Streetwise Professor

February 20, 2016

Brent: The George Washington’s Axe of Oil Pricing Markers

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Regulation — The Professor @ 12:53 pm

Platts is preparing for a Brentless future by introducing a new Dated Brent CIF Rotterdam assessment.  The idea is that as North Sea production continues its decline, other streams of light crude that are imported into Rotterdam can be added to the assessment. Adding (or substituting) say Nigerian crude to the FOB Brent assessment would be much more difficult because of locational differences: FOB Nigeria and FOB North Sea can be quite different, even adjusting for quality, due to freight differentials. A CIF contract eliminates that.

The decline in North Sea production has been occurring for some time, so the need to adjust the pricing mechanism has been apparent. Plants has been thrashing around for a while, mooting the possibility of adding other crude (e.g., Urals Med) to the assessment.  It had already widened the delivery window to make more cargoes eligible (remember 15 Day Brent? 21? It’s now 25 Day.) This problem has become more pressing though, as the decline in prices is hastening the decline in North Sea production.

It is ironic that at the same time that Platts (and therefore, ICE) are grappling with the problem of  declining supply, the main rival to Brent has the exact opposite problem. The WTI contract is currently drowning in oil. Storage at Cushing is bumping up against capacity, and there are reports that some storage operators there are refusing requests to store additional crude.

Although the current situation at Cushing (and in the North American market generally) is as much a demand story as a supply story, the facts are that (a) the NYMEX WTI contract is linked to a much more robust and flexible production base than Brent, and (b) the WTI contract’s periodic difficulties are due to infrastructure issues that are more readily, cheaply, and rapidly addressed than production issues. Thus it has been for the past five years or so, as I discussed when I wrote that those foretelling the demise of WTI were fundamentally mistaken:

But these problems are all surmountable.  WTI’s problems arise from the consequences of too much supply at the delivery point, which is a good problem for a contract to have.  The price signals are leading to the kind of response that will eliminate the supply overhang, leaving the WTI contract with prices that are highly interconnected with those of seaborne crude, and with enough deliverable supply to mitigate the potential for squeezes and other technical disruptions.

Brent’s problems are more fundamental, because they arise from declining supply.  Even as paper volumes continue to rise, physical volumes available for delivery are falling inexorably.  The Brent complex had faced this problem before, and confronted it by adding Forties, Oseberg, and Ekofisk to the eligible stream.  But BFOE production has declined from 1.6 mm bbl/d in 2006 to barely more than half that today.  And the decline continues apace.  This makes the contract vulnerable to squeezes of a kind that were chronic in the 1990s and early 2000s, and which spurred Platts to add the three other grades to the benchmark.

. . . .

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.

The CIF alternative makes sense, and is probably superior to the “economic par” contract I suggested in the 2011 post. But once you move to a Rotterdam pricing basis, why remain tied to an assessment mechanism based on transactions in immense full cargoes? The large size of the lots inherently limits the number of transactions, which makes the assessment mechanism more erratic and subject to manipulation. The lumpiness of the market has also led Platts to design a baroque process involving bids and offers, contracts for differences, futures prices, spreads, etc., to increase the number of trades that go into the assessment.

The WTI contract, in contrast, is based on delivery in store of modest-sized (1000 barrel) units of crude. This is much more flexible, and permits a large number of firms to participate in the delivery process. This makes delivery and the threat of delivery a reliable and efficient way of ensuring convergence of futures to cash market values. The mechanism is not immune to all types of manipulation: delivery squeezes are still possible (though relatively unlikely in current market conditions). But small numbers of transactions can’t have a pronounced impact on pricing, and the in store delivery mechanism does not rely on an arcane and mysterious assessment mechanism (which also helps to enrich the party making the assessment).

So rather than shifting to a Rotterdam CIF mechanism, why not shift the futures market to a Rotterdam in store delivery contract? This mechanism is more flexible and resilient in the short run, and is readily adjusted in the long run to respond to changes in the underlying physical production base as NYMEX did by adding foreign crude streams (including Brent) to address the (then) declining domestic production base.

I can see why Platts wouldn’t like this, but it has some decided advantages for ICE, not the least of which is reducing its dependence on Platts. Given the difficulties of changing contract specifications, or generating liquidity for even a better contract introduced in competition with an established liquid one, I doubt this will happen. Which means that ICE, and the market generally, will have to continue to endure periodic changes the “Brent” assessment mechanism as North Sea production continues to decline.

I put “Brent” in quotes because the handwriting is on the wall: any future European-based contract may be called “Brent” even after Brent (and Forties, and Oseberg, and Ekofisk) no longer represent the bulk of the benchmark stream. The contract will come to resemble the old Harry Anderson comedy bit, where he juggled a chainsaw and an axe. He would stop juggling, hold up the axe and say: “This is George Washington’s axe. The handle was replaced years ago, and I just put on a new head, but it’s George Washington’s axe!” So it will be with Brent, and sooner than anyone would have thought even a few short years ago.

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February 16, 2016

Deep Social Thought: Trump=Bitter Clingers+Facebook

Filed under: Economics,Politics — The Professor @ 8:20 pm

I am not a Trump supporter, for many reasons. But the depth and intensity of support that he has attracted is an important social and political phenomenon, that needs to be understood before the deep concerns and anger that he has tapped can be addressed with good policies.

I made a preliminary attempt here. Others have done a much more thorough job. Most notable of these is Walter Russell Mead, on whose idea of Jacksonian Americans I drew upon in my post. His Andrew Jackson, Revenant, is a must read on the subject. So are Charles Murray’s Trump’s America and Angelo Codevilla’s Does Trump Trump?

Then there is Tom Nichols. The Naval War College professor’s theory is–I am being serious here–“Facebook envy.” Specifically, social media has made middle and working class Americans newly and keenly aware that there are people with more stuff than them. This has made them green with envy, and their envy-fueled anger has driven them to support Trump.

