that Greece faces Armageddon is the debt Greeks owe to themselves. The immediate source of Greece’s peril is the impending collapse of its banking system. The banks hold about €11 billion in Greek government bonds and about €14 billion in Greek Treasury Bills, money, per Krugman’s formulation, that Greeks owe to themselves. Greek banks are scraping by only because the ECB has agreed to fund these bonds. If Greece defaults, this funding goes away, and the banks will collapse. And it’s not just sovereign debt. The remainder of the nearly €400 billion on Greek bank balance sheets is loans to Greeks, i.e., money Greeks “owe themselves.” Many of those loans are underwater too.

In other words, money Greeks owe themselves will almost certainly bring down the banking system, and with it the Greek economy, once the ECB safety net goes away. But I’m sure Krugman will find a way to say that’s a good thing. Or that the problem was that they didn’t borrow enough from themselves. Or something.

Hit Number 2. The game theorist likely behind the let’s-play-crazy referendum and negotiating strategy, Finance Minister Yanis Varoufakis, has resigned. But don’t get excited. His replacement is a hardcore Marxist. But no worries. The FT assures us that he’s a pragmatist.  As if it really makes a difference whether a Menshevik or Bolshevik is in charge of economic policy.

Forget the debt issue. That will be resolved, for worse or for worser. The real reason that Greece is well and truly screwed is its statist, leftist, and frequently Marxist political culture. Greece needs to grow. Replacing one Marxist with another Marxist ensures that it won’t.

But look at the bright side. Now Venezuela has company.

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July 5, 2015

1. Referendum. 2. ???? 3. Prosperity!

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 8:38 pm

The Greeks voted a resounding No! in today’s referendum, thereby rejecting a deal that had been taken off the table.

Figuring out the Syrzia plan is something of a puzzle. It reminds me of the old South Park Underwear Gnomes bit, hence the  title of this post. One can see the desired objective (a more prosperous future liberated from a crushing debt burden) and one can see the initial move (referendum), but the middle steps are a complete mystery.

At first blush-and second, and third-it appears that what the Greek government is doing is crazy and self-destructive. This suggests two alternatives:

  1. The Greek government is crazy and self-destructive.
  2. The Greek government is pretending to be crazy and self-destructive for tactical reasons.

I say crazy because the Greeks are claiming that they are willing to accept economic Armageddon instead of making far less costly concessions to the Europeans. But if there is even a small probability that people are of this type (i.e., they much prefer to die on their feet than live on their knees), pretending to be this way and getting a reputation for being this way can be an effective way of extracting concessions from an adversary. It is often rational to defer to craziness.

This gambit works best if a repeat player is matched against a series of one-shot players: the repeat player benefits from creating a reputation, the one-shot players don’t. That’s not the case here, though. The solvent Euros (e.g., the Germans and Dutch) also have an incentive to build a reputation for being tough in negotiations, because they are repeat players. They reason that if they concede to the Greeks, the Southern Euros (Spain, Portugal, Italy in particular) will try to extract concessions as well. So they have an incentive to play tough with the Greeks even though if this was a one-off situation it would make sense to make more concessions.

Which all means that I have no idea how this will play out.

Furthermore, this is primarily a game about redistribution rather than creating wealth. This maximizes the potential for conflict, and increases the incentives for rent seeking and rent dissipation. The exact outcome is difficult to predict, but the basic contours of this outcome are pretty predictable: everybody ends up poorer and miserable.

It is hard to have sympathy for either side. The Greeks have a corrupt and bloated state, and its people have a socialist, welfare/entitlement state mindset, and they borrowed lavishly to achieve a lifestyle that their productivity could not support. The Europeans gladly lent more to a corrupt and bloated state, and a people with a socialist-tinged, welfare/entitlement state mindset than they could afford to repay. They jointly made their bed, and now they have to lie in it. So be it.

The least likely outcome is that Greece makes fundamental changes and conjures up a growth miracle, like postwar Japan or Germany, or Taiwan or Korea. The socialist/statist/welfarist impulses are too deeply rooted, and its interlocutors-the Euros-are also too statist to compel or persuade the Greeks to change their ways.

