Streetwise Professor

May 24, 2018

Gazprom and Its Connected Contractors: The Credit Mobilier Scheme, With Russian Variations

Filed under: Commodities,Economics,Energy,History,Russia — The Professor @ 6:05 pm

A couple of SWP friends were kind enough to send me a copy of the swan song of one Alex Fak, an erstwhile senior analyst at Sberbank.  Alex lost his job because he committed a mortal sin: telling the truth, in this instance about the monstrosity that I have savaged for years–Gazprom.

Alex said that the oft-heard question “why does Gazprom do such stupid things?” is off base because it presumes that the company is run in the interest of shareholders: if it were, its unmatched record of value destruction would indeed be stupid.  However, Mr. Fax opined that the company’s actions over the decades are definitely not stupid if you evaluate them from the perspective of its contractors, who make massive amounts of money building obscenely negative NPV projects.

Why does this persist, in the Putin era, which allegedly cracked down on oligarchic thievery? Well, one reason is that the biggest contractors happen to be owned by–wait for it–the two biggest friends of Vova: Gennady Timchenko (a hockey buddy) and Arkady Rotenberg (a judo buddy).*  Putin did not eliminate oligarchs, so much as replace them with his cronies.  Calling out such connected men by name is no doubt why Mr. Fax is an ex-Sberbank analyst.  And saying this kind of thing puts him at risk of being an ex-person.

The Gazprom MO described by Mr. Fak  represents a continuation of, and a mega-sizing of, the bizness model of the 1990s, when the “red directors” of state-owned firms tunneled out huge amounts of funds by having their firms buy supplies and services at seriously inflated prices from firms owned by their relatives.

Indeed, in the pre-Cambrian days of this blog–2006(!)–I hypothesized that Gazprom and its contractors were in effect a Russian version of Credit Mobilier, the construction firm that the Union Pacific hired to build the railroad.

The WaPo article also mentions that Gazprom’s pipeline construction costs are two to three times industry norms. To me this suggests a Credit Mobilier-Union Pacific type situation, where inflated prices for materials and equipment flow into the pockets of companies owned by Gazprom managers. Just thinkin’.

Thomas C. Durant was the president of the Union Pacific–and the major shareholder in Credit Mobilier.  The UP paid Credit Mobilier around $94 million, and Credit Mobilier incurred only about $50 million in costs to build the UP.   The Gazprom arrangement is somewhat different given that neither Timchenko nor Rotenberg are executives at the Russian gas giant, but the basic idea is very similar. (I also noted early on that Transneft, the oil pipeline monopoly, operates on the same model.)  Gazprom and its contractors operate on the Credit Mobilier model, with Russian variations.

Once upon a time Gazprom CEO Alexei Miller boasted that he would make Gazprom the world’s first trillion dollar company.  Today it’s market cap is south of $55 billion.  Hey! anybody can be off by two orders of magnitude, right?

This is not surprising, because maximizing value to shareholders is not, nor has it ever been, the objective of Gazprom.  The objective is, and always has been, to divert resources to the politically connected via wasteful capital expenditures (that happen to be the revenues of the likes of Timchenko and Rotenberg).  Alex Fak understood this, and paid the price for shouting that the emperor had no clothes.

Both Gazprom and Rosneft are world leaders in destroying value, rather than creating it.  But this is a feature, not a bug, given the natural state political economy of Russia, which prioritizes rent creation and redistribution to the elite. And this is precisely why Russia’s pretensions to great power status rest on economic quicksand.  That should be blindingly obvious, and I am sure that Putin understands this at some level.  But revealed preference suggests that he values enriching his friends more than implementing the economic changes that would make his nation economically and militarily competitive.

*The sums tunneled from Gazprom to Timchenko make me laugh when I think about the oft-repeated allegation that oil trader Gunvor (half-owned by Timchenko) was a source of massive personal wealth for Putin (via Timchenko).  There was much more money to be made much closer to home, and completely outside the scrutiny of bankers and regulators.

May 23, 2018

Ayatollah Khamenei Performs at Open Mike Night

Filed under: Politics — The Professor @ 7:59 pm

Some comic relief from an unexpected quarter today. Namely, Ayatollah Khamenei–such a card! He accused Germany, France, and the UK of “disloyalty” for not confronting the US for walking on the non-treaty, and spelled out an ultimatum which, if the Europeans do not comply, will trigger a resumption of Iran’s nuclear activities:

He further blasted the Europeans for keeping mum about the US frequent violations of the 2015 nuclear deal in the last two years, and said “the EU is required to make up for this silence”.

Ayatollah Khamenei reminded that the US has violated UN Security Council Resolution 2231 that accompanies the nuclear deal, and said hence “Europe should issue a resolution against the US violation” of the agreement.

He said “the EU should also undertake to avoid a discussion of Iran’s missile and regional power”.

The Iranian Leader reminded that the nuclear talks were aimed at the removal of the sanctions, “many of which were not lifted, while they have been recently threatening to revive the sanctions desipte the emphasis of the UN Security Council resolution” to the otherwise.

The Leader further underlined that the EU should also pledge “to take action against any kind of sanction against the Islamic Republic and stand against the US sanctions on the basis of a clear-cut position”.