I think that is a very fair summary. Read for yourself:

In other words, Trump (and Sanders) have convinced people that the same socioeconomic arrangements that once benefitted them are actually screwing them, mostly on the premise that it’s not benefitting them enough.

No one factor explains Trump, but this underlying resentment is at least in part a result of the Information Age, which is spurring one of the biggest experiments in relative deprivation in human history. People who once had little idea how others outside of their social circle lived now constantly compare themselves not just to their neighbors, but to the wealthy, and even to the super-wealthy. They are not just keeping up with the Joneses next door, but via the Internet and cable they’re keeping up with the Reeds down the street, the Browns in the next town, the Smiths in the next state, and the Kardashians all the way across the country.

As one wag on Twitter put it, call it the “HGTV Effect.”

This is only possible because of new technology.

There are two parts to this theory. That the Trump phenomenon is driven by envy, and that this envy is a new phenomenon that was impossible in the era before Facebook.

This would be news to Rousseau, Kierkegaard, Nietzsche, Veblen, and Weber, just to name a few. Each of these wrote when literacy was rather limited, and newspapers and pamphlets represented the cutting edge of information technology. Yet each of them also devised theories of social relations based on the tendency of humans to compare themselves and their circumstances to those of others; to seek social status; and to measure status by material attainment. Not just absolute material attainment, but in comparison to others. Kierkegaard and Nietzsche explicitly used the French word “resentissment” that Nichols drops in his piece.

And all without Facebook. So the idea that some technological shock was necessary to cause Americans to cast a covetous eye at the wealth and consumption of others is beyond farcical. Concern about relative standing is as old as society.

Then there’s the issue of whether the visceral anger that Trump (and to some degree, Bernie Sanders) have tapped a manifestation of a mortal sin, or whether it is reflects legitimate grievances (which is a different issue as to whether Trump can address these grievances).

In fact, there is a strong basis for those grievances. In attributing Trump’s popularity to the base motives of his supporters Nichols is deeply condescending and insulting.

The grievances stem from two sources, which are somewhat interrelated.

The first is clearly economic. The middle and working classes in the United States have seen their incomes stagnate. The gap in incomes between those with and those without college educations has increased substantially. The expectation of upward mobility that was commonplace in post-WWII America no longer exists for many Americans.

It is remarkable that Nichols quotes and links to Murray, but fails to acknowledge that Murray has documented in detail (in his book Coming Apart) how the white middle class has become increasingly marginalized, and has experienced decline in several important socioeconomic dimensions.

Just what has driven these developments is the subject of intense controversy among economists. There is no consensus, which should not be surprising because it is unlikely that any major social development can be attributed to even a small number of causes, and because explaining complex phenomena is inherently difficult. But the data do clearly demonstrate that the phenomenon exists. What Trump is tapping into is therefore a legitimate-if somewhat inchoate–movement that reflects deep social forces, not the temper tantrum of people who don’t know how good they have it, and whose worst instincts have been awakened by Facebook.

The second major source is deep disillusionment with the “elites,” combined with the mixture of dismissiveness and condescension with with the elites have responded to the dissatisfaction of the hoi polloi. Codevilla in particular has eviscerated “the Ruling Class.” Thomas Sowell’s scathing criticism of “the Anointed”, which long predates the Trump phenomenon is good on this subject as well.

The gravamen of this criticism is quite simple. American governing elites have amassed a remarkable record of failure in foreign policy and economics. Iraq and the Great Financial Crisis are just the two most conspicuous examples. Yet, the elite has made out better than OK, and there has been virtually no accountability for these failures. That rankles deeply.

Furthermore, the elites–in both parties–often appear to have more globalist loyalties, than local ones. Jacksonians are nationalists, which is why Trump’s slogan of “make America great again” resonates deeply. This also explains why many Americans are perfectly content to extirpate ISIS, with few reservations about the inevitable collateral damage, but have no interest whatsoever in getting engaged in allegedly idealistic ventures in Syria–especially since the elite has shown no competence whatsoever in bringing these ventures to a successful conclusion (cf. Iraq, Libya, Afghanistan).

What’s more, the elite doesn’t get it. The GOP establishment’s response to Trump (and Cruz, who draws from the same well) proves this. Rather than trying to understand, and to come to grips with, the widespread discontent, the establishment has circled the wagons and doubled down on the condescension. The Nichols article is one example. So is National Review’s shrieking anti-Trump jeremiad.

And then they express shock and surprise that Trump only seems to get stronger. They don’t realize that even though they aim their insults at Trump, they hit the Jacksonians instead. And as Mead rightly pointed out, honor is deeply important to Jacksonians, and insults to their honor trigger their formidable combative instincts.

I still doubt (as I did last year) that Jacksonians can be part of a winning political coalition. I still believe that although their passions and beliefs are attractive to many, they repel many others. I also continue to doubt that the remedies that Trump proposes (especially on economic issues like protectionism) will  ameliorate the ills that have galvanized his followers.

But I do not doubt at all that superficial, condescending, and insulting analyses of what drives Trump supporters  will only strengthen Trump–even if they are written by a five time Jeopardy Champion. Saying that a large swathe of Americans with legitimate grievances, and legitimate critiques of their “betters,” are nothing but bitter clingers whose baser instincts were catalyzed by too much time on Facebook is not just deeply insulting. It is a sure fire way to strengthen Trump, not cut him down to size.

Those who disagree with Trump’s policies need to understand and engage the forces he has tapped. They need to persuade and attract, not insult and repel. If Trump becomes the Republican nominee, let alone president, it will be because his opponents fail in this task.

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February 15, 2016

“More Europe.” Yeah, Who Wouldn’t Want More of This?