A couple of years ago I said that Europe had a choice between amputation and gangrene in dealing with Greece. They chose not to amputate. They now have to live with the consequences.


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July 2, 2015

Though I’ve Been Away, I Keep a Weather Eye on Putinsanity

Filed under: Economics,Military,Politics,Russia — The Professor @ 6:50 pm

Apologies for the light posting. Some travel (to Sweden, Denmark and London), work, and a need to decompress for a bit account for the absence.

I have kept a watch on things, though, and some Putinsanity has caught my eye.

For instance, VVP has accused cursed furriners of luring, Pied Piper-like, talented Russian youth away from the glorious Motherland:

A network of [foreign] organizations has ‘rummaged’ through the schools in the Russian Federation for many years under the guise of supporting talented young people. In reality, they simply hoover everything up like a vacuum

Note to Vlad: the reason that “talented young people” want to leave in droves is less that “foreign organizations” attract them, but that the state and society that you have constructed repel them.

Note the rampant insecurity here. I think that Putin knows that Russia has little to offer. But he can’t admit that, so he rages agains the West.

Item two: Surprise, surprise, surprise. The Russia-Turkey gas pipeline project is stalled because of a failure to communicate on price. Don’t say I didn’t tell you so:

Russia’s plan to build a new $15 billion pipeline to Turkey is at risk of delay because of a fight over gas prices, according to people with knowledge of the matter.

State-run OAO Gazprom and its Turkish counterpart Botas had a six-month period to agree on prices for gas supplies between the two countries, which expired on Monday. The Ankara-based company now has the right to take the matter to international arbitration, three of the people said, asking not to be named because the information is private.

The dispute over prices means there’s no immediate prospect of signing a binding pact for the new pipeline, the second between Russia and Turkey. An agreement could now be delayed until at least October, two more people said, also asking not to be identified.

The Russians think that you are stupid enough to believe that this is due to Erdogan’s defeat in the recent parliamentary elections, but that’s just a face saving cover story. Truth be told, the Russians are masters of vapor agreements. By my rough estimate, two of the last 100 announced gas deals have come to completion. And I’m being generous.

Anyone who believes anything Russia/Gazprom say about any pipeline project, deal, contract, etc., please contact me! Have I got a deal for you!

(As an aside, Erdogan and Putin are doppelgängers in a competition for the coveted titled of Most Insane Wannabe Autocrat Obsessed With Restoring Lost Imperial Greatness. May the best nut win!)

Next comedic moment: the Russia-Greece pipeline vapor deal, which is effectively contingent on a (non-existent) Russia-Turkey pipeline vapor deal. (BTW: Why is everybody freaking out about Russia courting Greece? Let Putin have them! Just what he needs. Another economic basket case, to join Abkhazia, Transnistria, South Ossetia, Donetsk, Luhansk. May the Orthodox nations enjoy every happiness! They deserve one another!)

Item three: Russia blasts the new US defense doctrine, which (realistically) identifies Russia as a threat to the sovereignty of its neighbors due to its willingness to use force as “confrontational.”

This is a perfect illustration of Pirrong’s Principle of Putinist Psychological Projection. Whatever the Russians say about the US is a pitch-perfect description of what the Russians are doing. They are the masters of projection.

This leads to my last observation: what will Putin do in Ukraine? He can’t go back: that would be a humiliating climbdown which he is psychologically incapable of, and which could actually threaten his power. Maintaining the status quo is the lowest risk, but offers the least potential for gain, and creates the real potential for a creeping collapse as the economic drain of sanctions and militarization saps the economy. Going forward and attacking Ukraine presents serious risks. Ukraine might be able to deny him a quick victory and impose serious losses. Even if he prevails operationally, the costs of occupation will be steep. These include the direct costs, which will be especially high if Ukrainians resort to historical precedent and wage a grueling guerrilla war (remember the Greens?). They also include the indirect costs of almost certainly escalated sanctions.

He’s in a fine mess, and I don’t know how he will react. Time is running out for a summer offensive, but time is not on his side generally. My fear is that he will follow Eisenhower’s dictum: “If a problem cannot be solved, enlarge it.” The question is: where? The Baltic-Finland, Sweden, Denmark, as well as the Baltic States-is a real possibility. Putinsanity is hard to predict, but nothing is beyond the realm of possibility.