“Europe is also needed to ensure Iran’s full crude sales,” he said, and explained, “In case the Americans manage to strike a blow at our oil sales, (we) should be able to sell whatever volume of oil that we want. The Europeans should compensate (for the loss in crude sales) in a guaranteed manner and buy Iran’s crude.”

Ayatollah Khamenei also underscored that the EU banks should also ensure trade with Iran, and said, “We don’t want a fight with these three countries, but (we) don’t trust them either because of their past record.”

I have it on good authority, from sources who cannot be identified, that in a secret protocol Khamenei demanded that the Europeans supply him with daily shipments of M&Ms, with all of the brown ones removed.

The Leader (what a giveaway that is) also seems somewhat hazy on what JCPOA is: The Islamic Republic cannot deal with a government that easily violates an international treaty, withdraws its signature and in a theatrical show brags about its withdrawal on television.” Um, not a treaty! Obama denied it was a treaty.  He refused to submit it to the Senate for ratification as a treaty, as the Constitution requires.  Hence, whatever Khamenei says or thinks, it is not a treaty that legally binds the US, and hence, it was a simple matter for Trump to walk away, leaving the Ayatollah and the Europutians sputtering in rage.  A perfect illustration of “hoist on his own petard,” as it were (both Khamenei and Obama).

European companies have already made clear that they are not going to get crosswise with the United States.  The Iranian threat to resume processing of nuclear fuel is utterly abstract, and irrelevant to them: the threat of multi-billion dollar fines and the potentially devastating effects of secondary sanctions (cf. Oleg Derispaska) are very concrete and real.  The Germans, French, and British may wish that Iran won’t spin up its centrifuges again, but it would be absurd to impose penalties on their own companies for deferring to the US, especially since it would be trivially easy for the US to beat any penalty that the Europeans impose, and whereas Europe would be harming its own companies by imposing penalties (and incurring greater penalties from the US), it would cost the US nothing to impose them. Solving for the equilibrium in this game is pretty easy–maybe someone should explain it to Khamenei.

And just what “actions” and “stands” can the Europeans take?  Angela can stomp her feet and hold her breath until she’s blue in the face in anger at Trump, and it won’t matter a damn.  When it comes down to actual action, the Europeans are so impotent that all the Viagra in the world wouldn’t help.  It is clear who has escalation dominance here, and all Khamenei’s demands will not change that.

So Khamenei can demand and threaten, and at the end of the day it will avail him nothing, except maybe the Europeans will send  him those M&Ms.  As for the substance of his demands, he’s just pissing in the wind.

 

May 21, 2018

DOJ “Independence” Is Not a Thing: It Is an Extra-Constitutional Arrogation of Power

Filed under: Politics — The Professor @ 6:45 pm

On Sunday Trump announced (via Twitter, naturally) that he intended to order the Justice Department to investigate allegations of spying on his campaign: today, he followed through, and the DOJ has complied.

Immediately after Trump’s tweet, craniums began to explode all over DC and the media.  So many that it may be necessary to change the lyrics of the National Anthem to “heads bursting in air.”

Most of the exploding pates belonged to ex-DOJ officials and functionaries, many of whom do not come to this issue with clean hands (to understate things).  For example, ex-Assistant Attorney General Sally Yates shrieked (but I repeat myself):

“I think what we’re seeing here is the president has taken his all-out assault of the rule of law to a new level and this time he is ordering up an investigation of the investigators who are examining his own campaign. You know, that’s really shocking,” Yates said on MSNBC’s “Morning Joe.”

Yates, of course, is directly implicated in the anti-Trump campaign, notably for setting up Michael Flynn (and likely many other things as well, including unmasking of US citizens).

The highest ranking exploding head is ex-Attorney General Eric Holder, who tweeted:

Trump demand for DOJ investigation is dangerous/democracy threatening. DOJ response is disappointing.There is no basis/no predicate for an inquiry. It’s time to stand for time honored DOJ independence. That separation from White House is a critical part of our system.

Let us pause for amusement at the thought of a man who proudly proclaimed that his proud duty as AG was to serve as Obama’s “wingman” intoning about “separation from the White House.”  Let us guffaw at Holder’s claim of “no basis/no predicate” for an investigation, after recalling the findings of the House and Senate Intelligence Committees, not to mention numerous NYT and WaPo articles, many based on leaks clearly emanating from Justice.  Certainly there is much more “basis/predicate” here than hearsay from a partisan about the drunken ramblings of a peripheral campaign figure, or a completely unverified dossier that is risible on its face.

But now let us turn to the main issue: the assertion of “time honored DOJ independence.”

In fact, “DOJ independence” is not a thing.  Indeed, the assertion thereof is an extra-Constitutional arrogation of authority.  Trump’s actions in ordering an investigation are not a threat to the Constitutional order–instead, it is threatened by the actions of members of the executive branch who usurp power based on their inflated and utterly mistaken belief that somehow the DOJ is not subordinate to the President.

This is not that hard.  Trump’s unconditional authority to demand an investigation is explicit in black-and-white in Article II, Section 2 of the Constitution:

[the President] may require the Opinion, in writing, of the principal Officer in each of the executive Departments, upon any Subject relating to the Duties of their respective Offices. [Emphasis added.]