Filed under: History,Politics,Regulation — The Professor @ 7:34 pm

Two stories that illustrate what a clueless monstrosity the EU is. (H/T to @libertylynx on both.) (I was about to write “has become”, but that would be wrong–it’s been this way from the beginning.)

First, “France fails to win immediate EU action on farming crisis“:

France failed to secure further relief measures for its struggling livestock farmers at a meeting of European Union agriculture ministers on Monday, as it tries to contain protests sparked by persistent low prices.

French dairy and meat farmers have been staging protests for weeks, blocking roads, dumping manure, straw and earth in front of public buildings and supermarkets.

The growing crisis had prompted President Francois Hollande last week to promise tax cuts for farmers and to call for decisions at the EU farm minister meeting.

France, the EU’s largest agricultural producer, had gone to Monday’s EU meeting with a set of proposals to regulate oversupply in the milk and pigmeat sectors, but the European Commission asked it to come back with new proposals.

From the time that the Common Agricultural Policy began in the early-1960s, European farm policy has been a special interest nightmare. Agricultural markets have never been permitted to work, and 300+ million Europeans have been held hostage by a few million (relatively inefficient) farmers, particularly (but not exclusively) in France.

Second–again from France!–“Most vulnerable industries need 100 percent free carbon–France“:

Energy intensive industries most likely to leave the European Union because of costs should get all of their EU Emissions Trading System permits free until other major blocs have a carbon price in place, France‘s economy minister said on Monday.

The European Commission is revising its rules for handing out free permits to cushion energy intensive industries, such as the steel sector and oil refiners, from the expense of offsetting emissions on the ETS.

As if this wasn’t completely predictable. Apparently the Europeans believed that the world would immediately see the error if its ways, and defer to the shining example of Europe on climate change policy.

Actually, the rest of the world–the developing world/emerging markets in particular–pretty much decided that they didn’t like being poor, and if the Europeans were going to burden their energy intensive industries with myriad restrictions in the name of battling global warming, the rest of the world was perfectly willing to seize on the opportunity.

I could go on. The immigration mess. The fact that European post-crisis financial regulation (MiFID II and EMIR) makes Frankendodd look like light touch regulation. Energy policy. The list is endless.

There’s an old joke that Arkansas exists so that Mississippians have someone to look down upon. (Or is it Mississippi exists so that Arkansans have someone to look down upon?) I often think that the EU exists so the US has someone to look down upon. As dysfunctional as we are, we ain’t got nothing on them.

What makes it worse is that Europe presumes to lecture the world on policy and governance. That, and all the navel-gazing “more Europe” crap. “More hitting myself in the head with a ball peen hammer” sounds preferable.

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Rubio of Arabia

Filed under: History,Military,Politics — The Professor @ 1:08 pm

When asked what would make a good president, Marco Rubio answered: “Do they the know difference between Sunni & Shia..between ISIS & Al Qaeda?”

Apparently those able to answer the $200 question in Teen Jeopardy would make good presidents.

Rubio has been Johnny One Note on the Shia-Sunni issue. He is beyond insipid. It also brings to mind the time of the Iranian Hostage Crisis. The prevailing narrative at the time was that Shias were radicals, and that Sunnis represented the “moderate branch of Islam.” In retrospect, this was the Saudi propaganda line, and they are pushing the same thing today.

Perhaps it was excusable for Americans in 1979 and 1980 to be ignorant of the deep radicalism that permeated Sunni Islam. But in the aftermath of at least 20 years of Sunni terrorism, the relentless proselytizing of the Wahhabis, and the insidious operations of the Muslim Brotherhood, it is inexcusable to swallow the Saudi narrative, hook, line, and sinker, as Rubio clearly has. To add insult to injury, he presumes to lecture us on his superior knowledge of the nuances of Islam.

The best Western analogy to what is going on in Islam right now is the 30 Years War. A sectarian conflict between two branches of the same religion, being fought across a good portion of a continent. Taking sides in that is idiotic. But that is exactly what Rubio and his supporters and advisers are pushing, and claiming that it is wisdom.



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February 13, 2016

The Great White Hope With A Glass Jaw and Disastrous Policies

Filed under: History,Military,Politics — The Professor @ 12:50 pm

I haven’t written much about the ongoing presidential race because, well, it’s just too damn depressing. The race is nearing a critical period, so I’ll make a few observations and then go back to looking for an island to escape to.

Trump is still ascendant in the Republican race. His closest rival, Cruz, is almost as frightening to the Republican establishment as Trump. So said establishment has seized upon Marco Rubio as its savior. After Iowa, Rubio was anointed as the voice of reason with the best chance of defeating Hillary (assuming that she is the nominee, and given the way the Democratic nominating process is rigged, that could happen even if she loses every primary to the dotty socialist, and has to appear at her inauguration in an orange jumpsuit instead of a canary yellow Mao suit).

That lasted for about a week, when Chris Christie showed that the establishment’s Great White Hope had a glass jaw in the New Hampshire debate. This sent the establishment into paroxysms of defensive rage, directed mainly at Christie for having the temerity to challenge The One and undermining the Republican’s best chance at victory in November.

This logic is delusional. If Rubio can’t handle  a telegraphed punch from a fellow Republican, how could anyone possibly expect him to do anything but wither under the assault of the Clinton machine and the national media (but I repeat myself)?

Even if Rubio is toast, the establishment’s enthusiasm for him and his positions is disturbing, and reveals precisely why Trump and Cruz are dominating the process. Rubio has made foreign policy the centerpiece of his campaign. This despite the fact that the signs are all around that economic troubles are mounting, and that the election is likely to turn on economic issues than foreign policy ones. The seething discontent that feeds Trump (and Cruz, and Sanders on the Dem side) is at root a populist revolt driven by economic anxieties and a belief that the political system is favors elites that have done quite well in the aftermath of the crisis while many Americans are floundering.