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See You In the Funny Papers

Filed under: Clearing,Commodities,Derivatives,Economics,Exchanges — The Professor @ 6:01 pm

Here’s a first. I appear in a comic strip history of the CME-ICE rivalry in Bloomberg Markets Magazine. Quite the likeness!

Other than the fact that I appeared at all, the most amusing part of the, er, article, is the panel depicting CME’s Terry Duffy getting the news that ICE was making a rival bid for CBOT via a note slipped under his hotel room door at the FIA at Boca at 0600. I had eaten dinner with Duffy and CME CEO Craig Donohue the night before. They were in a little better mood then than they were the next day.

Bloomberg’s Matt Leising called me at about 0630 to ask me about the development. That led to an appearance on Bloomberg TV, where I was interviewed right before Jeff Sprecher. He watched me give the interview, and was not pleased with my prediction that CME would eventually prevail, but have to pay a lot more: I saw him say to the woman next to him (who I later found out was his wife, Kelly Loeffler) “who is this guy?” That was exactly how it worked out though, and apparently there were no hard feelings because Sprecher spoke at a conference I organized at UH a couple of years later. Either that, or he didn’t connect me with “this guy.”

Evenhanded guy that I am, I invited Craig Donohue to speak at a conference a year or two after that. His speech was interrupted by some Occupy types (remember them?), whom my tiger of an assistant Avani and I bodily shoved out of the room while the rest of the audience sat in stunned silence (not knowing what was going on).

So yeah. My involvement with CME and ICE sometimes does sound like something out of the funny pages. Now it’s official.

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June 23, 2015

Alexander the Great: Why Hamilton Deserves His Spot-Alone-on the Ten Spot

Filed under: Economics,History,Military,Politics — The Professor @ 7:20 pm

Last week the Treasury Department announced that in a redesign of the $10 bill, Alexander Hamilton would be replaced, joined, or supplemented by a Historical American Woman to be Named Later. Considering that Jackson, Grant, McKinley, and Cleveland also grace US Federal Reserve Notes, the decision to replace Hamilton of all people is lamentable in the extreme. Even overlooking his, to put mildly, controversial career, as a hater of paper money, assassin (and proud of it!) of the predecessor to the Fed, and an economic imbecile, Jackson in particular is a dubious choice to grace a greenback.

Hamilton, in contrast, merits sole possession of a widely circulated bill because it is hard to identify any figure, of any sex, president or no, who made a greater contribution to American history, and to its economic success. Off the top of my head:

  • A successful and brave staff and line officer during the Revolution. After long service on Washington’s staff (which led some to conclude, wrongly, that he was Washington’s brain), he took command of the Continental light infantry at Yorktown, and led the successful assault on Redoubt Number 10 which, along with the fall of adjoining Redoubt Number 9 to the French, sealed the fate of the besieged town.
  • The moving force (along with Madison) of the Annapolis Convention, which played a role in the convocation of the Constitutional Convention the next year.
  • Played a major role in the Convention.
  • Along with Madison, as the author of the Federalist Papers, provided the intellectual case for the passage of the Constitution. Worked assiduously to secure ratification of the Constitution.
  • First, and most important, Secretary of the Treasury. He righted the nation’s fraught fiscal situation, and made the nation creditworthy. He crafted a comprehensive fiscal and financial framework, including taxation, debt, and a national bank. (Even as the descendent of some Whiskey Rebels who objected to the whiskey taxes that were part of Hamilton’s system, I even understand his role as commander of the US forces sent to disperse the Rebels.) His Reports on Manufactures and Public Credit were incredibly economically sophisticated, and eminently practical. (I remember Robert Lucas in Econ 331 or 332 expressing his awe at Hamilton’s Reports.) It is not an exaggeration to say that the United States could not possibly have developed the way it did and as rapidly it did without his farsighted fiscal and economic stewardship
  • Founder of the Bank of New York, which exists to this day.
  • A man of liberal (in the Adam Smith/David Hume sense of the word) views, i.e., a lover of liberty. For all races. He was one of the few Founders who was not only a frank opponent of slavery and advocate of emancipation, but who also viewed those of African heritage equal as humans to whites.
  • A man who rose from extremely poor beginnings to become a colossus. Proof that birth is not fate, and that America has long been a land of opportunity for the able, ambitious, and hard working. (At Cal-Berkeley those sentences would be considered a “microaggression.” 1. I don’t do microaggressions. I move straight onto macroaggressions. Or maybe I pool and tranche my microaggressions to create MBS: Microaggression Backed Securities. 2. Cal-Berkeley can sod off.)

