Streetwise Professor

October 22, 2014

A Lack of Strategy Makes Kobane Strategic For the US

Filed under: History,Military,Politics — The Professor @ 9:20 pm

There’s been some chin pulling about whether Kobane is strategic for the US. Methinks that some of this is encouraged by nudges from people in the administration, who really don’t want to be involved there.

Truth be told, it is strategic, but it isn’t. Paradoxically, it is strategic because of the lack of a US strategy.

That’s not quite right, exactly. Obama has a strategy to achieve an objective defined by what he wants to avoid, rather than what he wants to achieve. But he has to do something, so he has effectively fallen back onto the last refuge of the strategically bankrupt, or those lacking the capability (or unwilling to use the capability) to take the initiative and succeed: attrition. When a campaign is focused on body counts, it is likely to be strategically barren.

 

Famous battles of attrition throughout history (think Verdun) have been hideously costly to both sides. US airpower allows it, under certain circumstances, to attrit its enemy at virtually no risk of casualties. The problem is that those circumstances are largely under the control of the enemy. An enemy that disperses and burrows into urban terrain is relatively immune, although by doing so it can hold what it has but can’t take more.

What is remarkable about Kobane is that IS has eschewed those tactics, and has concentrated large numbers of men and equipment, thereby presenting a target to American airpower. Given the American attrition strategy, these concentrations have become a strategic objective by default. It’s in that sense that a lack of strategy beyond attrition makes Kobane strategic, but then only because for some unfathomable reason ISIS decided to expose itself there.

As this Max Boot article argues, using Khe Sanh as an example, this can inflict large losses and keep even an isolated position from falling. But it cannot inflict a real defeat on ISIS (although the morale and propaganda effects of a failure to take Kobane would inflict some damage on it).

There are concerns that going after Kobane is limiting American ability to influence the battle in other, more important locations, like Mosul and Anbar. But this must be a consequence of self-imposed limitations on the resources committed to the theater. To put things in comparison, the shambolic Syrian air force is mounting far more sorties in Syria than US forces are in Iraq and Syria combined. For Syria, this is an existential conflict and it is pulling out all the stops. For the US, this is a conflict entered grudgingly with many strings attached. Gulliver is tying himself down.

ISIS is apparently mounting attacks elsewhere. These provide additional opportunities for American airpower. Outside of Mosul in particular, the US can cooperate with a reasonably competent ground force. But none of this is likely to prove decisive. ISIS has the luxury of fighting and running away with little fear of aggressive pursuit or the loss of territory (much of it desert waste anyways) from troops following in the wake of their retreat. It continues to have the initiative.

So the likely outcome is stalemate. US airpower, working with available local ground forces, can contain ISIS, and inflict some serious casualties. But that’s about it.

Austin Bay’s verdict is about right:

The battle for the Syrian Kurd town of Khobane has emerged as an opportunity to deal the Islamic State a military and political defeat. Maximizing the opportunity, however, requires what has been most grievously missing from the struggle against the terrorists and their so-called caliphate: persuasive, coherent and steadfast American leadership.

Not happening. Not going to happen.

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October 21, 2014

The Crown Family Affair

Filed under: Military,Politics — The Professor @ 10:29 pm

Yesterday the WaPo reported that the US was planning to sell to Iraq 46,000 HEAT rounds for 120mm M1A1 Abrams tank guns. I was scratching my head at reading this. Although HEAT rounds can be used against buildings, and hence could be of some use in an attack against ISIS in places like Fallujah, it hardly seems that this is a priority for the Iraqi Army. The priority for the Iraqi Army is to get it to stand and fight rather than flee. An attack against a place like Fallujah is a long, long way away. What’s the point of giving Iraq more tank rounds, when its tankers bail out at the first opportunity?

Since this didn’t make sense militarily the only explanation I had is that  this is really  about giving General Dynamics more than half-a-billion dollars under the cover of the (relatively) popular campaign against ISIS. Then @libertylynx pointed out that General Dynamics’ largest shareholder (and once-upon-a-time controlling shareholder) is the Crown family. The Crowns have about 10 percent of GD, and about 50 percent of their $7.5 billion fortune is invested up in the company.

