Streetwise Professor

April 30, 2020

WTI-WTF? Part 3: Did CLK20 Get TAS-ed?

Matt Levine wrote a typically amusing piece highlighting the role of Trade at Settle (TAS) contracts in the 4/20/20 oil futures debacle:

But actually a lot of oil changed hands at those negative prices. Not because a bunch of investors came to the market all at once looking to sell, and no one would buy from them at negative prices, but for a more technical reason. Some oil traders use “trade-at-settlement” contracts: Instead of buying (or selling) oil futures at the market price at the time of your trade, you agree in advance to buy (or sell) them at whatever the official 2:30 p.m. settlement price is that day. 1  This is a good trade, for you, if your job is to obtain the day’s settlement price: For instance, if you run an index fund or exchange-traded fund that is benchmarked to that price, using TAS futures guarantees you the benchmark price. If you invest in oil futures and your boss fires you if you miss the benchmark, you might use TAS futures, that sort of thing. If you are a savvy oil trader attuned to minute-by-minute changes in supply and demand and trying to capture as much value as possible from your skills, you’ll probably just trade the futures at their current prices, selling if the price is too high and buying if it’s too low. But a lot of oil traders are doing something else, something a bit more passive, and for them the ability to guarantee the settlement price is useful.

He goes on to ponder whether the TAS mechanism could be manipulated, and whether manipulation could have contributed to the settlement fire that Red Adair couldn’t have put out:

The basic pattern—agree in advance to buy (sell) stuff at the official settlement price at some fixed future time, and then sell (buy) a bunch of that stuff in the minutes leading up to the official settlement time with the effect of pushing down (up) the price at which you are buying (selling)—is incredibly common, and the gradation from “sensibly pre-hedging the exposure you will get at settlement” to “sloppily pre-hedging the exposure you will get at settlement” to “manipulating the market to push down the price you will get at settlement” is blurry. If you type in a chat room “lol I’m gonna pound out 500 contracts to push down the settlement price and make fortune on my TAS trades, I am really ripping those muppets’ faces off, hope I don’t go to prison bro, hashtag fraud hashtag crime hashtag manipulation,” you will get in trouble. But if you don’t type that, and you quietly sell the 500 contracts and the price goes down, then as far as anyone knows that was just pre-hedging.

So could somebody have popped CLK20 with a TASer last Monday?

Funny you should ask. I wrote a paper on TAS manipulation a while ago. My interest was sparked by the CFTC’s action against Dutch trading firm Optiver, which the agency accused of doing exactly the kind of thing Levine writes about in crude, gasoline, and heating oil futures back in March, 2008. You can read the complaint–and listen to some actual “ripping those muppets’ faces off” trader braggadocio.

How does manipulation work here? First, to make manipulation profitable, there has to be an asymmetric price response to purchases and sales. If the manipulator’s purchases impact prices the same as sales, just buying and selling a lot can’t move prices in a profitable direction. Indeed, the manipulator would have to pay transactions costs (crossing the spread, brokerage, etc.) and this would cause the trading to be unprofitable.

The model in the paper derives conditions under which purchases and sales of TAS have a smaller impact on prices than do trades in the underlying futures. The basic idea is that if information is short-lived, or if there is intense competition among informed traders, new information will be incorporated into prices very quickly. Under those circumstances, informed traders will not want to trade TAS: their information will already be incorporated into the price by the time settlement occurs. Thus, TAS is a mechanism that allows traders to signal that they are uninformed: many “muppets” choose to trade TAS, and the informed don’t. Thus, the price impact of TAS trades is smaller than the price impact of regular outright trades: trades move prices because of the possibility that they are motivated by private information, so trades that are unlikely to be privately informed move prices less than trades that are more likely to be so.

This creates the asymmetry that makes manipulation possible: the manipulator buys, say, the TAS and then sells in quantity immediately before and during the settlement period and profits as Levine describes.

