Streetwise Professor

March 11, 2017

One Degree of Idiocy: Michael Weiss Expounds on Trump-Putin Connections

Filed under: Energy,Politics,Russia — The Professor @ 9:59 pm

Some years ago, “Six Degrees of Kevin Bacon” was somewhat popular. The object of the game was to connect any randomly chosen actor to Kevin Bacon in six movies or less.

Today, the game that is all the range in DC and the media is Six Degrees of Donald Trump. The main difference is that the starting point is not any randomly chosen individual, but one very specific individual: Vladimir Putin.

Not surprisingly, the most  demented and absurd entry in this game was submitted by Michael Weiss of the Daily Beast. Here’s how it goes. Putin is connected to Gazprom. Gazprom was a participant in a consortium (which also included European energy giants Shell, ENGIE, Winterhall, OMV, and Uniper) to build the Nordstream 2 pipeline. This consortium hired McClarty Associates as a lobbyist. McClarty employs ex-US diplomat Richard Burt. Burt made suggestions about Russia policy that a third party passed on to Trump. As a bonus connection, Burt attended two dinners hosted by Jeff Sessions, and wrote white papers for him.

Burt has never met Trump. Like many in the foreign policy establishment, Burt advocates a pragmatic approach to Russia. He was engaged in diplomacy with the USSR while in the Reagan administration (hardly a hotbed of commsymps and Russophiles), and shockingly, has continued to do business in Russia in the past 30 years. But apparently under the Oceania Has Always Been at War With Eastasia mindset that dominates DC at present, this is tantamount to Burt being a Russian puppet (a view that requires the consignment of most of the history of that period, not least of all that of the Obama administration 2009-2014, to the Memory Hole).

As far as connections are concerned, this is about as tenuous as one can get. The headline (“The Kremlin’s Gas Company Has a Man in Trumpland”) is a vast overstatement. For one thing, Burt is barely in Trumpland. Indeed, although the article says that the connection offers “Republican bona fides,” it is almost certain that was not the reason for hiring McClarty. Astoundingly, the article fails to note that said McClarty himself is a Clintonoid: Mack McClarty is from an old-time Arkansas political family, was closely connected to Bill Clinton in Arkansas, and was Clinton’s first chief of staff. Weiss ominously starts his piece with a recounting of the importance of having a krysha (“roof”, i.e., political protection) and insinuates that hiring Burt was intended to obtain a roof in the Trump administration. But if anything, it would have been an entree into a Clinton administration–which, of course, everybody figured was an inevitability.

Furthermore, perhaps Weiss hasn’t noticed, but “Republican bona fides” are hardly a ticket into Trumpland. Trump’s relationship with the party establishment varies between the hostile and the transactional.

And the timing is all wrong: the contract was signed before Trump was even the Republican nominee, and at a time when no one figured he would be the party’s candidate, let alone president. Talk about a deep out-of-the-money option.

It’s also rather bizarre that the connection between Burt and Gazprom also involves several very large European companies, and a purely European issue. There is nary an American company involved, and the matter is an intramural European spat pitting eastern vs. western EU countries. Wouldn’t you think that if you are trying to buy influence in the United States, you’d engage McClarty/Burt on an issue that would allow them to interact with US officials and politicians?

Further, if you are going to buy a krysha in the Trump administration, dontcha think you’d want to hire somebody who, you know, actually knows Trump?

But our Mikey is not deterred by such pesky details. He has a connection between Putin and Trump, and he is going to flog it for all it’s worth. Which isn’t much.

Of course the details of the Burt-Trump (non-) connection alone wouldn’t make for much of an article, especially for Weiss, who typically drones on paragraph after endless paragraph. So he adds gratuitous ad hominem attacks on Burt, such as comparing him to the late Russian UN ambassador Vitaly Churkin (career diplomats are a type–who knew?), and trotting out Bill Browder, who snarked about how gauche the Russian influence efforts were back in the bad old days (you know, when he was on the make in Russia) and yet again drags out the corpse of his lawyer, Sergei Magnitsky, in order to score political points.

Weiss also notes that McClarty has been retained by a Mikhail Fridman company in the UK, but fails to point out that Fridman is hardly a Putin pet. Indeed, Fridman took on Sechin, and came out the winner. But in Weiss’ worldview–which makes that of a 1950s John Bircher look nuanced by comparison–all them Russkies are Putin pawns.

And the anti-Trump establishment should at least get its story straight. On the same day that Weiss’ article appeared, Foreign Policy ran a piece claiming that Tillerson is a weak Secretary of State (the weakest ever, in fact!) because he doesn’t have Trump’s ear. So Trump ignores his own Secretary of State but somehow a guy whom he has never met and who has no position in the administration exerts some great influence over him? And weren’t we told a month ago that Tillerson was going to be Putin’s cat’s paw in the Trump administration because of his extensive dealings there (including with Gazprom in Sakhalin I)? But now he’s a nobody? Damn, that Memory Hole is getting a helluva workout.