So what? you might say. Who are the Crowns, anyways? Well, they are a Chicago family that has  been a longtime supporter of Obama: they gave $128K for his 2006 senate campaign. According to the WaPo, they are part of the inner circle of Chicago Friends of Barack, and as the paper notes, Chicago ties are the ones that bind. And when Michelle goes skiing at Aspen, she crashes at the Crowns’. (“She likes it there!”)  In 2008, Crown elder Lester (briber of politicians-hey, he is from Chicago, you know-whose security clearance the Pentagon wanted to yank) did Barack a boon service by writing a letter aimed at Jewish voters assuring them of Obama’s “stellar record on Israel” and promising that as president Obama would be a great friend of the Jewish state. (How’s that working out, by the way?)

So the Crowns have been there for Obama, early and often (as the Chicago phrase goes), with money and a kind word to the right constituencies. It’s nothing of a stretch to conclude that the $600 million of love showered on General Dynamics is the least Barry can do in return. So spare me any shrieking about the Kochs or Dick Cheney and Halliburton. Obama is well-versed in Chicago ways, and this has Chicago written all over it, in more ways than one. There is no plausible military case to be made for putting $600 million in HEAT rounds at the top of military aid for Iraq, so there must be something else. Occam’s Razor suggests that this military aid is just (domestic) politics carried out by other means.

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October 19, 2014

It *Was* Too Quiet Out There

Filed under: Commodities,Derivatives,Economics,Energy,Financial crisis — The Professor @ 5:28 pm

Four weeks ago I gave the keynote talk at Energy Risk Asia in Singapore. My talk was a look back at commodity market developments in the past year, followed by a look forward.

The theme of the look back was “A Perfect Calm.” I noted that volatility levels across all markets, not just commodities, were at very low levels. Equity vols, as measured by the VIX, had been in the 10 percent range in August and had only ticked up to around 12 percent by late-September. Commodity volatilities were even more remarkable. Historically, the low level of commodity volatilities (the 5th percentile) have been around the median of equity vols and well above currency and bond vols. During the first half of the year, however, commodity vols were below the 5th percentile of equity vols, and below the 95th percentile of currency and bond vols. Pretty amazing.

I argued that this reflected a happy combination of supply and demand factors. In energy and ags in particular, abundant supplies put a drag on volatility. But volatility from the demand side was low too. The low VIX levels are a good proxy for macro uncertainty, or the lack thereof. Put both of those together, and you get a perfect calm.

But perfect calms are the exception, rather than the rule. The last slide in my talk looked forward, and cribbed a movie cliche: It was titled “It’s Quiet Out There. Too Quiet.” I noted that periods of very low volatility frequently bear the seeds of their destruction. When risk measures are low, firms and traders lever up and increase position sizes. A bit of economic turbulence increases volatilities, which leads to breaches in risk limits, which forces deleveraging and reductions in positions. This tends to lead to reduced liquidity, exaggerated price moves, yet higher volatility, leading to more deleveraging and repositioning, and on it goes. That is, there can be a positive feedback loop. Transitions from low to high volatility can be very abrupt.

It looks like that’s what has happened in the weeks since my return. Equity markets are down substantially. Commodities, notably energy, have slumped: Brent is down to around $88. Volatilities have spiked. The VIX reached over 31 percent last week, and the crude oil VIX went from about 15 percent at the end of August to over 37 percent last week.

The spark appears to have been mounting evidence of a slowdown in Europe and China. Ebola might have been a contributing factor in the last week or two, but in my view the economic weakness is the main driver.

I admit to being like the title character in My Cousin Vinnie. He had difficulty sleeping in the Alabama country quiet, but slept like a lamb in a raucous county jail. Times like these are more interesting, anyways.

So it turns out it was too quiet out there.

And remember. Today is the 27th anniversary of the ’87 Crash (one of the formative experiences of my professional life). Octobers are often . . . interesting (the most dangerous word in the English language). So the markets bear watching closely. If you aren’t interested in them, they may well be interested in you.