Further, the specifics of Rubio’s foreign policy positions are troubling and disconnected. Yes, terrorism is a major concern of many Americans. But Rubio’s nostrums involve a new round of interventions in Syria and Iraq that are unlikely to reduce materially the threat of terrorism. Indeed, mouthing the words of his neoconservative adviser Max Boot and his ilk, Rubio advocates getting involved in intra-Muslim sectarian civil war on the side of the primary source and funders of anti-American terror in a place where only minor American interests are involved, and where intervention would greatly increase the risk of a confrontation with Russia. And large swathes of the Republican establishment cheer him on.

Rubio talks constantly on the stump and in debates about taking the side of the Sunnis in the Sunni-Shia Muslim civil war. Let’s be clear about what he really means: he means taking the side of the Saudis and Qataris and Turks, none of whom are reliable allies, or have US interests at heart. Indeed, (a) the Saudis in particular are the wellspring of terror, and (b) their main interest is in manipulating the US to intervene in their battles to advance their interests, which are in no way aligned with ours. We have no stake in the Muslim civil war.

Ostensibly, Rubio’s (and Boot’s and the neoconservatives’ generally) support for Sunnis is aimed at fighting ISIS, and is anti-sectarian:

Because they currently occupy Sunni cities and villages. Sunni cities and villages can only truly be liberated and held by Sunnis themselves. If they are held by Shias it will trigger sectarian violence. The Kurds are incredible fighters, and they will liberate the Kurdish areas, but Kurds cannot and do not want to liberate and hold Sunni villages and towns. It will take Sunni fighters themselves in that region to take those villages and cities, and then to hold them and avoid the sort of sectarian violence that follows in the past. And why that is important is because if Sunnis are not able to govern themselves in these areas, you are going to have a successor group to ISIS. ISIS is a successor group of al Qaeda. In fact, they broke away from al Qaeda, because as horrible as al Qaeda is, ISIS thought al Qaeda was not radical enough. This is who we’re dealing with, and they have more money than al Qaeda ever had.

This is delusional for several reasons. First, it presumes that “Sunni fighters” are all that interested in fighting ISIS, which is an avowedly Sunni movement that wants to extirpate Shia. In Syria, the Sunnis are focused on toppling Assad. In Iraq, the Sunni powers in the region have little interest in defeating an insurgency because that would empower Iran and the Shia government of Iraq. Second, the governments of Syria and Iraq have no interest in empowering Sunnis who would, if they succeeded in defeating ISIS, become a threat to those governments. The aftermath of a putative defeat of ISIS by the magical Sunni fighters would almost certainly involve conflict between the victorious Sunni forces and the governments of Syria and Iraq, thereby involving the US as a partisan in civil conflicts in both countries. In the case of Syria, this would set up a direct confrontation between Russia and the US. Third, the idea that there are Sunni moderates, or that Sunnis with guns are likely to be moderate, is nuts. In Syria, the armed Sunni groups are overwhelmingly Al Qaeda or Muslim Brotherhood. Both are virulently anti-American. Even if they somehow vanquished ISIS, we would just be empowering other anti-American groups with a history of carrying out terrorism.

The Rubio model (or more accurately, the model of his advisors, because he seems incapable of independent thought) appears to be the Surge in Iraq. Yes, the Surge was very successful, much to the surprise of many. But its success depended on many conditions, none of which can be repeated now.

Remember what was “surged”: American combat units. 150,000 US personnel were involved. Although the Anbar Surge has received most attention, American troops also fought fiercely to subdue Shia militias as part of the effort. Indeed,  that was vital in giving the US credibility in forming alliances with the Sunni tribes in Anbar. Moreover, the Sunni tribes would not have stood up against Al Qaeda in Iraq (the predecessor of ISIS) if there were not tens of thousands of Americans in the fight. This is not happening, nor should it happen, because the gain is not worth the cost.

Nor can one ignore the fact that the US’s ignominious withdrawal from Iraq is what made it possible for ISIS to metastasize and wreak vengeance on those Sunnis who had cooperated. It also allowed the hardcore Shia sectarians in Iraq to run amok, and take their vengeance on Sunnis. The trust that Petraeus and other Americans so painstakingly built to coax the Sunni tribes into the conflict against AQI has been destroyed, and it will not be possible to restore it.

In brief, the success in Anbar was dependent on conditions that cannot be repeated. Those using the Surge as their model for the battle against ISIS are fighting the last war, which inevitably turns out badly.

I should also note that Rubio’s relentless criticism of Assad puts him clearly on the Sunni/Saudi/Turkish/Qatari side of the civil war in Syria. Further, his advisors, and those supporting him, are relentlessly anti-Shia and pro-Sunni. They demonize Assad-who is indisputably a malign man who has committed atrocities-but gloss over the equally malign nature of most of those fighting him. This black-and-white characterization of what is really a black-and-black situation is exactly what led to the disastrous intervention in Libya. Even if ISIS is subdued, the Rubio mindset makes it inevitable that he would get the US involved in a civil war in a minor country that is only tangential at best to American interests.

Here too Trump and Cruz have a better sense of the American people than Rubio. There is widespread opposition to another adventure in the Middle East, even one dressed up as a war against ISIS.

To some extent, this issue would be neutralized in a general election campaign between Clinton and Rubio, because Hillary is also an interventionist, and one who wears Libya like an albatross around her neck. But being an interventionist would be a disadvantage if Hillary was matched up against a non-interventionist.