Indeed, if the Burt connection (such as it is) and the like are the best that these people can come up with, they are doing a great job of showing how limited and tenuous Trump’s ties to Russia are. And remember the whole point of the Kevin Bacon game: it was a cutesy way of illustrating the “six degrees of association” theory, which posits that any two people in the world are separated by no more than six acquaintances. Any two people, no matter how obscure. Play Six Degrees of Vladimir Putin using yourself as the terminal connection: I bet you could connect with Vlad in six steps or less. I know I can. And does make me some sort of Putinoid? Hardly, as anyone who has read this blog knows.

When major international figures are involved, moreover, there are inevitably multiple such connections, often involving less than six steps. So finding a connection is about as earth shattering as finding sand on a beach. Furthermore, when considering a figure like Trump, he has myriad connections to other figures, many of whom may have interests and views contrary to Putin’s/Russia’s, or orthogonal thereto. Ignoring all these other contrary connections and focusing monomaniacally on ties to Putin and Russia when attempting to predict or explain Trump’s motivations is beyond asinine. In econometrics, this is called omitted variable bias–if you omit relevant variables, you get a very biased estimate of the influence of the ones you include.

But this is what passes for journalism in the United States right now: parlor games posing as deep analysis, latent with dark meanings.

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March 10, 2017

US Shale Puts the Saudis and OPEC in Zugzwang

Filed under: Commodities,Derivatives,Economics,Energy,Politics — The Professor @ 2:55 pm

This was CERA Week in Houston, and the Saudis and OPEC provided the comedic entertainment for the assembled oil industry luminaries.

It is quite evident that the speed and intensity of the U-turn in US oil production has unsettled the Saudis, and they don’t know quite what to do about it. So they were left with making empty threats.

My favorite was when Saudi Energy Minister Khalid al-Falih said there would be no “free rides” for US shale producers (and non-OPEC producers generally). Further, he said OPEC “will not bear the burden of free riders,” and “[w]e can’t do what we did in the ’80s and ’90s by swinging millions of barrels in response to market condition.”

Um, what is OPEC going to do about US free riders? Bomb the Permian? If it cuts output, and prices rise as a result, US E&P activity will pick up, and damn quick. The resulting replacement of a good deal of the OPEC output cut will limit the price impact thereof. The best place to be is outside a cartel that cuts output: you can get the benefit of the higher prices, and produce to the max. That’s what is happening in the US right now. OPEC has no credible way of showing off, or threatening to show off, free riders.

As for not doing what they did in the ’80s, well that’s exactly OPEC’s problem. It’s not the ’80s anymore. Now if it tries to “swing millions of barrels” to raise price, there is a fairly elastic and rapidly responding source of supply that can replace a large fraction of those barrels, thereby limiting the price impact of the OPEC swingers, baby.

Falih’s advisers were also trying to scare the US producers. Or something:

“One of the advisors said that OPEC would not take the hit for the rise in U.S. shale production,” a U.S. executive who was at the meeting told Reuters. “He said we and other shale producers should not automatically assume OPEC will extend the cuts.”

Presumably they are threatening a return to their predatory pricing strategy (euphemistically referred to as “defending market share”) that worked out so well for them the last time. Or perhaps it is just a concession that US supply is so elastic that it makes the demand for OPEC oil so elastic that output cuts are a losing proposition and will not endure. Either way, it means that OPEC is coming to the realization that continuing output cuts are unlikely to work. Meaning they won’t happen.

OPEC also floated cooperation with US producers on output. Mr. al-Falih, meet Senator Sherman! And if the antitrust laws didn’t make US participation in an agreement a non-starter, it would be almost impossible to cartelize the US industry given the largely free entry into E&P and the fungibility of technology, human capital, land, services, and labor. Maybe OPEC should hold talks with the Texas Railroad Commission instead.

Finally, in another laugh riot, OPEC canoodled with hedge funds. Apparently under the delusion that financial players play a material role in setting the price of physical barrels, rather than the price of risk. Disabling speculation could materially help OPEC only by raising the cost of hedging, which would tend to raise the costs of E&P firms, especially the more financially stretched ones. (Along these lines, I would argue that the big increase in net long speculative positions in recent months is not due to speculators pushing themselves into the market, but instead they have been pulled into the market by increased hedging activity that has occurred due to the increase in drilling activity in the US.)

Oil prices were down hard this week, from a $53 handle to a (at the time of this writing) $49.50 price. The first down-leg was due to the surprise spike in US inventories, but the continued weakness could well reflect the OPEC and Saudi messaging at CERA Week. The pathetic performance signaled deep strategic weakness, and suggests that the Saudis et al realize they are in zugzwang: regardless of what they do with regards to output, they are going to regret doing it.

My heart bleeds. Bleeds, I tells ya!


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March 4, 2017

Obama v. Trump: Strictly Correct & Misleading v. Not Strictly Correct But Fundamentally True

Filed under: Politics — The Professor @ 8:45 pm

I won’t comment in detail on the substance of today’s latest outbreak of our fevered politics: Trump’s accusation that Obama ordered wiretapping of Trump Tower and the Trump campaign. I will just mention one fact that strongly supports the veracity of Trump’s allegation: namely, the very narrow–and lawyerly–“denials” emanating from the Obama camp.