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Russian Truculence and a History of Russian Naval Mishaps Colliding in Swedish Waters?

Filed under: History,Military,Politics,Russia — The Professor @ 2:35 pm

Russia has been hyper-aggressive of late in probing the defenses of neighboring countries, including the US and Canada, mainly by aircraft. Sweden has been a frequent target as well.

Now Sweden may be the subject of another probe, this one from under the sea in the Stockholm Archipelago. Anomalous underwater activity was detected, as have been communications (some encrypted) from a point in the region to the Russian naval base at Kaliningrad. The comms purportedly include a distress call. A Russian tanker (under the Liberian flag with an English name, the Concord) has been circling suspiciously in the Baltic: some suspect it is the mother ship of a mini-sub. A Russian research ship, the Professor Lugachev, has suddenly set sail from Saint Petersburg.

Given history, and current events, the Occam’s Razor solution to this mystery is that a Russian sub, maybe a mini-sub, has run into trouble while probing Swedish waters.

The Russians, of course, deny everything:

A defence ministry spokesman in Moscow told reporters that the Russian navy’s submarines and surface ships were “performing tasks… according to plan”.

“There has been no irregular situation, let alone emergency situation, involving Russian navy vessels,” he said.

Again given history, the best thing to do is to assume the opposite is true. Consider the case of the Kursk:

In the days after the incident, the Navy and the government issued a blizzard of non-information, mis-information and dis-information.  At first, the Navy denied that anything was amiss, acknowledging a mere “technical difficulty.”  The government denied the problem for some time; it took two entire days to even admit that the ship “was in serious trouble,” and then lied about when the incident had occurred.  Indeed, the day after the sinking, the Navy commander told the press that the exercise had been flawless.  Yes: flawless.

They never used the word “sink.”  They claimed the entire crew was alive.  They claimed they were in communication with the crew, and that the ship was supplied with air and power from the surface.  The Navy excused its evident lack of preparation for a rescue by bewailing the weather conditions and strong currents, even though the weather was fine and the currents benign.  All complete and outrageous fabrications.

Enraged by the duplicity, at one Navy press conference, the mother of a Kursk officer, Nedezhda Tylik, launched into a screaming denunciation of official dishonesty.  In an event captured on film, a nurse was seen to move up behind Tylik, and inject her with a hypodermic needle.  Tylik collapsed and was taken from the room.  (A still photo is available here; I have not found the video online for free despite a diligent effort; there is a documentary that has the film that can be purchased here.)  She first claimed she had been sedated against her will, and the Navy said that it had indeed given her a sedative; in an Orwellian way, it acknowledged the “solicitous administration of needed tranquilizers.”

Then, remarkably, in the aftermath of a domestic and international outcry, the Navy denied that it had sedated her, and Tylik also recanted, claiming that she had only been given her heart medication at her husband’s request.  Yeah, sure.  Who you gonna believe?  Them or your lying eyes? (Tylik maintains this version in the documentary.  But why did neither she nor her husband make that statement initially?)

And how can we forget Russia’s dodgy naval safety record? I’ve often mocked how its carrier Kuznetsov, such as it is, never leaves home without a salvage tug bobbing along in its wake. The Russian naval curse even inflicts those dumb enough to buy its cast offs and then spend billions trying to fix them up. The Indians found this out to their cost when they bought the Admiral Gorshkov. Now the Chinese are having problems with the Liaoning, ex-VaryagNo biggie. Just that steam is flooding out of its boiler compartment. But it’s not a boiler explosion, apparently! So there’s that.

Given the combination of recent Russian truculence and the long record of Russian naval mishaps, the most likely explanation is that a Russian naval intelligence operation has come to ruin. Let’s hope that the crew survives-though given the track record one doubts that Putin and the Russian high command give a crap about that. Indeed, they would probably prefer that the crew die undiscovered than survive to be captured. Let’s also hope that the facts come out, and prove very embarrassing to VVP.

But one thing for sure: pay zero attention to what the Russians say about this. Well, that’s not right, exactly. Take what they say, and assume the exact opposite and you might be within visual range of the truth.