This type of manipulation is particularly pernicious because manipulative trades have persistent price impacts because they cannot be distinguished from informed trades (or liquidity trades, for that matter). Note that in Optiver, prices did not reverse after the firm’s trades,

This strategy is likely to be particularly profitable when markets are relatively illiquid, as in an illiquid market outright trades have bigger price impacts. Liquidity (measured by the bid-ask spread, quantity at the top of the book, price impact coefficients, etc.) has plummeted for everything since the CovidCrisis began, and the decline in CL liquidity has been particularly pronounced. Moreover, contracts close to expiration are less liquid anyways. Add to this the extreme physical constraints (which mean that small shocks to fundamentals have big price impacts) and the raging uncertainty about the logistical situation at Cushing, and it is likely that small volumes at the settle could have big impacts on prices.

To this I would add that an unexpected shortfall in buy orders (due to shorts exercising market power) at the settle could have price impacts, and exacerbate the price impacts of sell orders by exacerbating order imbalances.

Thus, the potential for a big asymmetry in price impact was pronounced on that fatal Monday.

In sum, it is not implausible that the market did indeed get TASed. Or at the very least, a TASer jolt contributed to the collapse. (Sort of like in this video!)

A final remark on the economic benefits and costs of TAS trading. TAS is a form of “cream skimming”–i.e., the skimming off of uninformed order flow. This tends to make the order flow in the regular continuous market more toxic, which reduces liquidity in that market. For this reason, other cream skimming mechanisms used primarily in equity markets (payment for order flow, dark pools, block trades) are frequently criticized. (This is why some regulators, particular in Europe, have attempted to curb such activity and force more trading into “lit” venues.)

I showed in my Market Macrostructure paper that things aren’t so simple. If the regular market isn’t perfectly competitive, the increased competition from a cream skimming mechanism can improve welfare. Moreover, there are distributive effects here: the uninformed traders who can utilize the TAS mechanism (e.g., those who are hedging exposures tied to the settlement price) benefit, while uninformed traders who can’t lose. Informed traders can lose too. Moreover–and this is a point that is almost always overlooked–some informed trading is essentially rent seeking (e.g., trading on information that will be released shortly anyways, and accelerating its incorporation into prices has little effects on resource allocation decisions). Reducing rent seeking informed trading is a good thing.

All in all, the role of the TASer is yet another piece of the 4/20/20 WTI WTF puzzle. The forensic analysis of this entire episode will be fascinating.

April 21, 2020

WTI-WTF? Part II (of How Many???)

Filed under: Clearing,Commodities,Derivatives,Economics,Energy,Regulation — cpirrong @ 2:23 pm

Just another day at the Globex, folks. May WTI up a mere $49.88 on its last trading day at the time I write this paragraph, a while before the close. (Sorry, can’t calculate a percentage change . . . because the base number is negative!) That’s just sick. But at least it’s positive! ($12.25. No, $9.96. No . . .) (This reminds me of a story from Black Monday. My firm did a little index arb. We called the floor to get a price quote on the 19th. Our floor guy said “On this part of the pit it’s X. Over there it’s X+50. Over there it’s X-20. I have no fucking idea what the fucking price is.”)

But June has been crushed–down $7.35 (about 35 percent). Now the May-June spread is a mere $.83 contango. That makes as little sense as yesterday’s settling galactic contango (galactango!) of $57.06. (Note that June-July is trading at at $7.71 and July-August at $2.65.

I’m guessing that dynamic circuit breakers are impeding price movements, meaning that the prices we see are not necessarily market clearing prices at that instant.

A few follow-ons to yesterday’s post.

First, the modeling of the dynamics of a contract as it approaches expiration when the delivery supply/demand curve is inelastic, and some traders might have positions large enough to exploit those conditions to exercise market power, is extremely complicated. The only examples I am aware of are Cooper and Donaldson in the JFQA almost 30 years ago, and my paper in the Journal of Alternative Investments almost a decade ago.

Futures markets are (shockingly!) forward looking. Expectations and beliefs matter. There are coordination problems. If I believe everyone else on my side of the market is going to liquidate prior to expiration, I realize that the party on the other side of the contract will have no market power at expiration. So I should defer liquidating–which if everyone reasons the same way could lead to everyone getting caught in a long or sort manipulation at expiration. Or, if I believe everyone is going to stick it out to the end, I should get out earlier (which if everybody else does the same results in a stampede for the exits.)