Obama and his surrogates–notably the slug (or is he a cockroach?) Ben Rhodes–harrumph that Obama could not unilaterally order electronic surveillance. Well, yes, it is the case that Obama did not personally issue the order: the FISA court did so. But even if that is literally correct, it is also true that the FISA court would not unilaterally issue such an order: it would only do so in response to a request from the executive branch. Thus, Obama is clearly implicated even if he did not issue the order. He could have ordered his subordinates to make the request to the court, or could have approved a subordinate’s request to seek an order. Maybe he merely hinted, a la Henry II–“will no one rid me of this turbulent candidate?” (And “turbulent” is a good adjective to apply to Trump.) But regardless, there is no way that such a request to the court in such a fraught and weighty matter would have proceeded without Obama’s acquiescence.

I therefore consider that the substance of Trump’s charge–that he was surveilled at behest of Obama has been admitted by the principals.

This episode illustrates a broader point that is definitely useful to keep in mind. What Obama and his minions (and the Democrats and many in the media) say is likely to be correct, strictly speaking, but fundamentally misleading. In contrast, what Trump says is often incorrect, strictly speaking, but captures the fundamental truth. I would wager that is the case here.

The lawyer word games are not limited to this episode. The entire Sessions imbroglio smacks of scumbag lawyer tactics. The Unfunny Clown, Senator Al Franken, asked (in a convoluted way) a very narrow question (which was related to an even narrower written question in a set of interrogatories) about Session’s interactions with the Russians. Sessions answered the question–which was not an unconditional query about contacts with the Russians, but which related to very specific types of contacts and discussions. Franken and the Democrats then accused Sessions of perjury because the Senator (and then-Attorney General designate) had met with the Russian ambassador to the US on two occasions. Asking a narrow question, and then claiming the answer was a false response to a broader question (that was not asked) is a sleazy lawyer trick (and one that has been tried on me, BTW).

One last thing. Why did Trump push this button today? I can think of offensive and defensive reasons. Offensively, he might want to gain the initiative in the war against Obama and the intelligence community. Defensively, this could be an excellent way of derailing the Russia hysteria, and the calls for an investigation. If it turns out that there was an FBI investigation, and it turned up nothing, then there is no justification for further investigation, whether by Congress or law enforcement. So it could actually help Trump if the FBI and the intelligence community were forced to acknowledge that they had investigated, to no avail. By raising the issue, Trump is pressuring the FBI to put up or shut up.

Figuring out Trump’s reasoning is always hard, but it is worth remembering that he is often at his most clever when he appears to be at his most unhinged and outrageous. So stay tuned. This isn’t over. By a long shot. And given that Trump has emerged triumphant whenever his foes have declared him to be dead meat, I would be very nervous right now if I were Barry or Ben or anyone in the IC.

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March 3, 2017

The Rocks Didn’t Go Anywhere. Go Figure.

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 2:58 pm

The conventional wisdom during the oil price collapse that started in mid-2014 and which accelerated starting in November of that year when the Saudis decided not to cut output was that the Kingdom was engaged in a predatory pricing strategy intended to drive out US shale producers. I mocked this in real time. Nothing really special about that analysis: economists have known for a long time that predatory strategies are almost never rational. They are irrational because the predator has to incur losses to cause its competitors to reduce production, but the competitors’ resources are unlikely to leave the industry permanently: they can come flooding back in when the predator attempts to restrict output to raise prices. Thus, the predator suffers all the pain at selling at low prices, but cannot recoup these losses by selling at higher prices later.

In the case of shale, the rocks weren’t going anywhere. Obviously. When prices fell, companies just drilled fewer wells–a lot fewer wells–but the rocks remained. The knowledge of where the right rocks were remained too. The knowledge of how to drill the rocks didn’t disappear. Idled rigs went into storage. Yes, some labor (including some skilled labor left), but this resource is pretty flexible and can come back quickly when demand goes up. E&P companies incurred financial losses, and some experienced financial distress and even bankruptcy, but this did not drive them out of the industry permanently, and did not drive out the human and physical capital that these firms employed. New capital required to drill new wells is available to E&P firms based on future prospects, not past failures. Indeed, one of the functions of bankruptcy and restructuring of distressed firms is to clean up balance sheets so that old debt doesn’t impede the ability of firms to take on positive NPV projects.

In sum, even though drilling activity plummeted along with prices, the resources needed to ramp up production weren’t destroyed or driven out of the industry. They were only waiting for more favorable prices. The industry went into hibernation: it didn’t die.

OPEC’s decision to cut output to raise prices–and the Saudis going beyond their share of output cuts to strengthen OPEC’s effect–provided the opportunity the industry had been waiting for. It rapidly awoke from its slumbers. Rig counts did a U-turn, up 90 percent in 9 months. And so has output. John Kemp reports:

U.S. crude oil production appears to be rising strongly thanks to increased shale drilling as well as rising offshore output from the Gulf of Mexico.

Production averaged almost 9 million barrels per day (bpd) in the four weeks to Feb. 24, according to the latest weekly estimates published by the Energy Information Administration.

Production has been on an upward trend since hitting a cyclical low of 8.5 million bpd in September (“Weekly Petroleum Status Report”, EIA, March 1).

Javier Blas chimes in:

“North American oil companies are going to increase their spending by 25 percent in 2017 compared to last year,” said Daniel Yergin, the oil historian-cum-consultant who hosts the CERAWeek. “The increase reflects the magnetism of U.S. shale.”