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Further My Last

Filed under: History,Military,Politics — The Professor @ 12:26 pm

Following up on yesterday’s Victory Disease post, here are a couple of articles that reinforce my basic conclusion. The Bronk piece in CNN is particularly complementary in its discussion of ISIS’s error in switching tactics, and the Telegraph article provides very current information and detail about how just accurate and devastating US airpower can be.  And lest you think I am a victim of confirmation bias, I did look for contrary information, and couldn’t find anything from independent sources.

The Bronk article reinforces something I was thinking the other day. T. E. Lawrence and other British officers assigned to the Arab rebels during WWI despaired of making them conventional soldiers. Lawrence, per his telling in the grips of dysentery-induced delirium, conceived that their genius was as irregulars who utilized mobility to carry out a war of hit and run attacks on a relatively immobile Turkish army of dodgy morale. Keegan’s History of Warfare states that this form of warfare was the Arab way going back to the times of Mohammed. For the Arabs, there was no dishonor in retreat. Hit weaker forces at a vulnerable point, don’t engage in standup fights, and run when a superior force appears. Keegan draws on V. D. Hanson’s work to argue that the standup, face-to-face fight is a peculiarly Western way of war deriving from the Greeks.

ISIS is most formidable when it fights in the traditional Arab way. (Chechens were also historically guerrillas and raiders.) It does its opponents a favor when it fights the Western way. But it appears that Victory Disease has deluded its leaders into believing that they can ape a conventional Western army and win. That delusion could be a great favor.

 

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October 18, 2014

Victory Disease in the Desert?

Filed under: History,Military,Politics — The Professor @ 7:35 pm

Definitive news out of Kobane is difficult to come by. Kurdish sources claim that ISIS has been pushed out of the city. Others report an increase in ISIS mortar fire. However, the city’s fall no longer seems imminent, and it does appear that the momentum has been reversed. This despite Turkey’s starving the Kurds of reinforcements and supplies.

What turned the tide? A modest increase in American air strikes, to around 15-20 per day. In terms of capability, and previous US campaigns, this is nothing. But even a few handfuls of American strikes can be devastating to troops, vehicles, and equipment in open desert.

Kobane is an operational blunder by ISIS. It has no real strategic importance. At most, capturing the city allows ISIS to consolidate and extend its control over northern Syria and clean up its rear. But the Kurds there posed no real threat to ISIS, so why divert a major effort there? Apparently hatred of atheist Kurds (whom they are fighting in Iraq as well) has  convinced the group to divert a major effort to this sideshow.

It may also be a case of what the Japanese in WWII called “Victory Disease.” After Japan achieved all of its strategic objectives by early 1942, it should have followed its original plan and create a defensive perimeter. Instead, intoxicated by easy success, Japan pushed beyond its original planned perimeter. The result was disaster: the short, crushing loss at Midway, and the long, grinding defeat in the Solomons.

ISIS’s boasting certainly betrays strong symptoms of VD. Moreover, the predicate for it is there: a series of rapid, unexpected and stunning victories that left its enemies reeling, confused, and demoralized. Ironically, even Obama’s diffident and indecisive response might have had the beneficial effect of encouraging ISIS belief in their invincibility, and the terror they inspired. Even America was afraid to confront them!

ISIS also believes in a sort of imminent eschatology. Its haste to declare a caliphate is a manifestation of that. They are in a hurry. Such minds are especially prone to Victory Disease, because they believe that they are destined to conquer, and conquer now, and look at every victory as a confirmation of that destiny.

The capture of American heavy equipment (including tanks and howitzers) from the hapless Iraqi army, and some Russian armor from the Syrians, has also fed ISIS’s belief that it is a real army that can fight conventionally, and that it can beat conventional armies. The farcical boasting about 3 captured MiG-21s (which are as dangerous to their pilots as the enemy, even when not stalked by F-22s or F-18s) is another example. (What do you call an ISIS MiG-21? A smoking hole in the ground.)