Require written reports on any subject relating to the duties of an executive department.  There is no dispute that DOJ is an “executive department.”  If Eric and Sally need any guidance on this score, please refer them to An Act to Establish the Department of Justice (passed on 22 June, 1870) which reads, in part, “That there shall be, and is hereby, established an executive department of the government of the United States to be called the Department of Justice, of which the Attorney General [a position that predated the establishment of the DOJ] shall be the head.”

Thus, DOJ is clearly subordinate to the Chief Executive, and said Chief Executive has the unconditional authority to order reports (which necessarily involve the performance of some sort of investigation) on any subject related to the DOJ’s “duties” (which include criminal and counterintelligence investigations).  There is no “except for investigations of his campaign” exception.  In fact, there is no exception at all.

Further, the DOJ is clearly subordinate to the President, whose primary duty is to “take care that the laws be faithfully executed.”

Against this no doubt the likes of Holder and Yates and the other lesser lights who have also weighed in (heavy on the outrage) will respond: but it is necessary to ensure that the President does not violate his duty to execute the laws by interfering in investigations, particularly those that threaten him or his personal or political interests.

Two remarks are apposite in reply.  First, yes, this is a danger, but the Constitution has a remedy.  Presidents are subject to impeachment by Congress if they engage in such conduct–which would violate their duty under the Take Care Clause. Impeachment is the check on executive conduct–not the judgment of the executive’s subordinates.  One co-equal branch checks another: it is incoherent for the subordinate parts of one branch to check the acts of the head of that branch.  It is an inherent part of the system for the head to check the acts of the subordinates.  Indeed, it is his duty.

Second, it is particularly outrageous to raise this argument in this context, because if a President’s motives are suspect in a case involving his own interests, the motives of DOJ (including FBI) employees present and past are deeply suspect in the cases of spying on the Trump campaign, and the Clinton email investigation.  Indeed, all of the stonewalling of requests by Congress, and the extensive redactions, usually based on claims of “national security”, have been exposed as efforts of the DOJ to conceal its misdeeds and to protect senior department officials past and present.  Any presumption of independence and clean hands is risible here.  DOJ personnel past and present are up to their necks in this, and it is imperative to hold them accountable.

Thus, the rantings of Yates about threats to the rule of law, and Holder’s assertion of DOJ independence, are inversions of the truth.  Trump is not threatening the Constitutional order: he is upholding it by demanding accountability by those delegated by him pursuant to his Constitutional power in order to perform his Constitutional duties.

The hysterical reaction to Trump’s action is quite revealing.  Some people are afraid.  Very afraid.

Good.  Damn good.

My main reservation is the approach that emerged from today’s meeting between Trump, Sessions, and Rosenstein: delegating to the DOJ Inspector General the responsibility of investigating and reporting on the campaign spying issue–in addition to all of the other investigations on his plate.  This means that we will learn something in oh, 2020 or so.

Not acceptable.  This is an urgent matter that must be resolved quickly.

It would be preferable for Trump to exercise another of his unconditional powers–the power to declassify.  At the very least, he should order all relevant documents be made available to Congress, unredacted, and should order all DOJ personnel to make themselves for Congressional questioning.  I would consider going further: declassifying and releasing unredacted to the public the relevant documents, to let us decide.

May 19, 2018

Step Right Up! See the Amazing Anti-Trump Contortionists Defy the Laws of Anatomy and Reason!

Filed under: Politics,Russia — The Professor @ 4:46 pm

If you’ve been asking yourself where all the carnival barkers and side-show contortionists have gone, wonder no longer! They have joined the elite media and vast swathes of the US bureaucracy, especially intelligence and federal law enforcement.

The examples are uncountable, but two are of particular moment today.  The first relates to Operation Telling the Truth Slowly (Very Slowly), which relates to a counterintelligence operation mounted against the Trump campaign.  You’ll remember that the original response, 14 months ago, to Trump’s allegation that he had been “wiretapped” was outraged denial.  Said denials no longer being plausible have required massive contortions to create a new narrative.  The barkers at the NYT are promoting the show, based on leaks from US law enforcement and intelligence.   Well, yes, a US intelligence asset located in Britain was sent out to contact Carter Page and George Papadopolous, because of their suspect Russian ties.  Michael Flynn was also targeted because despite his vitriolic anti-Russia rhetoric in a book, he shared a table with Putin once at an RT function.

But this wasn’t a campaign directed at the Trump campaign! Oh–quite to the contrary! According to the whatever-is-worse-than-execrable-and-then-whatever-is-worse-than-that James Clapper, with the WaPo serving as chief barker now, this was intended to PROTECT Trump from insidious Russian influences.  Which of course had to be accomplished by never telling him that his hangers on were being investigated.

There is widespread speculation about who the individual pointed at Page and Papadopolous was.  The Republicans in Congress are demanding to know the name, which has sent the deep staters and their barkers (e.g., Ben Witless, I mean Wittes) into paroxysms of rage.  Krugman went so far as to assert that demanding the revelation of this name is treason.

Um, the NYT article has released leaked information about just about everything about the guy but his shoe size.  (That’s probably tomorrow’s exclusive.) . Certainly every intelligence agency in the world from whom we would want to protect his identity already knows who he is–and did so probably even before the leaks.  So it is beyond superfluous to conceal his identity–except to buy the FBI and CIA and others some time and perhaps the chance to cover their sorry asses.