U.S. benchmark West Texas Intermediate traded at $52.79 a barrel on Friday. Futures bounced between $51.22 and $54.94 in February.

So far this year, U.S. energy companies have raised $10.5 billion in fresh equity, with shale and oil service groups drawing the most investment, the best start of the year since at least 1999 and equal to a third of what the sector raised in the whole of 2015. [A clear indication that “debt overhang” is not constraining the ability to access capital to fund drilling programs, which would have been the only way the Saudi strategy had a prayer of working.]

In Midland, the Texas city at the center of the Permian basin, the activity rush is palpable, as is the threat of higher costs for shale companies. The county’s active-rig total ranks second in the U.S., behind only Reeves County further to the west.

“You could see the town’s energy is back,” said Alan Means, founder of Cambrian Management Ltd., a Midland-based firm that operates more than 200 oil wells in the Permian across Texas and New Mexico. “The rigs are up again, the fracking crews are busier and the highway traffic is increasing.”

As activity rises, the man-camps in the town outskirts are flush again, with workers arriving from the Bakken in Montana and North Dakota, and from as far way as Canada. The 1,000-bed Permian Lodging camp is now 100 percent full, up from 65 percent in July, according to camp owner Ralph McIngvale. [See how quickly labor resources can return?]

Shale firms have also become more efficient.

In sum, the predatory strategy hasn’t made shale go away. Now, the longer the Saudis and the rest of OPEC (and the non-OPEC countries that have joined in) hold down output, the larger the fraction of that output loss will be redeemed by resurgent shale production in the US.

In other words, shale makes the the demand for OPEC (and non-OPEC cooperators’) oil pretty elastic. This raises serious questions about the rationality of the output cuts from the perspective of the cutters, especially the big countries like Saudi Arabia (which has cut substantially–more than it promised) and Russia (whose cooperation is more equivocal). This, in turn, makes the durability of the cuts problematic.

The quick turnaround in US shale provides a new data point for the Saudis, Russians, et al. Their dreams that they could make rocks disappear–or that they could make it permanently unattractive to extract oil from their rocks–have proved chimerical. Persisting in output cuts will become progressively less profitable, and indeed, is likely to be downright unprofitable soon. What’s the over-under on how long until they figure that rocks will outlast them, and give up the output cut game?

Teaser: I am currently slogging through oil well data (tens of thousands of wells in all the major basins) in a study of the sources of productivity gains in shale production. Hopefully I will be able to report some results soon. Initial results are particularly ominous for OPEC. I am finding evidence of learning-by-doing in both oil and gas. That is, drilling wells today generates knowledge that enhances future productivity and lowers future costs. This means that the increased shale output resulting from OPEC’s current attempt to prop up prices will increase the US shale industry’s future productivity, making it even harder for OPEC to keep prices high months or years from now.

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March 2, 2017

The Politicization of the Death of CPO Ryan Owens

Filed under: Military,Politics — The Professor @ 4:00 pm

Today the WaPoo serves as ventriloquist dummy for ex-Obama NSC staffer Colin (with an “i”) Kahl. Kahl continues his criticism of Trump’s handling of the planning and approval process for the mission in Yemen that resulted in the death of SEAL Ryan Owen. The gravamen of Kahl’s criticism is that the Obama administration engaged in much more internal debate at high levels, including at the presidential level, before approving such a mission. Kahl insinuates that the (allegedly) perfunctory process was a cause of the deadly outcome of the mission.

However, as I noted in my first post on the Yemen raid, there were multiple special operations mission in the Obama era that resulted in casualties and deaths among American special operators. Thus, more extensive internal debate is obviously not a sufficient condition for avoiding casualties. The fact is that these sorts of operations are inherently dangerous, and go wrong with some regularity. By failing to point out that reality, and the reality that a more “hands-on, deliberative process used by the previous administration” did not suffice to avoid American casualties in multiple cases, Kahl is lying by omission, and the WaPoo is facilitating that lie.

Further, Kahl and his WaPoo mouthpieces fail to point out that extensive internal debate, and senior involvement in the planning and approval process to the point of micromanagement, has its costs too. It must be pointed out that while Obama and his senior aides fretted about what to do about ISIS in 2014, the group ran amok and conquered much of Iraq and Syria. There was a clear case where Hamlet-like indecisiveness resulted in a result that was far more catastrophic than the failure of a particular special operations raid to go according to plan. Indeed, some of the raids resulting in American casualties undertaken by the Obama administration wouldn’t have been needed if the Obama administration had checked ISIS in the summer of 2014, instead of deciding that it was the JV and letting it go on a rampage.

The micromanagement continued throughout the Obama administration. This inevitably reduced the effectiveness of the war on ISIS, the cost of which is written in blood. Pace Bastiat, one has to consider the unseen in war as well as in economics.

The issue of the Yemen raid and the death of Ryan Owen required the WaPoo’s emergency intervention because it is widely recognized (even by Van Jones, for crissakes) that Trump’s recognition of his widow at his speech before Congress on Tuesday was a powerful moment that resonated with Americans. The left, and assorted non-left Trump haters (e.g., bloated, drunken, unemployed flashers who pontificate on security matters on Twitter), have worked themselves into a frenzy in an attempt to discredit this moment.