Rubio’s advisors are strong advocates of the idea of the US as the world’s policeman, and have blasted Cruz, Christie, Paul and Fiorina as “isolationists” because of their skepticism over engaging in new adventures in Syria and elsewhere. Yes, Obama’s anti-interventionism has contributed to the current chaos in the world. But just as Obama over-learned the lessons of the Bush presidency, Rubio, his neoconservative advisors, and the Republican establishment, seem hell-bent on over-learning the lessons of the Obama presidency. The average between too much and too little isn’t “just right.” Rather than see-sawing between extremes, we need a foreign policy that is discriminating in where and how it intervenes, focusing on areas of vital US interests, ignoring sideshows (as tragic as they are), not picking unnecessary battles even with egregious actors (e.g., Putin) and not being played by regional actors with their own agendas.

A callow Rubio, who is clearly very reliant upon the advice of others who are anything but discriminating, would combine the worst characteristics of Bush and Obama. This is definitely not what the US needs right now. Unfortunately, what the US needs is not on offer. Not even close.


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February 10, 2016

I[gor], Robot (Hater)

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Russia — The Professor @ 9:40 pm

Igor Sechin comes in a close second to Rogozin the Ridiculous in providing Russian comic relief. Perhaps there are others in Russia that excel them, and I am only aware of these two because they have a bigger presence in the West, but both can be relied upon for some levity–unintentional, to be sure.

Sechin no longer has the outrageous mullet to amuse, but his public utterances suffice. Today at International Petroleum Week in London are a case in point. The mood at the event was gloomy, with pretty much everyone predicting that we are in a prolonged era of low prices, and everyone had their favorite culprit. But Sechin’s scapegoat was unique: Robots! Well, “robot traders”, anyways:

He blamed ‘financial players’ and automated ‘robot’ traders for driving down the price, saying the collapse to near $30 had little to do with supply and demand.

I presume he means algo traders and HFT. Just how these “robots” trading at subsecond frequencies have mesmerized producers and consumers to behave so as to lead to relentless buildups of inventory–including a looming topping out of capacity at Cushing–is beyond my mere economist’s skills to fathom.

Maybe Igor can commiserate with US cattle producers, who blame HFT for causing excessive volatility in beef prices.

Igor also seems to misunderstand that the “US” is not analogous to Saudi Arabia as a producer (although the phrasing is ambiguous, but I interpret this to include the US in “they”):

“At the end of 2014 some Middle East producers followed the US in their desire to increase production,” Mr Sechin told London’s International Petroleum Week. “They have deliberately created this situation and they are committed to low prices.”

The US oil sector is not a unitary decision maker in the way the Saudis are. The US industry is extremely fragmented and diffuse, with dozens of producers acting independently. They are price takers, not price makers. Very different from KSA or other producers with NOCs. (Relatedly, this is why calling the US the “new swing producer” analogous to the Saudis is dumb.)

It’s also more than a little hypocritical of him to criticize others for increasing output: Russian production has been increasing steadily over this same period.

Sechin also engaged in a little wishful thinking:

He forecast prices would recover later this year as US shale output slows. “We believe that in the coming years US shale will lose its grip on the market,” he said.

Good luck with that, Igor. US shale output has proved to be far more resilient than anyone had expected. Productivity gains and lower input costs have mitigated the impact of low prices. More importantly, the shale sector has the ability to ramp up output rapidly if prices do rise, either due to a rise in demand, or an attempt by other major producers to cut output. Indeed, this is likely the real reason the Saudis resist cutting output: they know it is futile because the supply of non-OPEC output is much more elastic than it used to be. This makes the demand for the output of the major producers, notably the Saudis (and the Russians!) more elastic than it used to be. This implies that it is not in the individual interest of any major producer to cut output unilaterally.

Which brings us to the most informative and refreshingly different part of Sechin’s remarks: his discussion of the prospects of a coordinated output cut involving OPEC and Russia.

This idea has captivated traders, who chase the idea like Randy Chasing the Dragon, shooting (the price!) up every time the rumor is floated, only to watch it fly away from their grasp. Once upon a time, Igor was notorious for encouraging such notions. Not this time around:

The most powerful figure in Russia’s oil industry on Wednesday signalled his steadfast opposition to combining with Opec to reverse the crude price rout through co-ordinated cuts in production.

. . . .
“Who are we supposed to be talking to about cuts?” Mr Sechin said when asked by the Financial Times if he was considering working with Opec, the producers’ cartel, to try to shore up the oil price. “Will Saudi Arabia or Iran cut production?”

Methinks that the real story is that the Saudis have made it clear that they trust neither the Russians nor (especially) other members of OPEC to adhere to any agree upon cuts, even assuming a deal can be cut, which is highly doubtful. So Sechin is acting as if he is the one rejecting the idea, primarily because he knows that it is DOA.

Not that this will stop all those Randys from chasing the next rumor of a coordinated cut.

Which raises the questions: Is Randy a robot? Are robots programmed to buy whenever a rumor of a Russo-Saudi oil deal is announced?

Maybe Igor will enlighten us in his next public appearance. Maybe he can do it to some musical accompaniment. Might I suggest this?:

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February 6, 2016

Putin Plays Pyrrhus

Filed under: Music,Politics,Russia — The Professor @ 7:46 pm

The Assad regime and the Russians are on the verge of victory in northern Syria. In particular, the rebel stronghold of Aleppo is on the verge of falling.

This is not all that surprising. It demonstrates the decisive effect of airpower if–and this is crucial–it is operated in support of an even minimally competent ground force, especially one with armor. This is particularly true if the airpower is utilized ruthlessly, with little squeamishness about civilian casualties.

The few victories against ISIS–Kobane, Sinjar, and Ramadi–demonstrate the same point, as does the ineffectualness of the “allied” air attacks against ISIS in Syria and Iraq generally, because these attacks are not mounted in support of a coherent ground attack undertaken by an even moderately effective infantry and armor force.