In sum: Military hero. Political giant. Political scientist. Economist. Practical manager. Entrepreneur. I defy you to find anyone with as diversified a portfolio as Alexander Hamilton. He truly was Alexander the Great.

The fact that the Treasury is even countenancing removing Hamilton is proof of the historical idiocy of supposedly educated Americans. The excuse that the $10 bill was next in line for a redesign doesn’t cut it. That sounds like typical bureaucratic cowardice, hiding behind procedure and routine to avoid defending a position that is indefensible on the merits.

So by all means put a woman on a bill. Just not the $10. And use this as an opportunity to teach Americans who know far too little about their past about one of the most remarkable figures in American history.

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June 15, 2015

Always Follow the Price Signals. I Did on Brent-WTI.

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 8:18 pm

As a blogger, I am long the option to point out when I call one right. Of course, I am short the option for you all to point out when I call one wrong, but I can’t help it if that option is usually so far out of the money (or if you don’t exercise it when it is in) 😉

I will exercise my option today, after reading this article by Greg Meyer in the FT:

West Texas Intermediate crude, once derided as a broken oil benchmark, is enjoying a comeback.

Volumes of futures tracking the yardstick have averaged 1m contracts a day this year through May, up more than 45 per cent from the same period of 2014, exchange data show. WTI has also sped ahead of volumes in rival Brent crude, less than two years after Brent unseated WTI as the most heavily traded oil futures market.

. . . .

WTI has also regained a more stable connection with global oil prices after suffering glaring discounts because of transport constraints at its delivery point of Cushing, Oklahoma. The gap led some to question WTI as a useful gauge of oil prices.

“I guess the death of the WTI contract was greatly exaggerated,” said Andy Lipow of consultancy Lipow Oil Associates.

But in the past two years, new pipeline capacity of more than 1m barrels a day has relinked Cushing to the US Gulf of Mexico coast, narrowing the discount between Brent and WTI to less than $4 a barrel.

Mark Vonderheide, managing partner of Geneva Energy Markets, a New York trading firm, said: “With WTI once again well connected to the global market, there is renewed interest from hedgers outside the US to trade it. When the spread between WTI and Brent was more than $20 and moving fast, WTI was much more difficult to trade.”

Things have played out exactly as I forecast in August, 2011:

One of the leading crude oil futures contracts–CME Group’s WTI–has been the subject of a drumbeat of criticism for months due to the divergence of WTI prices in Cushing from prices at the Gulf, and from the price of the other main oil benchmark–Brent.  But whereas WTI’s problem is one of logistics that is in the process of being addressed, Brent’s issues are more fundamental ones related to adequate supply, and less amenable to correction.

Indeed, WTI’s “problem” is actually the kind an exchange would like to have.  The divergence between WTI prices in the Midcontinent and waterborne crude prices reflects a surge of production in Canada and North Dakota.  Pipelines are currently lacking to ship this crude to the Gulf of Mexico, and Midcon refineries are running close to full capacity, meaning that the additional supply is backing up in Cushing and depressing prices.

But the yawning gap between the Cushing price at prices at the Gulf is sending a signal that more transportation capacity is needed, and the market is responding with alacrity.  If only the regulators were similarly speedy.

. . . .

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

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

This really wasn’t that hard a call to make. The price signals were obvious, and its always safe to bet on market participants responding to price signals. That’s exactly what happened. The only surprising thing is that so few publicly employed this logic to predict that the disconnection between WTI and ocean borne crude prices would be self-correcting.