This has taken two tacks. One is the Kahl tack–to claim that Trump is responsible for Owens’ death through shoddy planning. The other is to claim that Trump somehow used Mrs. Owens, or even forced her to appear. Kahl’s tack is fundamentally dishonest (as discussed above) and the other tack is just disgusting. Carryn Owens was obviously deeply moved and appreciative. She wanted to be there, and wanted her husband’s sacrifice to be recognized. As to how she could have been forced to appear (as alleged by aforementioned bloated flasher), I have no clue. Insofar as using is concerned, Trump invited scrutiny of the events leading up to Owens’ death, and obviously believes he has nothing to hide, and that recognizing Owens’ sacrifice was more important: recall that Trump met Owen’s body when it was returned to the US.

If there is politicization of the death of CPO, that is coming primarily from the left in its unrelenting war on Trump, in which all is fair.

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March 1, 2017

Ivan Glasenberg: Mistaking Luck for Genius?

Filed under: China,Commodities,Economics,Energy — The Professor @ 8:58 pm

Glencore is back from the brink, posting a $1.4 billion profit for 2016. When I first read about the 2016 results, I wondered aloud to a friend whether Ivan Glasenberg would have learned something from the company’s near death experience, or instead would consider the fall someone else’s fault, and the resurrection the result of his genius. I should have known it would be the latter.

Glasenberg has been gloating about the 2016 results, and flaunting them as some sort of vindication. He is openly musing about paying a $20 billion dividend to the company’s “long suffering shareholders,” and is looking for acquisitions, including in North American grain trading.

The fact is that Glencore and Ivan Glasenberg were (and are) just along for a ride on the commodity price roller coaster, which is located at a Chinese amusement park. When the roller coaster plunged as the Chinese economy shuddered in 2015, Glencore plunged along with it. Now, in large part due to Chinese policy moves that have caused the prices of coal and other raw materials to climb again, Glencore has rebounded. Management genius had nothing to do with it.

Well, that’s not completely true. Glasenberg made the conscious choice to transform Glencore from a trading firm that was basically flat price neutral to a mining firm with a big exposure to the flat prices of coal and copper in particular. So the big drop and the rebound are the result of his choice.

When Glencore was in peril in 2015, I said that its fate was dependent on commodity prices, and hence on Chinese policy, rather than any decision that management can make. I said that Glencore was along for the ride. That turned out to be true. It remains true going forward. That was the fundamental strategic choice that has shaped and will continue to shape its performance. Management can at best optimize performance over the cycle, but the cycle will dominate.

Prior to 2015, Glencore management did not optimize. The firm was over-leveraged: it continued to operate with trading-firm like leverage levels even though it faced bigger commodity price risks. Glasenberg/Glencore have cut down on debt in the past year, and this reduces the likelihood of a repeat of 2015–if they stick to a lower leverage policy going forward. But the fact is that the biggest driver of Glencore’s fate is not decisions made in Baar, but the whims of policymakers in Beijing.

It is interesting to compare Glasenberg’s crowing to the more muted tones of other mining firms which have also profited from the rebound. The managements of these other firms apparently realize that what the cycle giveth, the cycle can taketh away. Is Peabody Coal’s management preening over the company’s rebound? No. They are silently grateful that factors outside of their control have turned their way. Similarly, Noble eked out a profit, but its management isn’t breaking their arms patting themselves on the back.

Traders typically make deals of relatively short duration, and it is possible to evaluate trading decisions and trading acumen based on P/L. But by transforming Glencore into a mining company with a  supersized trading arm, Glasenberg purposefully made a very long term trade with a duration of years (decades, even): quarterly or even annual fluctuations in P/L tell you little about the wisdom of such a trade. It is therefore rather disturbing to watch Glasenberg gloat on the basis of a profitable year driven by a cyclical turn with which he had exactly zero to do with.

And let’s put this in perspective. Glencore lost $5 billion in 2015. 2016 made up less than 30 percent of that loss. There is still a long way to go to determine whether the big, multi-year trade that Glencore made a few years ago was a smart play or not.

Perhaps Glasenberg still has a trader’s mindset, and a trader’s time horizon, suited for a transaction cycle measured in weeks or months, not years or decades. If so, the company might be in for a big future fall, because its guiding light is apt to mistake luck for skill.

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February 26, 2017

If You Want Blood, You Got It–Tesla Redux

Filed under: Climate Change,Economics — The Professor @ 3:24 pm

When Musk announced his plans to merge Tesla and Solar City, I remarked that “Tesla bleeds cash like a Game of Thrones battle scene.” Elon (who long ago blocked me on Twitter, BTW) apparently recognized this. In an August 29, 2016 email to Tesla employees Musk emphasized how important it was for the company to report a positive cash flow for 3Q16:

I thought it was important to write you a note directly to let you know how critical this quarter is. The third quarter will be our last chance to show investors that Tesla can be at least slightly positive cash flow and profitable before the Model 3 reaches full production. Once we get to Q4, Model 3 capital expenditures force us into a negative position until Model 3 reaches full production. That won’t be until late next year.

. . . .

Even more important, we will need to raise additional cash in Q4 to complete the Model 3 vehicle factory and the Gigafactory. The simple reality of it is that we will be in a far better position to convince potential investors to bet on us if the headline is not “Tesla Loses Money Again”, but rather “Tesla Defies All Expectations and Achieves Profitability”. That would be amazing!