I actually take comfort in their rage.  It means they are very, very afraid.

What is interesting is Carter Page’s silence.  All he has to say is: “I met the following people”–and let the frenzy begin!  He wouldn’t be disclosing any intelligence, because he would not represent, nor would he know, who was a US source.  That he remains silent suggests he is scared.

Or of course some intrepid journalist could ask him (perhaps dropping a name like, I dunno, Stefan Halper)!

I know.  I’m so droll.

One last thing on this.  The conventional reporting, especially on the pro-Trump side, is that there was a spy in the campaign.  This is misleading (based on what we know) and they should stop saying so NOW to avoid providing a convenient straw man for the anti-Trumpers to knock down.

I think what happened is more analogous to The Sting, or another classic con.  Someone was sent to set up a mark.  In this case, the marks were Page and Papadopolous,  After they were set up, they could serve as a pretext to mount a counterintelligence operation that wormed into the Trump campaign via their communications, and the communications of everyone they communicated with.

The second contortion act, involves yesterday’s meeting between Merkel and Putin.  Now,  non-contortionists with a modicum of sense of shame and intellectual consistency would blast her for meeting with their alleged arch enemy, whom they claim happens to be the root of all evil in the world.  But, what is clear is that despite all of their ravings about Putin as part of their jeremiads against Trump, that in their minds Trump is the arch enemy and the root of all evil in the world.   Putin is just a convenient stick to beat him with, and when that stick doesn’t work, they will pick up another.

But instead she is being lionized, and being credited for reasonably working with Putin to oppose Trump’s anti-Putin measures (such as threatening to block Nord Stream) and Trump’s move on the Iran deal.  FFS, if Trump had met with Putin the anti-Trump lot would be barking that  it is because he was selling out the West, and that he is the equivalent of the South Seas Cannibal.  Merkel is making cooing noises at Russia and Putin–primarily out of her narcissistic pique at Trump–and saying how important it is for Germany to have a good relationship with Russia.

Merkel says to applause that good relations with Russia are important to Germany.  Which is exactly what Trump has said about Russia and the US–only to have this thrown back in his face as evidence of his being Putin’s pawn.

If Trump said or did any of these things the barkers would be screaming. SELLOUT.  TRAITOR. COLLUSION. IMPEACH HIM–THEN BURN HIM AT THE STAKE!

And tell me: how is Making America Great Again anti-western?   If anything, it is a muscular assertion of Western primacy by a Gulliver who is unwilling to be tied down by Europutians.  I would argue that in fact, Germany is far less part of the West than the US, and has been since before Arminius slaughtered three Roman legions in the Teuteborg Forest.  (I may well write a post on this.  Suffice it to say that German thought has always been decidedly opposed to Anglo-Saxon, French, and Italian thought, and two world wars show exactly how and why.) Meaning that making America great again is far more pro-Western than Making the EU Great ever will be, given that it is a crypto-socialist Trojan Horse for German ambitions.

I also note that Merkel is–get this–reaching out to Xi as an ally on free trade.

No, really.

This is such utter bullshit that even my 800 SAT score scatalogical vocabulary is utterly inadequate to do it justice.  Yet all of the carnival barkers not only eat it up, they regurgitate it.  (This also happened in spades at Davos.)

So we see why all the contortions are necessary.  Every argument must be bent and twisted and contorted in order to support the anti-Trump crusade, even though doing so violates the rules of logic, the rules of evidence, and basic human decency.

May 17, 2018

Rosneft: The Farce Continues

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 7:22 pm

Remember when the Russian government said it was going to privatize a piece of Rosneft? Hahahaha. That is so 2016–please try to keep up!  In its announcement of “Rosneft 2022” the company proposes to buy back about $2 billion in shares, which is just about 20 percent of the piece sold off in 2016–no, wait–2017–no, wait–2018.  Adding even more hilarity is that the buyback plan was apparently at the insistence of Qatar, the last buyer standing which agreed to buy most of the shares initially privatized, much to the relief of the banks (Intesa and unnamed Russian ones) who were wearing a big piece of the risk.

I’m guessing that this was one of the terms Qatar laid down to absorb the entire hand-me-down stake for the original 2016 price, even though in Euro terms Rosneft’s shares are substantially lower today (despite a rallying oil price!)

Quite the vote of confidence there, eh?  Well, not that that’s surprising.  The conspicuous failure of any Chinese buyer to step into the shoes of disgraced CEFC tells you just how much confidence Rosneft inspires these days.

I am hard pressed to recall such a farcical series of events involving a major company.  If this one of  Russia’s state champions, just think of the shape the palookas are in!

Today’s Adventures in Trumpland

Filed under: Economics,Energy,Politics,Russia — The Professor @ 6:38 pm

The WSJ reports that the Trump administration has told Germany that the US would restart talks on a trade deal with Europe if Germany pulls the plug on support for the Gazprom-led Nord Stream project.  I find the linkage rather odd, but we’re talking the Trump administration here, and moreover, it may well be a brushback pitch after all of the German-led Eurowhining about the US: “Think it’s bad now? Let’s see what it’s like when I put my mind to it.”