In these situations, anything can happen, and the process of coordinating expectations and actions is likely to be chaotic. Cooper-Donaldson and Pirrong lay out some plausible stories (based on particular specifications of beliefs and the trading mechanism), but they are not the only stories. They mainly serve to highlight how game theoretic considerations can lead to very complex outcomes in situations with market power and inelasticity.

One thing that is sure is that these game theoretic considerations don’t matter much if the elasticities of delivery supply and demand are large. Then no individual can distort prices very much by delivering too much or taking delivery of too much. Then the coordination and expectations problems aren’t so relevant. However, when delivery supply or demand curves are very steep–as is the case in Cushing now due to the storage constraint–they become extremely relevant.

Perhaps one analogy is getting out of a theater. When there are many exits, there won’t be queues to get out and little chance of tragedy even if someone yells “fire.” If there is only one exit, however, hurried attempts of everyone to leave at once can lead to catastrophe. Moreover, perverse crowd dynamics occur in such situations. That’s where we were yesterday.

About 90 percent of open interest liquidated yesterday. That is why today is returning to some semblance of normality–the exit isn’t so crowded (because so many got trampled yesterday). But that begs the question of why the panicked rush yesterday? That’s where the game theoretic “anything could happen” answer is about the best we can do.

About that storage constraint. My post yesterday focused on someone with a large short futures position raising the specter of excessive deliveries by not liquidating that position, thereby triggering a cascade of descending offers until the short graciously accepted at a highly profitable price.

But there is another market power play possible here. A firm controlling storage could crash prices (and spreads) by withholding that capacity from the market. The most recent data from the EIA indicates about 55 mm bbl of oil storage at Cushing. That’s about 80 percent of nameplate capacity (also per EIA.). Due to operational constraints (e.g., need working space to move barrels in and out; can’t mix different grades in the same tank) that’s probably effectively full. Therefore, someone with ownership of a modest amount of space could withhold it drive up the spread. If that party had on a bull spread position . . .

Third, we are into Round Up the Usual Suspects mode:

And first in line is the US Oil ETF. There has been a lot of idiotic commentary about this. They were forced to take delivery! (Er, delivery notices aren’t possible before trading ends.) They were forced to dump huge numbers of contracts yesterday! (Er, they publish a regular roll schedule, and were out of the May a week before yesterday’s holocaust. They also report positions daily, and as of yesterday were 100 pct in the June.)

Not to say that USO can be implicated in hinky things going on in the June right now, but as for May–that dog don’t hunt.

Fourth–WTF, June WTI? Well, my best explanation is that the carnage in the May served to concentrate minds regarding June. No doubt risk managers, or risk systems, forced some longs out as the measured and perceived risk for June shot up yesterday. Others just decided that discretion was the better part of valor. The extremely unsettled positions no doubt impaired liquidity (i.e., just as some wanted to get out, others were constrained by risk limits formal or informal from getting in), leading to big price movements in response to these flows. If that’s a correct diagnosis, we should see something of a bounceback, but perhaps not too much given the perception (and reality) of an extremely asymmetric risk profile, with going into expiry short being a lot more dangerous than going into it long. (This is why expectations about future conditions at delivery can impact prices well before delivery.)

Fifth, on a personal note, in an illustration of the adage that the apple doesn’t fall far from the tree (and also of Merton’s Law of Multiples) my elder daughter Renee completely independently of me used “WTI WTF” in her daily market commentary yesterday. I’m so proud! She also raised the possibility of negative prices some time ago. Good call!

And I finish this just in time to bring you the final results. CLK goes off the board settling at $10.01, up a mere $47.64. CLM settles at $11.57, down -$8.86. The closing KM20 spread, $1.56.

Someday we’ll look back on this and . . . . Well, we’ll look back on it, anyways.

April 20, 2020

WTI–WTF?