Were you amazed(!) that Tesla eked out a positive cash flow in the third quarter? If so, do you feel like a fool now that the 4Q16 results are out, showing that the blood is gushing again? For in the quarter, Tesla set a record (and not the good kind!) for free cash flow: a cool $1 billion to the negative, -$447 in operating cash flow and $522 in capex. The operating number reflected lower vehicle emissions credits, illustrating the company’s dependence on this source of revenue.

So what?, you say. Elon said that “Once we get to Q4, Model 3 capital expenditures” will make results look bad. But it appears that Telsa actually held back on capex. In the vaunted 3Q guidance, the company implied that it would spend $1 billion in capex in 4Q16: it barely spent half of that. This does not bode well for delivering the Model 3 on time, and demonstrates the dilemma that Musk faces.

Given Musk’s emphasis on delivering a positive cash flow number in the third quarter, it appears that his accountants rose to the task. There raises serious questions about the legitimacy of the third quarter number. It was obviously a one-off. Elon said that it was vital to “convince potential investors to bet on us” by “defying expectations.”  Was it necessary to lie to defy?

Any such suspicions should be strengthened by the, well, suspicious resignation of Tesla’s CFO on the day its 8-K was filed, to be effective when its 10-K is filed.  The reason given is rather odd: Wheeler plans to “pursue opportunities in public policy.” Well, I guess it’s better than “I want to spend more time with my family.”

The resignation of a CFO is never a good sign, especially when it coincides with the release of an ugly earnings report that follows an earnings report that appeared to be too good to be true at the time–and which looks even more too good to be true in retrospect.

Even Elon appears a little anxious. He said that the company’s cash position is “very close to the edge.” So get ready to have your stock watered again, boys and girls: “So we’re considering a number of options but I think it probably makes sense to raise capital to reduce risk.”

Or, to mix metaphors: another transfusion for the bleeder. In the vein, out the artery. Investors and Wall Street have been very forgiving. For years. How long can that continue?

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February 25, 2017

Should Social Media Be Regulated as Common Carriers?

Filed under: Economics,Politics,Regulation — The Professor @ 6:43 pm

Major social media, notably Twitter and Facebook, are gradually moving to censor what is communicated on them. In Twitter’s case, the primary stated rationale is to “protect its users from abuse and harassment.” It has also taken upon itself to  “[identify] and [collapse] potentially abusive and low-quality replies so the most relevant conversations are brought forward.” There are widespread reports that Twitter engages in “shadowbanning”, i.e., hiding the Tweets of those users it identifies as objectionable, and making these Tweets inaccessible in searches.

Further, there are suspicions that there is a political and ideological component to the filters that Twitter applies, with conservative (and especially alt-right) content and users being more likely to fall afoul of these restrictions: the relentlessly leftist tilt of CEO Jack Dorsey (and most of its employees) gives considerable credence to these suspicions.

For its part, Facebook is pursuing ways to constrain users from posting what it deems as “misinformation” (aka “fake news”). This includes various measures such as cooperating with “third party fact-checking organizations“. Given the clear leftist tilt of Mark Zuckerberg and Facebook’s workforce, and the almost laughably leftist slant of the “fact-checkers”, there is also considerable reason for concern that the restrictions will not be imposed in a politically neutral way.

The off-the-top classical liberal/libertarian response to this is likely to be “well, this is unfortunate, but these are private corporations, and they can do what they want with their property.” But however superficially plausible this position appears to be, in fact there is a principled classical liberal/libertarian response that arrives at a very different conclusion. In particular, as arch-libertarian Richard Epstein (who styles himself as The Libertarian in his Hoover Institute podcast) has consistently pointed out, even during the heyday of small government, classical liberal government and law, the common law recognized that restrictions on the autonomy of certain entities was not only justifiable, but desirable. In particular, natural monopolies and near-monopolies were deemed to be “common carriers” upon whom the law imposed a duty of providing access on a non-discriminatory basis. The (classically liberal) common law of that era recognized that such entities could exercise market power, or engage in discriminatory conduct without fear of competitive check. Thus, the obligation to serve all on a non-discriminatory basis in order to constrain the exercise of market power, or invidious discrimination based on the preferences of the owner of the common carrier.

Major social media (and Google as well–perhaps most of all) clearly have market power, and the ability to discriminate without fear of losing business to competitors. The network nature of social media (and search engines) leads to the dominance of a small number of platforms, or even one platform. Yes, there are competitors to Facebook, Twitter, and Google, but these companies are clearly dominant in their spaces, and network effects make them largely immune to competitive entry. Imposition of a common carrier-inspired obligation to provide non-discriminatory access is therefore quite reasonable, and has a substantial economic and legal foundation. Thus, libertarians and classical liberals and conservatives and even fringe voices should not resign themselves to being second or third class citizens on social media, merely because these are private entities, rather than government ones. (Indeed, the analogy should go the other direction. A major reason for limiting the ability of the government to control speech is because of its monopoly of legal violence. It is monopoly power, regardless of whether in a market or political setting, that needs to be constrained through things like rights to free speech, or non-discriminatory access to common carriers.)