Speaking of not enjoying the laugh, the exchange where Brent is traded-ICE-issued a rather churlish statement:

Atlanta-based ICE blamed the shift on “increased volatility in WTI crude oil prices relative to Brent crude oil prices, which drove more trading by non-commercial firms in WTI, as well as increased financial incentive schemes offered by competitors”.

The first part of this statement is rather incomprehensible. Re-linking WTI improved the contract’s effectiveness as a hedge for crude outside the Mid-continent (PADD 2), which allowed hedgers to take advantage of the WTI liquidity pool, which in turn attracted more speculative interest.

Right now the only potential source of disconnect is the export ban. That is, markets corrected the infrastructure bottleneck, but politics has failed to correct the regulatory bottleneck. When that will happen, I am not so foolish to predict.




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June 13, 2015

Definitive Proof That The New York Times’ David Kocieniewski Is A Total Moron*

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 6:06 pm

Not that further proof is needed, but still.

You may recall that NYT “reporter” (and by “reporter,” I mean “hack”) David Kocieniewski slimed me on the front page of the NYT on 31 December, 2013. In a nutshell, Kocieniewski accused me of being in the pocket of oil traders, and that this had led me to skew my research and policy positions. Specifically, he insinuated that I opposed position limits and defended speculation in energy markets because I had been suborned by oil traders who profited from high prices, like those that occurred in 2008 (before the crash). Kocieniewski’s main piece of “evidence” was that I had written a white paper sponsored by Trafigura. According to Kocieniewski, as an oil trader, Trafigura benefited from high prices.

At the time I pointed out that this demonstrates Kocieniewski’s appalling ignorance, as Trafigura is not a speculator, and is typically short futures (and other derivatives) to hedge its inventories of oil (and other commodities). Companies like Trafigura have no real interest in the direction of oil prices directly. They make money on margins and volumes. The relationship between these variables and the level of flat prices depends on what makes flat prices high or low.  I further said that if anything, commodity traders are likely to prefer a low price environment because (1) low prices reduce working capital needs, which can be punishing when prices are high, and (2) low price environments often create trading opportunities, in particular storage/contango plays that can be very profitable for those with access to storage assets.

Well, imagine my surprise (not!) when I saw this headline and article:

Crude slide bolsters Trafigura’s profits and trading margins

Trafigura has posted record half-year profits and a doubling of trading margins, illustrating how one of the world’s largest commodity trading houses has been a big beneficiary of the collapse in oil prices.

Profits at the group rose almost 40 per cent in the six months to 31 March, reaching $654m, while margins hit 3.1 per cent, as the Switzerland-based company used its global network of traders and storage facilities to buy cheap crude and take advantage of dislocations in the oil market.

. . . .
It was not the only company to benefit. Other trading groups including Vitol, the largest independent oil trader, and Gunvor have posted strong results for this period. Even ShellBP and Total managed better-than-expected first quarter results thanks to the performance of muscular trading operations.

Wow. In Kocieniewskiworld, “Crude slide bolsters Trafigura’s profits” would be a metaphysical impossibility. Here on earth, that’s an eminently predictable event. Which I predicted. Not that that makes me a genius, just more knowledgeable about commodity markets than David Kocieniewski (which is a very low bar).

Not that there was ever anything to it in the first place, but this pretty much blows to hell the entire premise of Dim Dave’s story. Proof yet again that if you read the NYT for economics stories, you’ll wind up dumber after reading than before.

* As well as an unethical slug who blatantly violated the NYT’s ethics guidelines. Not that his editor gave a damn, making him as much of an unethical slug as Kocieniewski.

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June 11, 2015

The Ethanol Mandate is Enough to Drive Me to Drink

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — The Professor @ 6:13 pm

About 19 months ago I wrote about RINsanity, i.e., the United States’ nutty ethanol (and other biofuel) program. RINsanity has long outlived the phenomenon (Lin-sanity) that inspired the neologism. A couple of weeks ago, the EPA announced the ethanol and biodiesel quotas . . . for 2014. Who said time travel is impossible? That Einstein. What an idiot!  (The EPA also announced quotas for 2015 and 2016.)