The Syrian-Russian success also provides an interesting contrast to the Saudi fiasco in Yemen. The Saudis have bombed ruthlessly, with little military effect, because the bombing is not coupled with a credible ground campaign against the Houthis. This no doubt reflects the Saudi’s knowledge of the severe limitations of their ground forces.

These limitations made me laugh at the Saudi offer to deploy troops to fight ISIS in Iraq and Syria. Even overlooking the logistical impracticality of this, the Saudis would be setting themselves up for an embarrassing failure.

The Russians and Syrians actually intensified their offensive in the lead-up to the farcical “peace” talks in Geneva. No surprises here. They are in this to win decisively, not to negotiate a compromise. And there is no better way to send that message than by victory on the battlefield on the cusp of talks.

This has left the US and Europeans and Gulf Arabs sputtering in ineffectual rage. John Kerry was particularly embarrassing (nothing new here!):

“Hospitals have been hit, civilian quarters have been hit, and in some cases, after the bombing has taken place, when the workers have gone in to try to pull out the wounded, the bombers come back and they kill the people who are pulling out the wounded,” Kerry told reporters in Washington. “This has to stop. Nobody has any question about that. But it’s not going to stop just by whining about it.”

But what else is he (or anyone else) doing about it other than whine? Nothing. It would have been better for Kerry to remain silent, rather than advertise his (and The US’s) impotence.

It is also interesting to note that Kerry is damning the Russians and Syrians for bombing civilians, yet is utterly silent on the equally bad (if not worse) Saudi air campaign in Yemen.

In response to the Aleppo debacle, Turkey has closed its border with Syria. Erdogan is no doubt attempting to create (exacerbate, really) a humanitarian crisis in order to goad the US and Europe into intervening. It will never happen. The Europeans lack both the will and the means. The US has the military capability, but not the will: whatever will existed at one time (which was minimal) disappeared when intervention meant a confrontation with the Russians.

So Putin will likely get a battlefield victory. But so what? He and his Syrian creature will conquer a depopulated and devastated country. This will have little impact on the strategic balance in the region, and virtually no impact on US interests. Yes, Erdogan’s imperial and sectarian ambitions will be thwarted. Saudi and Qatari sectarian supremism will be defeated. To the extent that the US is impacted, these are actually favorable developments.

Those in the West who fulminate over Putin’s success in Syria are ironically engaged in the vacuous zero-sum thinking that drives Putin. A Putin victory is not necessarily an American defeat.

But the zero-sum thinker Putin is probably gleeful at the shrieks of distress from Kerry, the head of the UN, the Europeans, and various anti-Russian elements in the Western media. It’s all music to his ears, and also quite useful to him domestically. Another irony, that: the more that Putin’s enemies in the West screech about what is happening in Syria, the more it helps him.

Putin’s victory may be hollow, though, and his glee short-lived. He initially attempted to utilize his intervention in Syria as a way of presenting Russia as an ally of the West in the war against ISIS in order to undermine the sanctions regime, and to bring Russia in from the diplomatic cold. However, his unabashedly pro-Assad campaign, his intensifying the offensive in the run-up to the Geneva talks, the resultant humanitarian and refugee crisis, and the minimal Russian targeting of ISIS will make it impossible for the Europeans to do anything that will appear to be rewarding him. Putin’s intervention, with its demonstration of the cynicism and pointlessness of American policy, and thereby make Obama look bad, will cause our petulant president to retaliate in his passive-aggressive way, but maintaining sanctions, and pressuring the Europeans to do the same.

Putin is overplaying his hand elsewhere in Europe as well. The Russian media and government histrionics over the “Lisa” fake rape case in Germany has deeply angered Merkel who is already under siege over the migrant crisis (and especially the sexual assault crisis that has followed in its wake). Further, Putin met with Bavarian governor Horst Seehofer, Merkel’s most strident critic on immigration.  This will also anger Angela.

Putin, of all people, should realize that if you strike at the king (or queen) you better strike to kill. If Merkel survives-which is likely-she will be ill-disposed to ease sanctions, especially since Putin is ratcheting up the conflict in Donbas as well. Long surviving politicians tend to have long memories as well.

In sum. Air power can be dominant when teamed with infantry and armor. Putin will likely win a tactical victory in Syria. But the victory will be strategically barren, and possibly counterproductive, because (a) the “winner” will inherit a blasted and dysfunctional battleground, and (b) this “victory” will set back Putin’s efforts to roll back sanctions.

If anyone “wins” out of this, it is Iran. The Iranians will maintain their pipeline to Hezbollah, and deal the Saudis a stinging defeat. So Putin will succeed as the mullahs’ muscle, and in the process he will gain the satisfaction of humiliating the US (which stupidly set itself up to be humiliated), but at the cost of perpetuating Russia’s economic isolation, which is exacting a terrible toll on a country already reeling from the collapse in oil prices. That is about as Pyrrhic a victory as one could imagine.

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February 2, 2016

Russian “Privatization”? Only If Putin Is Desperate Indeed

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 10:11 pm

Putin held a meeting with the CEOs of seven state-owned enterprises to discuss the sale of minority stakes in their companies (a move sometimes mischaracterized as “privatization”). Putin frankly admitted that the impetus for this discussion is Russia’s dire budgetary situation. Putin caused some confusion by saying the “new owners of privatized assets must have Russian jurisdiction,” leading some to conclude that he was ruling out foreign investment. Peskov clarified the next day, saying that Russia welcomed foreign investors, but “If the question is about a foreign investor, that’s one thing. If it’s about a Russian investor, it must not be another offshore scheme.”

I consider it likely that this initiative will be stillborn, at least insofar as sales of stakes to foreigners are concerned. Putin said that the sales must not take place at “knockdown prices.” Well, in the current environment, the prices (especially for Rosneft and VTB) are likely to be very low indeed.