Further, insofar as leftists (including the managements of the major social media companies) are concerned, it is utterly incoherent for them to assert that as private entities they are perfectly free to restrict access according to their whims, given that leftists also adamantly (indeed, obnoxiously) insist that anti-discrimination laws should be imposed on small entities operating in highly competitive environments. Specifically, leftists believe that bakers or caterers or pizzarias with zero market power should be required to serve all, even if they have religious (or other) objections to doing so. But a baker refusing to sell a wedding cake to a gay couple does not meaningfully deprive said couple of the opportunity to get a cake: there are many other bakeries, and given the trivial costs of entry even if most incumbent bakers don’t want to serve gays, this only provides a commercial opportunity for entrant bakers to cater to the excluded clientele. Thus, discrimination by Baker A does not impose large costs on those s/he would prefer not to serve (even though forcing A to serve them might impose high costs on A, due to his/her sincere religious beliefs).

The same cannot be said of Twitter or Facebook. Given the nature of networks, social and otherwise, entrants or existing competitors are very poor substitutes for the dominant firms, which gives them the power to exclude, and which makes their exercise of this power extremely costly to the excluded.  In other words, if one believes that firms in highly competitive markets should be obligated to provide service/access to all on a non-discriminatory basis, one must concede that the Twitters, Facebooks, and Googles of the world should be similarly obligated, and that given their market power their conduct should be subject to a substantially higher degree of scrutiny than a small firm in a competitive market.

Of course, it is one thing to impose de jure an obligation on Twitter et al to provide equal access and equal treatment to all, regardless of political beliefs, and quite another to enforce it de facto. Of course Jack and Mark or Sergey don’t say “we discriminate against those holding contrary political opinions.” No, they couch their actions in terms of “protecting against abusive behavior and hate speech” or “stamping out disinformation.” But they retain the discretion to interpret what is abusive, hateful, and false–and it is clear that they consider much mainstream non-leftist belief as beyond the pale. Hence, enforcement of an open non-discriminatory access obligation would be difficult, and would inevitably involve estimation of discriminatory outcomes using statistical measures, a fraught exercise (as employment discrimination law demonstrates). Given the very deep pockets that these firms have, moreover, prevailing in a legal battle would be very difficult.

But this is a practical obstacle to treating social media like common carriers with a duty to provide non-discriminatory access. It is not a reason for classical liberals and libertarians to concede to dominant social network operators that they have an unrestricted right to restrict access as a matter of principle. In fact, the classical liberal/libertarian principle cuts quite the other way. And at the very least, imposing a common carrier-like obligation would substantially raise the cost that social network operators would pay to indulge in discrimination based on politics, beliefs, or ideology, and this could go a long way to make these places safe for the expression of political opinions that drive Jack, Mark, et al, nuts.


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February 20, 2017

Trolling Brent

Filed under: Commodities,Derivatives,Economics,Energy,Regulation — The Professor @ 10:14 am

Platts has announced the first major change in the Brent crude assessment process in a decade, adding Troll crude to the “Brent” stream:

A decline in supply from North Sea fields has led to concerns that physical volumes could become too thin and hence at times could be accumulated in the hands of just a few players, making the benchmark vulnerable to manipulation.

Platts said on Monday it would add Norway’s Troll crude to the four British and Norwegian crudes it already uses to assess dated Brent from Jan 1. 2018. This will join Brent, Forties, Oseberg and Ekofisk, or BFOE as they are known.

This is likely a stopgap measure, and Platts is considering more radical moves in the future:

It is also investigating a more radical plan to account for a possible larger drop-off in North Sea output over the next decade that would allow oil delivered from as far afield as west Africa and Central Asia to contribute to setting North Sea prices.

But the move is controversial, as this from the FT article shows:

If this is not addressed first, one source at a big North Sea trader said, the introduction of another grade to BFOE could make “an assessment that is unhedgeable, hence not fit for purpose”. “We don’t see any urgency to add grades today,” he added. Changes to Brent shifts the balance of power in North Sea trading. The addition of Troll makes Statoil the biggest contributor of supplies to the grades supporting Brent, overtaking Shell. Some big North Sea traders had expressed concern Statoil would have an advantage in understanding the balance of supply and demand in the region as it sends a large amount of Troll crude to its Mongstad refinery, Norway’s largest.

The statement about “an assessment that is unhedgeable, hence not fit for purpose” is BS, and exactly the kind of thing one always hears when contracts are redesigned. The fact is that contract redesigns have distributive effects, even if they improve a contract’s functioning, and the losers always whinge. Part of the distributive effect relates to issues like giving a company like Statoil an edge . . . that previously Shell and the other big North Sea producers had. But part of the distributive effect is that a contract with inadequate deliverable supply is a playground for big traders, who can more easily corner, squeeze, and hug such a contract.

Insofar as hedging is concerned, the main issue is how well the Brent contract performs as a hedge (and a pricing benchmark) for out-of-position (i.e., non-North Sea) crude, which represents the main use of Brent paper trades. Reducing deliverable supply constraints which contribute to pricing anomalies (and notably, anomalous moves in the basis) unambiguously improves the functioning of the contract for out-of-position players. Yeah, those hedging BFOE get slightly worse hedging performance, but that is a trivial consideration given that the very reason for changing the benchmark is the decline in BFOE production–which now represents less than 1 percent of world output. Why should the hair on the end of the tail wag the dog?