In a nutshell, despite protestations to the contrary, the EPA largely conceded to the reality of the E10 “blend wall” (the fact that the vast bulk of auto engines are incapable of burning fuel with more than 10 percent ethanol), and announced quotas that were (a) smaller than the market expected, and (b) smaller than the statutory amounts that Congress specified in its farseeing omniscience 10 years ago. At the same time, the EPA decreed larger quotas for biodiesel.

As a result, the market did the splits. The price of ethanol RIN credits that count towards the ethanol quota plunged, while the price of biodiesel RIN credits that count towards the biodiesel quota rose. Scott Irwin and Darrell Good have all the gory details here. (Those are the guys to follow on this issue, folks. I’m just kibitzing.)

As a result, pretty much everyone is upset. The nauseating biofuel lobby is screaming bloody murder because the ethanol quota is too small, and is threatening to go to court. Those holding ethanol credits are fuming due to the forty plus percent price decline.

This all points out the dysfunctional nature of environmental markets in which the supply is set by some opaque politicized bureaucratic process unhinged from economic reality. (The European CO2 credit market is another classic example.) The Congressional mandate set quotas (supplies) years in advance based on forecasts of future fuel demand that turned out to be wildly incorrect. So the EPA played Mr. Fixit, and through some unknown process, divined what Congress meant to do-really!-and announced some surprising numbers that caused prices to plummet.

The EPA’s reaction? It is shocked! Shocked! to find gambling going on at Rick’s (ethanol served here!):

The EPA didn’t intend for the program to create a speculative market, and an agency spokesperson declined to comment on RIN price movement.

“RINs are used to demonstrate compliance under the Renewable Fuel Standard program,” the EPA said. The agency manages an electronic system that tracks the RINs, but not their prices on the open market.

Earth to EPA! Earth to EPA! (And hey-aren’t you supposed to be earth’s stewards? So what are you doing orbiting Pluto?): if you create a scarce resource (ethanol credits) a market-and yes, one with speculation!-will appear. This is inevitable as the sun rising in the east. Another unintended but metaphysically certain event.

Indeed, the kind of speculation that these markets foster is particularly bizarre, because of the necessity of speculating on the feedback between the market and the EPA’s decisions on the amount of the scarce resource it creates. A big part of the RIN prices is market participants’ expectations about what the EPA will decide. If the EPA’s decision takes the market price into account, in some unknown (and almost certainly unarticulated) way, the reasoning chain becomes mind-numbingly complex very quickly. Mr. Market guesses what the EPA will do. That affects prices. The EPA takes the price, and guesses what this says about what the market knows about fundamentals . . . and what the market thinks about what the EPA is going to do. It adjusts its decision accordingly. Market participants have to make judgments about the feedback between the price and the EPA’s decision, which can affect the EPA’s decision, and on and on, ad infinitum. (This is analogous to Keynes’s beauty contest metaphor, and Soros’s theory of market “reflexivity.” Sign of the apocalypse alert: I gave Keynes and Soros a favorable mention in a single blog post.)

That’s no way to run a market, but the alternatives are  likely worse. One alternative would be to set quotas for years far into the future, and then not adjust them based on the evolution of other fundamentals that cannot be foreseen when the quotas are set.

It’s pretty clear that events like have just rocked the biofuel world are an inherent part of the system. Somewhat arbitrary, inherently difficult to predict (in part because they are politicized), and “reflexive” decisions are a major determinant of supply. These decisions are made at discrete times. It is extremely likely that there will be disconnections between the quantity the market thinks the EPA will select and what the EPA actually chooses. Given the inelasticity of demand for energy products, these supply surprises lead to big price impacts.

All of which goes to show that a better use of ethanol is imbibing it to cope with the craziness of a faux market.

Of course it’s not just that the market is crazy: it’s crazy that there is a market. Ethanol is an economic and environmental and humanitarian monstrosity. Yes, ethanol would play a role without subsidies or mandates. But a much smaller role. Forcing and inducing its use is costly, not environmentally beneficial, and raises the price of food, which hits the poorest the hardest. So this crazy market shouldn’t exist in the first place. I think I need another drink.




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