But the most telling indicator of Victory Disease is ISIS’s throwing a good portion of its forces (including perhaps some of the hardcore Chechens) against a strategic luxury, and getting drawn into an urban battle as the attacker (rather than the defender) and therefore having to remain stationary while it gets pounded from the air.

ISIS’s future success also depends on the perception of its inevitability and invincibility. This is something that has to be conserved. A few defeats, especially bruising ones in major efforts that appeared on the verge of another victory, can shatter that perception.

Thus, I hope they continue to come out and play in Kobane. I also hope they try to go against type and fight conventionally elsewhere. That’s playing to the US strengths, and ISIS’s weakness. And I hope that we dial it up a little bit. It appears that a modest increase in effort has had a major impact. So crank it up a little more.

 

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October 16, 2014

The Double Down (On Stupid) Administration, Ebola Edition

Filed under: Politics — The Professor @ 5:22 pm

The Obama administration doubles down on everything. It never, ever, admits an error, or that conditions have changed in  ways that makes its previous choices suboptimal and therefore worth changing. Obama repeatedly doubles down on deploying combat forces to fight ISIS. He has recently doubled down on closing Gitmo. And today, the despicable head of CDC doubled down on a travel ban:

Frieden later warned, however, that imposing a ban on air travel from these nations could induce potentially infected people to come into the U.S. through other countries.

“Right now we know who’s coming in. If we try to eliminate travel, the possibility that some will travel over land, will come from other places…will mean that we won’t be able to do multiple things,” he said, explaining that temperature checks and interviews conducted at airports provide valuable safeguards to public health.

Frieden said one reason a travel ban would not work is that the borders in West Africa are “porous.”

Um, the question is how porous the US border should be. The porousness of West African boundaries doesn’t mean jack if people fleeing west Africa encounter an impermeable border bounded by the Atlantic, the Pacific, the Rio Grande, and the 49th Parallel.

And as for land travel, last time I checked there were several thousand miles of shark filled ocean between west Africa and North America. So, the options are (a) flying to a Western Hemisphere country, then traveling by land to the US, (b) stowing away on a ship or on a plane, or (c) swimming, and using really good shark repellent.

I think we can reject options (b) and (c). (Even if we can’t, the cost raising effect I discuss below works even more strongly with regards to them.)

So let’s consider (a). Those arriving at the US border from Mexico or Canada by land at a border crossing must present a passport. They can be refused entry if they come from a banned country, such as Liberia.

Of course, they can try to sneak across the border. It happens all the time, but it is sufficiently difficult that there are organized networks for smuggling people across, and these people don’t work for free. So consider a Liberian contemplating flying to Mexico, getting hooked up with a coyote (they’re not in the phone book), and paying the cost of getting across the border. Not so easy. Not impossible, but damn hard. And the coyote may not be that wild about transporting someone who could be an Ebola carrier, or may charge way above the normal rate (reasons to create FUD!). It’s one thing for a Mexican or Guatemalan to make it across the Rio Grande, it’s another thing for someone from Sierra Leone. Indeed, it might take so long that said person might perish from Ebola long before reaching the US. Or s/he can try to freelance it. Yeah, fly from Africa to Mexico City, get on a bus to Juarez, or Nuevo Laredo, and start hiking. Good luck with that.

And even this option can be constrained substantially by coordinating the travel ban with Canada and Mexico. Even if they are not predisposed to cooperate,  Frieden’s very fear that a US travel ban would induce attempts to circumvent it would mean that if the US did impose the ban unilaterally, Mexico and Canada would be faced with  an influx of Ebola carriers. That would no doubt concentrate their minds, and make them much more cooperative.

So even (a) is a stretch as a concern.

Frieden is right that no prophylactic will be perfect. There is always a positive probability that someone sick will get in.

But the perfect is the enemy of the good. And this categorical reasoning (“if it doesn’t work 100 percent, it’s not worth doing”) is a crock. The point is that raising the cost of reaching the US from the afflicted regions will reduce the flow of potential carriers, and thereby reduce the risk to the US. If a travel ban is in place, the cost of circumventing it isn’t infinite, but it’s damned high, and will stem the flow dramatically.