This is especially so since foreign investors will demand a substantial discount to compensate for expropriation risk. Savvy investors with long memories will recall that Putin justified expropriating Shell’s Sakhalin II project by saying that the terms of the Sakhalin PSA were unfair to Russia, and that Shell had exploited Russia’s economic desperation when it signed the deal at a previous time of low energy prices. Putin (or whoever succeeds him) could easily resurrect such rhetoric in the future when oil prices rebound. Further, minority shareholders in Russian enterprises–especially state enterprises–have few protections against schemes that divert assets, or which dilute their holdings.

Given that prices are likely to be very low, if there are sales to foreigners, it will indicate (1) that Russia is desperate indeed, and (2) Putin et al consider it unlikely that sanctions will be relaxed anytime soon.

If there are sales, it is likely to be to Russian oligarchs, and in particular those with extensive holdings outside Russia. Just as Putin dragooned them into paying for Sochi and other prestige projects, he could well pressure them into overpaying for stakes in the state enterprises. This would allow him to kill two birds with one stone. It would help stanch the budgetary bleeding. It would also advance Putin’s longstanding goal of onshoring Russian capital. That would fit with the “owners must have Russian jurisdiction” remark.  And Putin has substantial leverage to get oligarchs to do his bidding–literally.

Even if partial sales take place, it will be merely a stopgap budgetary measure: it will not indicate a fundamental reconsideration of Russian economic policy.  Putin is still obviously a firm believer in the state control/state champion model, despite its manifest inefficiency. Putin prefers the control over resources that state control provides to having an efficient economy. Which is why he finds himself in his current straits.

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February 1, 2016

The Buck Stops With Hillary? Unless It’s From Goldman, You Must Be Kidding

Filed under: Politics — The Professor @ 12:13 pm

Hillary’s email excuses get more lame by the day. For months her story–and she has stuck to it–is that none of the emails were marked as classified. Yesterday, when (miracle of miracles!) George Stephenopolous called her on this, her excuse became even lamer. And if I were Cheryl  Mills, Huma Abedin, or Jake Sullivan, I would be afraid, very afraid, after hearing it.

Specifically Stephenopolous asked about a non-disclosure agreement Clinton signed before becoming Secretary of State, which states: “classified information is marked or unmarked … including oral communications.” That is, marking is a sufficient, but not necessary, condition for establishing whether something is classified. The mention of “oral communications” points out the obvious issue: if marking was necessary, verbal information could never be an official secret, which is obviously absurd.

Hillary’s response? Here’s to you, Cheryl, Huma, and Jake!:

Clinton pointed to her aides, saying: “When you receive information, of course, there has to be some markings, some indication that someone down the chain had thought that this was classified and that was not the case.”

Someone down the chain is apparently responsible for establishing whether something sent up the chain should be classified.

There’s only one little problem with this. Per an Obama Executive Order on classified information (which parallels EOs of previous presidents), Hillary was an”original classify[ing] authority.”

Sec. 1.3.  Classification Authority.  (a)  The authority to classify information originally may be exercised only by:

(1)  the President and the Vice President;

(2)  agency heads and officials designated by the President; and

(3)  United States Government officials delegated this authority pursuant to paragraph (c) of this section.

(b)  Officials authorized to classify information at a specified level are also authorized to classify information at a lower level.

(c)  Delegation of original classification authority.

(1)  Delegations of original classification authority shall be limited to the minimum required to administer this order.  Agency heads are responsible for ensuring that designated subordinate officials have a demonstrable and continuing need to exercise this authority.

The “classification authority”, as the title suggests, has the authority and responsibility to classify:

Section 1.1.  Classification Standards.  (a)  Information may be originally classified under the terms of this order only if all of the following conditions are met:

(1)  an original classification authority is classifying the information;

(2)  the information is owned by, produced by or for, or is under the control of the United States Government;

(3)  the information falls within one or more of the categories of information listed in section 1.4 of this order; and

(4)  the original classification authority determines that the unauthorized disclosure of the information reasonably could be expected to result in damage to the national security, which includes defense against transnational terrorism, and the original classification authority is able to identify or describe the damage.

In brief, Hillary was the ultimate classification authority in the State Department, and everyone else in the Department was exercising that authority because it had been delegated by her to them. Further, Hillary had the authority to determine whether “disclosure of the information reasonably could be expected to result in damage to the national security.” The power to make these determinations was explicitly vested in her.

In other words: the classification buck should have stopped with Hillary. She cannot escape the authority and duties assigned her by statute and implementing executive orders.

But of course, the only bucks that stop with Hillary are those donated to the Clinton Foundation for “speaking fees” from Goldman, etc., or extracted from tuition paying college students by political sycophant university administrators.

Hillary is clearly preparing  to throw her closest aides to the wolves. “I was failed by my subordinates who failed to mark properly this information that should have been classified.”  It’s the Clinton way.

It’s also a legal travesty. The woman who believes that it is her right to be a successor of Harry Truman definitely does not live by his motto: “The Buck Stops Here.” It stops with the patsies who have to take the fall in order to protect Her Highness’s political viability.


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January 31, 2016

CCPs & RTGS: Devil Take the Hindmost?

Filed under: Clearing,Derivatives,Economics,Politics,Regulation — The Professor @ 6:37 pm

The frantic sewing of parachutes in a plane that is 30,000 feet in the air continues apace. Last week the Office of Financial Research (a Son of Frankendodd) released its 2015 Annual Report. This tome received attention mainly because it raised alarm about potential systemic risks arising from central clearing mandates. An improvement, I guess, but like most official evaluations of the systemic risks of CCPs, it misses the real problems.