One EU official responded as follows:

“Trump’s strategy seems to be to force us to buy their more expensive gas, but as long as LNG is not competitive, Europe will not agree to some sort of racket and pay extortionate prices,” an EU official said.

I could perhaps take this seriously, were it not for the fact that Germany forces its own citizens to pay “extortionate prices” for power produced by outrageously uncompetitive means as a result of its idiotic energiewende policy.

How extortionate? How uncompetitive? The article claims that US LNG would cost about 20 percent more than Russian gas.  Well, Germans pay approximately 50 percent more for power than the average across the EU, and EU-wide average prices are about double the US average.

In other words, Europe has its own energy extortion racket in place, and doesn’t want to let in any Americans.

The other interesting aspect to this story is that it is yet another example (I’ve lost count of the number) of the alleged Putin pawn Trump taking a major shot at the Russians.  The Russians are not pleased:

The Kremlin shot back immediately as spokesman Dmitry Peskov called the U.S. efforts “a crude effort to hinder an international energy project that has an important role in energy security.”

“The Americans are simply trying crudely to promote their own gas producers,” he said.

All I can say is that if Trump was bought, he sure as hell didn’t stay bought.  Not that any of those who have invested their entire being in the Trump-Russia collusion narrative will bother to notice.

Speaking of the obsessed and delusional, yesterday represented an all time low in the dishonesty of the inveterate Trump haters.  In a meeting with law enforcement officers, Trump called members of the brutal Salvadoran gang MS-13 “animals,” but the media and many politicians widely asserted that he was referring to immigrants as a whole.  If you read the transcript, it is clear that only someone who is deeply and deliberately dishonest could make such an assertion.

The fallback position of these reprobates is that well, MS-13 members are people too, so it is wrong to call them animals.

All right, if that’s what you think–prove it.  Invite a few to move in with you, and you can discuss the nuances of “kill, rape, and control” (“mata, viola, controla“) which just so happens to be the MS-13 motto. (Some say that “rob” is part of the motto too.)  If you’re real nice, they just might honor your request not to bring those icky guns into your house, and will just bring their machetes instead.  After a few verses of Kumbaya, I’m sure that your common humanity will shine through, along with some light illuminating the hole in your neck where your head used to be.

Of course, that will never happen.  Those who are preening and posing would never dare even enter the neighborhoods where MS-13 and similar gangs operate, let alone invite them into their houses.

Further: by defending these beasts, our better thans are condemning decent and innocent people whom they claim to care about to their depredations.

This is the worst kind of moral posing by the worst kind of poseurs.  These are twisted partisan hacks pretending to be moral titans. To let their rank partisanship utterly blind them to the reality of evil, and to ignore those who will have to suffer from that evil, is appalling beyond words.

May 15, 2018

Contrary to What You Might Have Read, the Oil Market (Flat Prices and Calendar Spreads) Is Not Sending Mixed Signals

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 9:27 pm

In recent weeks, the flat price of crude oil (both WTI and Brent) has moved up smartly, but time spreads have declined pretty sharply.  A common mistake by oil market analysts is to consider this combination of movements anomalous, and an indication of a disconnect between the paper and the physical markets.  This article from Reuters is an example:

Oil futures prices have soared past three-year highs, OPEC’s deal has cut millions of barrels of inventory worldwide and investors are betting in record numbers that prices could rocket past $80 and even hit $90 a barrel this year.

But physical markets for oil shipments tell a different story. Spot crude prices are at their steepest discounts to futures prices in years due to weak demand from refiners in China and a backlog of cargoes in Europe. Sellers are struggling to find buyers for West African, Russian and Kazakh cargoes, while pipeline bottlenecks trap supply in west Texas and Canada.

The divergence is notable because traditionally, physical markets are viewed as a better gauge of short-term fundamentals. Crude traders who peddle cargoes to refineries worldwide say speculators are on shaky ground as they drive futures markets above $70 a barrel, their highest levels for three-and-a-half years, on concerns about tighter supply from Venezuela and the potential impact of U.S. sanctions on supply from Iran.

Investors have piled millions of dollars in record wagers in the options market, betting on a further rally on the back of rising geopolitical tensions, particularly in Iran, Saudi Arabia and Venezuela, and the global decline in supply.

“Guys who are trading futures have a view that draws are coming and big draws are coming,” a U.S.-based crude trader at a global commodity merchant said, adding that demand could ramp up as global refinery maintenance ends.

. . . .

BIG DISCONNECT

Those on the front lines of the physical market are not convinced. Traders say the surge in U.S. exports to more than 2 million bpd has saturated some markets, leaving benchmark prices ripe for a correction.

“There is a huge disconnect between futures and fundamentals,” a trader with a Chinese independent refiner said. “I won’t be surprised if prices correct by $20 a barrel.”

In fact, the alleged “disconnect” is readily explained based on recent developments in the market, notably the prospect for interruption/reduction in Iranian supplies due to the reimposition of sanctions by the US.  The situation in Venezuela is exacerbating this situation.  Two things are particularly important in this regard.