Given the exponential nature of the risk, any reduction in this flow is incredibly important. Even halving the number of infected people who come into the US reduces the expected number of US cases by far more than one-half, due to the nature of epidemics.

This last fact is what makes me particularly  livid. There is huge leverage in reducing the inflow of the potentially infected. Reducing inflow by one individual reduces the number of Ebola cases by a multiple of that. This leverage means that the payoff to reducing the flow into the US is huge. And the head of CDC should damn well know that: if he doesn’t, he should lose his head. (Metaphorically. But let me think about that.)

I mentioned prophylactic a bit ago. That sparked a thought. The CDC’s logic in opposing a travel ban is that since the ban wouldn’t be perfect, it shouldn’t be implemented. By that logic, the CDC should also oppose the use of condoms to prevent AIDS. After all, condoms, by the CDC’s own admission, aren’t perfect. Sometimes the virus gets through. Since the CDC’s travel ban logic implies that if something isn’t perfect, it shouldn’t be used,  obviously-obviously!-the CDC must oppose the expenditure of even a penny on condoms, right?

Well, of course, it doesn’t oppose condoms: it actively encourages their use. It calls condom distribution programs a “structural level intervention” that can materially reduce the incidence of AIDS transmission.

How about a “structural level intervention” to reduce the risk of Ebola transmission, Dr. Frieden? Or are you, and the rest of the administration, so tightly welded to your previous position, or so bound to some open borders ideology, that you cannot countenance embracing your inner Roseanne Roseannadanna and can’t even consider saying “Nevermind!”?

 

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October 15, 2014

Dallas Shows That By the Time Ebola Gets Here, It’s Too Late

Filed under: Politics — The Professor @ 6:02 pm

A second nurse in Dallas has contracted Ebola. Better yet, before she was diagnosed but while she may have been contagious, she flew to Cleveland and back.

This puts another nail-and hopefully the final one-into the CDC’s and the administration’s stubborn refusal to countenance a travel ban, or at least far more draconian travel restrictions, from the afflicted countries of western Africa.

The CDC justification was based on two arguments.

The first one was idiotic a priori, and has only been rendered more idiotic by experience. The CDC argued that restricting travel into the US would made it more difficult for health care workers to go to Africa to help in the efforts: they would be less willing to go if they could not return.

But health care workers treating the disease are at far greater risk of contracting it, and hence greater risk of spreading it, than just about anyone. So if they go, it is especially important to prevent them from returning until it is almost certain that they are virus free. Yes, this is a burden, but one that can be ameliorated by special quarantine facilities.

The fact that most of the cases outside of Africa are health care workers exposed to the disease just confirms the risk that they pose that should have been obvious on mere reflection.

The CDC’s second argument was: “We don’t have to restrict travel into the US, because we can stop the disease in its tracks here.” Um, no.

There is a dispute over whether the health care workers failed to follow protocol, or the protocol was inadequate. The dispute is really pointless, and terribly unfair to the unfortunate women who were thrown into a deadly situation totally outside of their normal jobs and training.

The CDC model is that any random hospital in the fifty states and DC into which an infected individual happens to wander is capable of diagnosing and treating him or her while incurring very low risk of having that individual infect others, including most notably the caregivers.

That requires believing that all major hospitals are capable of handling an extraordinary disease which requires extraordinary precautions. That tens of thousands of health care professionals are at this very minute prepared and trained to treat it, will do so flawlessly, and will do so in a way that they poses no risk of  transmitting the disease to the millions of people they interact with.

That is delusional.

This is a disease that requires highly trained, professional, and meticulous caregivers. Specialists, not generalists.

One model would be to dispatch teams to hospitals that have admitted an infected person. Another model is to take the infected person to a special facility where the teams operate. The first model would probably be best if it could be assured that there would be only one or two cases, as it would eliminate the necessity of transporting the patient with the attendant risks. But it is not a scalable model. Since a team can likely handle multiple patients, it’s better to have teams at select hospitals around the country, and bring the patients to them.