It gets off on the wrong foot by misstating the real benefits of CCPs. According to OFR, the top two benefits of clearing are related to the ability of CCPs, and via them regulators, to get more complete, accurate, and timely information on derivatives positions and trading prices. But these can be achieved by transaction reporting alone, without going the full monty to clearing, which also entails collateralization (including both initial and variation margining) and mutualization of default risk. (Trade reporting has turned into a nightmare, which I will write about further soon. But the point is that you don’t need clearing to get the benefits OFR touts.)

But the main problem, yet again, is that OFR focuses on the “single point of failure”/interconnectedness/default loss contagion channel for CCP systemic risk. This is not immaterial, but it is not the main thing. The main thing is that CCPs create potentially massive contingent demands for liquidity, where the liquidity contingency is likely to occur precisely at the worst time–when the system is undergoing a financial crisis.

Further, OFR gets it wrong when it states that CCPs “reduce the risk of counterparty default.” CCPs redistribute the risk of the insolvency or illiquidity of a large financial institution away from its derivatives counterparties towards its other creditors. It protects one group of creditors at the expense of others.

It is very much open to question whether this reallocation is systemically stabilizing, or is instead a means whereby one relatively concentrated group of market participants can advantage themselves at the expense of others.

Reading Izabella Kaminska’s excellent FT Alphaville post on Real Time Gross Settlement (RTGS) mechanisms makes plain that this phenomenon of substituting liquidity risk for credit risk, and redistributing credit risk away from core banks, is not limited to derivatives clearing. RTGS replaced deferred net settlement (DNS) because of banks’ and central banks’ concern that in the latter, interbank credit balances could accumulate, resulting in a default loss to settlement banks in the event that an net payer bank failed before the next netting cycle. RTGS eliminates interbank credit exposure.

But, of course, this doesn’t make credit exposure go away. It redistributes it to settlement banks’ other creditors. To a first approximation, the total losses from the inability of a bank to meet its obligations are the same under RTGS and DNS. The difference is who gets a chair when the music stops. Settlement banks–and crucially, the central banks–like RTGS because they almost always are going to get a chair.

Furthermore, as even its proponents acknowledge, RTGS is much more liquidity intensive. To be able to make every payment in real time, a settlement bank either has to have the cash on hand, or the ability to borrow it on demand intraday from the central bank. Liquidity needs scale with gross payments, which are substantially larger than net payments. Thus, like CCPs, RTGS substitutes liquidity risk for default risk.

This risk is exacerbated by the fact that a prisoner’s dilemma problem exists in RTGS. Participants concerned about the creditworthiness of other banks have an incentive to delay payments and hoard liquidity, since once a payment goes into the system, it is final and the payer is at risk to loss of the entire gross amount if a bank that owes it fails before it pays. This can lead to a seizing up of the liquidity supply mechanism, as the prisoner’s dilemma logic kicks in and everyone starts to hoard.

Since holding cash in sufficient amounts to meet all payment obligations is extremely expensive, RTGS has evolved to permit central banks to lend intraday on a collateralized basis. But as was seen in the 2008 crisis, collateralization poses its own risks, including ballooning haircuts that can set off price spirals due to collateral fire sales. Further, due to the potential for the breakdown of long and large collateral chains, this creates an interconnection risk, and represents a further coupling of the system. And it is coupling, remember, that is at the root of most catastrophic accidents. Secured lending can create a false sense of security.

Izabella’s post also points out another problem with RTGS, which is common to central clearing. It creates a much more tightly coupled system that is very vulnerable to operational risk. This risk crystalized in October, 2014, when a seemingly innocuous change to the system (deleting a member bank) caused the failure of the UK’s CHAPS  settlement system for a day. Ironically, this was the result of an interaction between one part of the system, and another part (the Liquidity Savings Mechanism) that was intended to economize on the liquidity demands of RTGS, and essentially created an RTGS-DNS hybrid. As in most “normal accidents”, unexpected interactions between seemingly unrelated parts of a complex system led to its failure.

There is another way to see all of this. Both central clearing and RTGS are intended to create “no credit” systems. That is true only in a very limited sense–a profoundly unsystemic sense. Yes, CCPs and RTGS are designed so that participants in those arrangements don’t have credit exposure to one another. But those participants aren’t the entire system, just a part of it: the exposure is pushed away from them to others. Further, the method for reducing credit exposure among the participants is to require extensive reliance on liquidity mechanisms that are prone to breakdown in stressed market conditions. Further, these liquidity mechanisms are based on credit: banks (or the CCP) borrow from other banks, or from central banks in order to obtain liquidity. Further, the credit moves into shadowier places.

Not to sound like a broken record, but things like CCPs and RTGS redistribute and transform risks, rather than eliminate them altogether. Unfortunately, these transformations do not necessarily reduce the risk of a systemic crisis, and arguably increase it in some cases. The failure of officialdom, and large swathes of the banking sector, to recognize or address this reflects in large part a failure to take a systemic perspective. Perhaps cynically, this can be explained by the fact that the central banks and banks that drive these reform efforts mistake their own interests for the interest of the system as a whole: le système, c’est nous. As a result, “Devil take the hindmost” could well be applied as the motto of RTGS and central clearing.

This illustrates a broader problem in public policy. Government is too often invoked as a deus ex machina that internalizes externalities. But the fact that most regulatory change efforts are driven by, or ultimately controlled by, a small subset of interested parties who have the most concentrated stake in an issue. Given the diffuseness of other impacted parties this is inevitable. But it means that in practical terms internalizing externalities via regulation of something as complex as the financial system is a chimerical goal. The externality hot potato gets tossed from one segment of the financial sector to another. Government regulation, as opposed to self-regulatory initiatives, mainly affect the makeup of the subset of participants who are involved in influencing the process, and the distribution of the bargaining power. This works through the entire process, from the crafting of legislation, to the writing of regulations, to their implementation. This is why we get things like RTGS or CCP mandates, which make a certain set of participants better off, but which it is heroic indeed to believe are truly welfare increasing.




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