First, the Iranian situation is a threat to future supplies, not current supplies: the potential collapse in Venezuela is also a threat to future supplies (although current supplies are dropping too).  A reduction in expected future supplies increases future scarcity relative to current scarcity.  The economically efficient response to that is to share the pain, that is, to shift some supply from the present to the future by storage.  To reward storage, the futures price rises relative to the spot price–that is, the time spread declines.  However, since the driving shock (the anticipated reduction in future supplies) will result in greater scarcity, the flat price must rise.

A second effect works in the same direction. This is a phenomenon that I worked out in a 2008 paper that later was expanded into a chapter my book on commodity price dynamics.  Both the US actions regarding Iran, and the current tumult in Venezuela increase uncertainty about future supplies.  The efficient way to respond to this increase in fundamental uncertainty is to increase inventories, relative to what they would have been absent the increase.  This requires a decline in current consumption, which requires an increase in flat prices.  But incentivizing greater storage requires a fall in calendar spreads.

An additional complicating factor here is the feedback between inventories or calendar spreads (which are often used as a rough proxy for inventories, given the opacity and relative infrequency of stocks numbers) and OPEC decisions.  To the extent OPEC uses inventories or calendar spreads as a measure of the tightness of the supply-demand balance, and interprets the fall in calendar spreads and the related increase in inventories (or decline in the rate of inventory reductions), it could respond to what is happening now by restricting supplies . . . which would exacerbate the future scarcity. Relatedly, a known unknown is how current spread movements reflect market expectations about how OPEC will respond to spread movements.  The feedback/reflexivity here (that results from a price maker/entity with market power using spreads/inventory as a proxy for supply-demand balance, and market participants forming expectations about how the price maker will behave) greatly complicates things.  Misalignments between OPEC behavior and market expectations (and OPEC expectations about market expectations, and on an on with infinite regress) can lead to big jumps in prices.

Putting to one side this last complication, contrary to what many analysts and market participants claim, the recent movements in flat prices and spreads are not sending mixed signals.  They are a rational response to the evolution in market conditions observed in recent weeks: a decline in expected future supply, and an increase in fundamental risk.  The theory of storable commodities predicts that such conditions will lead to higher flat prices and lower calendar spreads.

Merkel Seems Intent on Proving Churchill (“Germany Is Either At Your Feet or At Your Throat”) Right

Filed under: History,Military,Politics — The Professor @ 6:25 pm

The political and commercial elite in Germany generally, and Angela Merkel in particular, are having quite the meltdown of late.  Angela angrily said that Germany would no longer hold back its anger against the United States. And a mere few days after lamenting that Europe could no longer depend on the US to defend it, Merkel huffily said Germany would not comply with Trump’s “demand” that it increase its defense spending.

The proximate cause of Merkel’s rage was Trump’s decision to withdraw from the Iran “deal”–a secretly negotiated, and largely undisclosed, transaction negotiated between Obama and the mullahs, never submitted for ratification, and which therefore is a legal nullity insofar as the US is concerned.  Obama refused to formalize it because he knew such an attempt would fail, but figured that it would live on because Hillary would succeed him.  Ah, Barack, the best laid plans, eh? Your personal agreement as president could be undone by your successor, and with the same effort that was exerted to give it the force of law: that being none whatsoever.

Germany is particularly distressed at the prospect of losing investment in and trading with Iran.  Even if Europe does not reimpose sanctions, it knows that is irrelevant because the secondary US sanctions of the kind that cost BNP Paribas a cool $9 billion, and risk destroying Rusal, make it suicidal for any European company to deal with any Iranian entity the US sanctions.

One reason that Merkel, and other Europeans, are beside themselves is that their utter impotence is exposed.  They pretend as if they are an independent geopolitical force, but can act only at the sufferance of the US.   Being exposed as powerless and subordinate does breed rage, no?

The evidence of this is all around, both in Trump’s punitive actions (the sanctions on Rusal or ZTE, for instance), and in his proffers of mercy (again to Rusal or ZTE).  Mercy is the prerogative of the powerful: masters can extend mercy, and doing so is the most powerful demonstration thereof.

This whole episode also demonstrates the irrelevance of the Europeans to the process from its beginning.  What is happening now demonstrates that German, French, and British participation was utterly irrelevant to imposing economic hardship on the mullahs.  The US could have–as it is doing now–unilaterally deterred the Europeans from offering Iran aid and comfort.  Including them only led to a more Iran-friendly deal.  (Actually, it just basically cheer-led for Obama’s Iran friendly deal, because he was about as friendly as could be imagined to the mullahs.)

It must also be noted that the German posture towards Iran is beyond unseemly, given Germany’s history.  The moral obtuseness of Germany, of all nations, panting after the business of a nation that has vowed to destroy Israel is mind boggling.

It is especially mind boggling given the German predilection for moral preening, and their tendency to lecture all about their moral superiority.

If you think this is too harsh, consider the fact that Germany’s Incitement to Hatred law (i.e., its Holocaust Denial law) makes it a felony punishable by five years imprisonment for those who:

  1. incites hatred against a national, racial, religious group or a group defined by their ethnic origins, against segments of the population or individuals because of their belonging to one of the aforementioned groups or segments of the population or calls for violent or arbitrary measures against them; or
  2. assaults the human dignity of others by insulting, maliciously maligning an aforementioned group, segments of the population or individuals because of their belonging to one of the aforementioned groups or segments of the population, or defaming segments of the population,

So, if the mullahs did in Germany what they do in Iran on a daily basis, they’d be in the slammer for a nickel.  But they’re OK to do business with, even though they have far more power to act on their threats than some skinhead in Leipzig. AfD is beyond the pale, but the mullahs–now there’s somebody to do business with!