Regardless, at present neither system is in place and the CDC’s anybody can do it model is obviously fundamentally flawed. Which means that we can’t rely on it, that we can’t depend on the system stopping each case in its tracks without risk of further spread within the country. This in turn means we have to move the defense perimeter out, and prevent people coming in from the affected regions. Dallas demonstrates that by the time Ebola reaches the US, it’s too late.

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October 14, 2014

The IEA Has Identification Issues: Econ 101 Fail

Filed under: Commodities,Economics,Energy — The Professor @ 1:39 pm

The IEA’s most recent report includes this gem of an analysis:

Recent price declines have sparked speculation about their potentially supportive impact on demand. The price elasticity of oil demand tends to be asymmetric in nature: oil demand falls on high prices more easily than it expands on lower prices. Looking at the last five incidences of crude oil price declines of 15% or more over a four‐month period (as occurred, at the time of going to press, June‐through‐ October), only in one case (in 2006) was a noticeable uptick in demand seen.

The immediate impact tends to be weakening demand reducing oil prices, as opposed to lower prices triggering additional deliveries, which is very much lagged. The dramatic price decline of late 2008/early 2009, for example, was not followed by a noticeable uptick in global oil demand growth until 2H09, many months after prices had started to rebound. Oil price changes will naturally affect demand differently depending on whether they are themselves supply‐ or demand‐driven. The price drop in 2008 was overwhelmingly demand led, whereas recent declines appear to have been largely in response to rising supply. Nevertheless, recent price movements are not expected to significantly lift demand in the short term, especially since crude price drops are not fully carried through to retail product prices.

That sound you just heard was me doing a I-coulda-had-a-V8 head slap.

Um, the IEA is making the most basic error possible: mistaking a fall in quantity demanded (consumed) for a fall in demand. A decline in demand (i.e., a movement in the demand curve) leads to a decline in price and quantity. This is exactly what happened in the episodes the IEA discusses: the 2008-2009 episode is the most severe example. Demand fell precipitously due to the financial crisis and subsequent Great Recession. This cratered prices, and also led to a decline in consumption.

Prices and consumption move inversely when there is a move along the demand curve. This occurs due to a supply shock.

This is Econ 101 textbook stuff, people. It has an name: identification. You can identify a demand curve only by holding it fixed and moving the supply curve. If the demand curve is moving around, you can’t identify a demand curve from price and quantity movements.

Hell, the IEA even recognizes this problem: look at the second paragraph. But if they recognize the problem in the second paragraph, why did they write the first paragraph? And this asymmetry in elasticity stuff? What, did the IEA have an acid flashback of a 60s textbook’s analysis of Sweezy’s Kinked Demand Curve?

I would seriously question whether the current price drop is totally supply driven as well. Chinese demand appears to have dropped steeply, and the European economy is slowing notably: Germany in particular has hit a rough patch.

So the IEA fails Econ 101, but we’re supposed to take seriously its analysis of more complex issues?

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October 13, 2014

Russia in a Nutshell: Three Stories That Convey Important Truths About an Aggressive, Mendacious, and Economically Weak Empire

Filed under: Commodities,Economics,Energy,Military,Politics,Russia — The Professor @ 2:43 pm

A quick rundown on some Russia stories. Three stories that encapsulate important truths about an unhappy country that seems intent on forcing others to share in its unhappiness.

First, there was a lot of attention paid to Putin’s announcement that 17,000 soldiers would be withdrawn from Rostov, on the Ukrainian border, to return to their bases. The reactions are a combination of poor memory, ignorance, and wishful thinking. Poor memory because something similar happened in the spring, which didn’t preclude an invasion in the summer. Ignorance, because if you are aware of Russia’s conscription cycle, you are aware that the fall 2013 conscript class is due to be mustered out, and units must return to their bases to discharge last year’s class and induct and train this year’s. That’s what happened in the spring. This ignorance is inexcusable now, as it was written about in the spring, notably by Pavel Felgenhauer: I wrote about it here as well. Wishful thinking, because everyone is grasping at the hope that Putin will back down from the Ukraine battle. As if.