Insofar as the competition with WTI is concerned, the combination of larger US supplies, the construction of pipelines to move supplies from the Midcon (PADDII) to the Gulf (PADDIII)  and the lifting of the export ban have restored and in fact strengthened the connection of WTI prices to seaborne crude prices. US barrels are now going to both Europe and Asia, and US crude has effectively become the marginal barrel in most major markets, meaning that it is determining price and that WTI is an effective hedge (especially for the lighter grades). And by the way, the WTI delivery mechanism is much more robust and transparent than the baroque (and at times broken) Brent pricing mechanism.

As if to add an exclamation point to the story, Bloomberg reports that in recent months Shell has been bigfooting–or would that be trolling?–the market with big trades that have arguably distorted spreads. It got to the point that even firms like Vitol (which are notoriously loath to call foul, lest someone point fingers at them) raised the issue with Shell:

While none of those interviewed said Shell did anything illegal, they said the company violated the unspoken rules governing the market, which is lightly regulated. Executives of several trading rivals, including Vitol Group BV, the world’s top independent oil merchant, raised objections with counterparts at Shell last year, according to market participants.

What are the odds that Mr. Fit for Purpose is a Shell trader?

All of this is as I predicted, almost six years ago, when everyone was shoveling dirt on WTI and declaring Brent the Benchmark of the Forever Future:

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.

That’s exactly how things have worked out, even down to the point about the difficulties of getting the big boys to play together (a lesson gained through extensive personal experience, some of which is detailed in the post). Just call me Craignac the Magnificent. At least when it comes to commodity contract design 😉

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February 19, 2017

More Contradictions and Confusions

Filed under: History,Politics — The Professor @ 2:12 pm

One could really make a parlor game out of identifying all of the contradictions and confusions in the “thinking” of the identity progressive left.

Further yesterday’s point, how can they possibly win (in the US, anyways)? On their terms, winning would mean the subjugation of the victimizers (e.g., the alleged white patriarchy, including all of those white privileged denizens of Appalachia). How is this to occur? Since those to be subjugated are unlikely to voluntarily agree to become Morlocks, they must be subdued by force or the ballot box. The current correlation of forces, however, is strongly on the side of the alleged oppressors. Re-education camps to get their minds right would also be required, but “elite” liberal arts colleges (the closest thing to such camps currently in operation n the US) have already made plain their unwillingness to admit such people, and coercion would be required to force them into something that Pol Pot could love. And given that those to be coerced have the guns (a fact the left never ceases to bewail), how could that possibly work?

And is victory even possible? The leftist version of identity politics is predicated on the conflict between the oppressed and the oppressors. What happens if the oppressed defeat the oppressors? How could they function if a vital piece of their worldview disappears? When your life is structured around fighting The Man, what do you do when The Man loses/dies/disappears? My guess is that there would be a period of internecine struggle to identify who assumes the role of oppressor, and who gets the prized role of being the oppressed.

This brings to mind the Taoist critique of other (not exclusively, but mainly) western religions and philosophies which posit wars between light and darkness, goodness and evil, and so on, which can be summarized as: “um, what happens when light/good win?” Similar critiques have been applied to progressive thought (cf. Alan Watts): how is progress possible in a world of polarity? This problem is particularly acute for identity leftists, because polarity (oppressed/oppressors) is at the core of their mental model.

Traditional Marxists faced a similar dilemma. Marx was quite detailed in describing the class struggle and its ultimate outcome of a dictatorship of the proletariat, but he was quite hazy at describing just what that dictatorship would look like, and how it would be free of conflict (in the presence of any specialization at all).  I would guess that in the unlikely event of victory that the intramural contests on the left would put the intra-party conflicts among the Bolsheviks post-1917 to shame. (And remember what ended the latter conflict: Stalin killing everybody who disagreed with him.)

One last thing. the focus on identity has led to a category error in interpreting US politics, Trump’s rhetoric, and the appeal of that rhetoric to his supporters. In the identity left’s worldview, nationalism is inherently based in national, racial, and ethnic supremacism (and gender and sexual orientation and on and on). Hence, when Trump or a Trump supporter celebrates or asserts American nationalism, the Pavlovian response on the left is to think of European nationalism of the blood and soil variety. No! American nationalism has always been different, and to equate Trump with a Le Pen or an Orban–or a Putin!–on this issue is fundamentally wrong.

On this eve of Presidents’ Day, a review of Lincoln’s formulation of American nationalism, and his distinction between American and European varieties is quite useful. Sadly, all too many people have forgotten this fundamental distinction, including Republican Senators, notably John McCain, who committed this very category error a few days ago. In a statement aimed clearly at Trump, as well as continental nationalist leaders, he said:  “[The founders of the Munich conference] would be alarmed by an increasing turn away from universal values and toward old ties of blood and race and sectarianism.”

Maybe that’s true in some countries, but it is not what is going on in the United States. Indeed, it is a disgusting insult of tens of millions of Americans to insinuate that it is. McCain’s combination of senility and narcissism is becoming too much to bear, but this remark (and other things he said in Munich) demonstrate how deeply the identity left/progressive rot has penetrated establishment opinion in the US.



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