Got it.

As for Merkel’s threats to show her displeasure–who’s stopping you? Go ahead.  Act like any respectable Resistance member. Stomp your feet.  Roll around on the floor screaming.  Hold your breath until your face turns blue.

I won’t say that it won’t have any effect on me–because I’ll genuinely enjoy the spectacle, primarily because it just makes all the more clear your impotence.

As Putin is fond of saying: the dog barks, but the caravan moves on.

As for Trump’s “demand” regarding defense spending.  Um, this was a commitment that Germany voluntarily made to Nato, on more than one occasion long before Trump came to office.  So I guess it’s utterly outrageous for the US to walk away from a deal with the mullahs that did not involve the imprimatur of America’s designated representative body (the Senate), but it’s totally OK for Germany to stiff the US and other Nato allies–all European, mind you–because they are just too fucking cheap (despite having the healthiest fiscal condition of any large nation).  (I further note that Germany is more than happy to “stitch up” (Tim Newman’s phrase) its European confreres when there’s money to be made, kumbaya rhetoric notwithstanding.)

Churchill came close to the truth when he said that the Germans were either at your feet or at your throat.  They certainly go for the throat of the weaker members of the EU, and now at the UK for having the audacity to leave. These days, however, they don’t have the might to tear at the US’s throat, their presumptions notwithstanding.  So while they practice proskynesis at Persian feet, the best they can muster is to nip at Donald Trump’s ankles.

May 8, 2018

Libor Was a Crappy Wrench. Here–Use This Beautiful New Hammer Instead!

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Regulation — The Professor @ 8:02 pm

When discussing the 1864 election, Lincoln mused that it was unwise to swap horses in midstream.  (Lincoln used a variant of this phrase many times during the campaign.) The New York Fed and the Board of Governors are proposing to do that nonetheless when it comes to interest rates.  They want to transition from reliance on Libor to a new Secured Overnight Financing Rate (SOFR, because you can never have enough acronyms), despite the fact that there are trillions of dollars of notional in outstanding derivatives and more trillions in loans with payments tied to Libor.

There are at least two issues here.  The first is if Libor fades away, dies, or is murdered, what is to be done with the outstanding contracts that it is written into? Renegotiations of contracts (even if possible) would be intense, costly, and protracted, because any adjustment to contracts to replace Libor could result in the transfer of tens of billions of dollars among the parties to these contracts.  This is particularly like because of the stark differences between Libor and SOFR.  How would you value the difference between a stream of cash flows based on a flawed mechanism intended to reflect term rates on unsecured borrowings with a stream of cash flows based on overnight secured borrowings?  Apples to oranges doesn’t come close to describing the difference.

Seriously: how would you determine the value so that you could adjust contracts?  A conventional answer is to hold some sort of auction (such as that used to determine CDS payoffs in a default), and then settle all outstanding contracts based on the clearing price in the auction (again like a CDS auction).  But I can’t see how that would work here.

Let’s say you have a contract entitling you to receive a set of payoffs tied to Libor.  You participate in an auction where you bid an amount that you would be willing to pay/receive to give up that set of payoffs for a set of SOFR payoffs.  What would you bid?  Well, in a conventional auction your bid would be based on the value of holding onto the item you would give up (here, the Libor payments).  But if Libor is going to go away, how would you determine that opportunity cost?

Not to mention that there is an immense variety of payoff formulae based on Libor, meaning that there would have to be an immense variety of (impractical) auctions.

So it will come down to bruising negotiations, which given the amounts at stake, would consume large amounts of real resources.

The second issue is whether the SOFR rate will perform the same function as well as Libor did.  Market participants always had the choice to use some other rate to determine floating rates in swaps–T-bill rates, O/N repo rates, what have you.  They settled on Libor pretty quickly because Libor hedged the risks that swap users faced better than the alternatives.  A creditworthy bank that borrowed unsecured for 1, 3, 6, or 12 month terms could hedge its funding costs pretty well by using a Libor-based swap: a swap based on some alternative (like an O/N secured rate) would have been a dirtier hedge.  Similarly, another way that banks hedged interest rate risk was to lend at rates tied to their funding cost–which varied closely with Libor.  Well, the borrowers (e.g., corporates) could swap those floating rate loans into fixed by using Libor-based swaps.

That is, Libor-based swaps and other derivatives came to dominate because they were better hedges for interest rate risks faced by banks and corporates than alternatives would have been.  There was an element of reflexivity here too: the availability of Libor-based hedging instruments made it desirable to enter into borrowing and lending transactions based on Libor, because you could hedge them. This positive feedback mechanism created the vexing situation faced today, where there are immense sums of contracts that embed Libor in one way or another.

SOFR will not have this desirable feature–unless the Fed wants to drive banks to do all their funding secured overnight! That is, there will be a mismatch between the new rate that is intended replace Libor as a benchmark in derivatives and loan transactions, and the risks that that market participants want to hedge.