There is no news here. This is an artifact of Russia’s conscription system. Period. Watch for new training exercises in a few months, and the deployment of units to the Ukrainian border again, once the new conscripts are integrated into their units.

Second, Russia will sign several intergovernmental agreements with China when Premier Li visits next month. One of them is an agreement to export gas from Russia to China.

I know what you’re thinking: “Wait, didn’t they sign that deal to huge fanfare back in May?” Apparently not:

Russia has prepared intergovernmental agreements to sign during Chinese Premier Li Keqiang’s visit to Moscow next week including one on a $400 billion natural gas deal agreed in May, Russia’s deputy foreign minister said.

Russian gas exporter Gazprom and China National Petroleum Corp (CNPC) have agreed that Russia will supply China with 38 billion cubic metres of gas starting from 2019.

Yet on Friday Gazprom said an intergovernmental agreement between Russia and China required for the plan to come into force had not yet been signed.

Russian Deputy Foreign Minister Igor Morgulov told Chinese state news agency Xinhua that governmental agreements including one on gas were ready for signing during Li’s coming visit.

“They include an intergovernmental agreement on natural gas supplies via an “‘eastern’ route,” he said. [Emphasis added.]

Proving yet again that announcements from the Russians about any deal should be treated with extreme skepticism. They are the masters of vaporcontracts.

The Russians are touting various deals with the Chinese as proof of their invulnerability to western sanctions and pressure. The feebleminded believe this. In fact, Russian desperation is palpable: the fact that they hyped the gas non-deal is a perfect example of this. If you don’t think that the Chinese are aware that they have the whip hand here, and are flogging the Russians for all it is worth, please contact me. I’ve securitized some bridges, and I’m sure they’d be perfect for your portfolios!

Third, the Russians are in full paranoid mode over the decline in oil prices. Brent is down to $88/bbl, which puts Urals at about $86. Speaking of 86, they are having flashbacks to 1986, when the Saudis flooded the world with oil. This began the fatal crash of the Soviet economy (described well in Gaidar’s book, Empire).

The vice-president of Russia’s state-owned oil behemoth Rosneft has accused Saudi Arabia of manipulating the oil price for political reasons. Mikhail Leontyev was quoted in Russian media as saying:

Prices can be manipulative. First of all, Saudi Arabia has begun making big discounts on oil. This is political manipulation, and Saudi Arabia is being manipulated, which could end badly.

Er, this is way different from 1986. At most, the Saudis have increased output only slightly (about 100kbbl/day): in ’86, they more than doubled output. The Saudis are just acknowledging market reality. Demand is weak,  supplies from the US are growing, and Libya is coming back into the market. Put those  things together, and prices are inevitably going to fall. The Saudis can see the writing on the wall, and their market share is sufficiently small that unilateral reductions in their output are not economically rational. Funny, now that I mention it: Saudi market share is about the same as Russian market share. The Russians produce up to capacity, because that is profit maximizing. Yet they expect the Saudis to cut back output? Of course they do! The Saudis should sacrifice their own interests to bail out the Russians! Of course they should!

Leontyev seems to be vying with the Gazprom guy Komlev to see who can make the most idiotic statements about world energy markets. Something that commentor Ivan passed on suggests that as idiotic as Komlev was, Leontyev has him hands down. The Rosneft spokesman also blamed low oil prices on ISIS selling oil at a “triple discount.” Hilarious! World oil prices are determined in the world market. ISIS has to sell at a huge discount because it is politically radioactive, and because it cannot access world markets directly. Those to whom it sells pocket the discount to adjust for the risk of dealing with a political leper (a radioactive leper!-I’m not mixing metaphors), and sell at the world price. The world price is determined by world output, not the price of the first sale. If anything, ISIS is propping up prices by reducing output in Syria (not a big deal) and threatening output in Iraq (a bigger deal).

Together, these three stories convey important truths  about Russia. And truth is ugly indeed. An aggressive, economically tottering empire dependent on commodity rents, and constitutionally unable to tell the truth or deal with reality.

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