In essence, the Fed identified the problem with Libor–its vulnerability to manipulation because it was not based on transactions–and says that it has fixed it by creating a benchmark based on a lot of transactions.  The problem is that the benchmark that is “better” in some respects (less vulnerable to a certain kind of manipulation) is worse in others (matching the risk that market participants want to hedge).  In a near obsessive quest to fix one flaw, the Fed totally overlooked the purpose of the thing that they were trying to fix, and have created something of dubious utility because it does a poorer job of achieving that purpose.  In focusing on the details of the construction of the benchmark, they’ve lost sight of the big picture: what the benchmark is supposed to be used for.

It’s like the Fed has said: “Libor was one crappy wrench, so we’ve gone out and created this beautiful hammer. Use that instead!”

Or, to reprise an old standby, the Fed is like the drunk looking for his car keys under the lamppost, not because he lost them there, but because the light is better.  There is more light (transactions) in the O/N secured market, but that’s not where the market’s hedging keys are.

This is an object lesson in how governments and other large bureaucracies go astray.  The details of a particular problem receive outsized attention, and all efforts are focused on fixing that problem without considering the larger context, and the potential unintended consequences of the “fix.” Government is especially vulnerable to this given the tendency to focus on scandal and controversy and the inevitable narrative simplification and decontextualization that scandal creates.

The current ‘bor administrator–ICE–is striving to keep it alive.  These efforts deserve support.  Secured overnight rate-based benchmarks are ill-suited to serve as the basis for interest rate derivatives that are used to hedge the transactions that Libor-based derivatives do.

May 5, 2018

Coup by Pretext

Filed under: Politics — The Professor @ 6:04 pm

The Fourth Branch of Government (the professional bureaucracy, especially its law enforcement and intelligence branches) seems incapable of doing anything in a forthright manner, acting instead like a cast of sidling crabs.  This perhaps reflects the fact that it has arrogated to itself this status, it being found nowhere in the Constitution, thus making it necessary to act by indirection.

The battle between the bureaucracy and the president, ostensibly over the “Russia investigation” is an ongoing (and going and going and going) illustration of this phenomenon.  Virtually every action undertaken by various bureaucrats that has advanced the investigation has been justified by a pretext that has nothing whatsoever to do with the real motives:

  • A supposed violation of the hoary–and never enforced–Logan Act was a pretext for Sally Yates to order the unmasking of  Michael Flynn. (Hey Sally–no doubt if you were still in office you’d be siccing the dogs on John Kerry, right? Right?)
  • The same supposed violation was a pretext for Yates to order the FBI to conduct an ambush interview of Flynn.
  • The inconsistency between Flynn’s statement to the FBI and the NSA intercept of his conversation with the Russian ambassador was a pretext to prosecute him, in the hope of getting him to roll on Trump, and at the very least, give Mueller a scalp to justify his investigation.
  • The dossier, with its farcical claim that Igor Sechin had offered Trump via Carter Page either (a) a 20 percent stake in Rosneft, or (b) a brokerage fee on the 20 percent stake (which is hard to say, given the idiotic wording of the dossier) was used as a pretext to get a FISA warrant on Page. (By the way, as @soncharm points out to me on Twitter, how could Qatar buy a stake in Rosneft if it had been promised to Carter Page? Great question! :-P)
  • The FISA warrant on Page was a pretext to conduct surveillance on the Trump campaign.
  • The Comey briefing of Trump on the dossier was a pretext to leak it to the media.
  • Comey’s memos to himself, and the leak thereof, were a pretext intended to lead to the appointment of a special counsel.
  • As US District Court Judge T.S. Ellis scathingly noted in a hearing yesterday, Mueller’s prosecution of Paul Manafort for crimes bearing absolutely zero connection with the ostensible purpose of the Mueller inquiry is a pretext to pressure him into rolling on Trump.
  • Mueller’s apparently focus on obstruction of justice is a pretext to continue an inquiry that has apparently failed to find any evidence of the turpitude he was charged to investigate.
  • Stormy Daniels was used as a pretext to conduct a raid on Trump’s lawyer.
  • Rob Rosenstein’s and the FBI’s repeated claims of national security to justify refusal to produce documents or the heavy-handed redaction of the documents that they grudgingly do produce are merely pretexts to cover up their dubious behavior. (By the way, I am more convinced by the day that Rosenstein is the Iago in this entire affair.  On Thursday, I asked how given his involvement in many aspects of case–such as his involvement in the Page warrant–Rosenstein did not recuse himself.  Judge Ellis asked the same thing on Friday.  The guy is conflicted out the wazoo.  Recusal is required at a bear minimum.)

Indeed, the entire Russia collusion investigation is merely a pretext for the Fourth Branch’s rebellion against the elected president.

The repeated reliance on subterfuge and pretext is prima facie evidence of dishonorable motives and conduct by public “servants” who believe themselves to be rightfully masters, accountable to no one.  The pervasiveness of this conduct demonstrates that the importance of this issue transcends Trump.  It calls into question whether the federal government is in fact accountable, and subject to Constitutional checks and balances.  Indeed, it is worse than that: it largely answers that question, and the answer is disturbing indeed.

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