Today was one of the most epochal days in the history of oil trading, which is saying something. The front month May contract–which expires tomorrow (21 April, 2020)–(a) settled at a negative price of -$37.63, (b) declined $55.90 from the previous day’s settlement, and (c) exhibited a trading range of $58.17, which is about 3.5x Friday’s settlement price.

Even these eye-popping numbers don’t tell the full story. The last traded price was -$13.10. Note that the settlement price is based on the volume weighted average price during the last two minutes of trading, so an average price of $-37.63 in the last two minutes and a last traded price of -$13.10 means prices moved more that $25/bbl in these minutes.

And we’re not done yet! As I write at 1841 CDT, the price is up to -$5.00–an increase of $32.63.

That there’s what they call volatility, folks.

To put these numbers in perspective, the largest trading range on the any day of the last three trading days of CL contracts from 2000-2019 is $26.65, a day around the time of the financial crisis and the aftermath of Hurricane Ike (October 2008 contract): here’s what I wrote about that event. The median intra-day range on the last three days is $1.6, the mean is $1.5, and the standard deviation is $1.47. So we are around a 40 standard deviation event here.

The largest daily price change during the last 3 trading days is $16.37, with a median of $.73 and a standard deviation of $1.45.

The calendar spread is also extreme, settling at $58.06 between the June and the May. Meaning that if you had storage, you could get paid to take delivery, sell it forward, and lock in that $58.06 (net of what the storage costs you). I guess you could call that the megacontango.

All in all, a historically unprecedented day.

The proximate cause of these wild gyrations, and unprecedented negative prices is, of course, the collapse of demand and the looming exhaustion of storage space, including at the delivery point of Cushing, OK. But although this is a necessary condition for today’s events, it is not a full explanation.

The storage issue has been known for weeks, and discussed intensely. It had been priced in to a considerable degree: contango was already at a historically high level. What information about the availability of storage arrived between Friday and today? Unlikely to be anything that could cause such chaotic price movements.

The likely cause is the difficulty of liquidating about 100,000 open contracts (100 million barrels!) in such extreme technical conditions. It is plausible, and indeed likely, that strategic behavior–perhaps rising to the level of manipulation–is the major cause of how prices moved today against the background of conditions that were widely known on Friday.

Let me start out by noting that something similar, though not as extreme, occurred during the demand collapse and associated flooding of storage during the Financial Crisis. As I documented here, the expiries of the January, February, and March 2009 WTI contracts saw what were then historically unprecedented price collapses. So did other US grades of oil. Here’s a picture from the linked document:

The big downward spikes in the front month-back month spreads correspond with the days around expiry.

How does strategic behavior/market power/manipulation play into this? The model of short manipulation in my 1996 book (only $169 paperback–buy two!) and 1993 J. of Business article formalizes the argument, but the intuition is fairly straightforward. Manipulation exploits frictions and bottlenecks. (My article/book refer to “frictional manipulations.”). There is now a huge friction/bottleneck in Cushing–constrained storage. This bottleneck makes the demand curve for crude at Cushing extremely inelastic, and means that the movement of even small excess quantities of oil into that location will cause prices to decline dramatically.

In these conditions, a trader, or a group of traders with modest-sized short positions can exercise market power by delivering even a small amount of oil over and above the quantity that should flow to Cushing. This drives down the price and allows the trader or traders to cover his (their) position(s) at artificially low prices.

In this situation, the storage bottleneck is the gasoline, the exercise of the market power is the match. With 100,000,000 barrels of open long positions needing to liquidate, given the storage constraint, the resulting conflagration can be epic.

This is, at this stage, a hypothesis. It is a possible explanation of the beyond extreme movements observed today. Under the circumstances, it is a very plausible explanation, and one that deserves scrutiny. And given the amount of money that changed hands today (~$6 billion on a mark-to-market basis) I’m sure that it will get it.

The only parallel I can think of is the onion market in 1955, when the movement of a couple of superfluous carloads of onions into Chicago, and delivery thereof against futures, caused the price to crash below the cost of the bags that they had to be delivered in. There was no demand for the onions (being perishable, and people eat only so many hot dogs), so many of the excess plants ended up getting dumped into the Chicago River. (Which, in 1955, probably improved the water quality.) (Another irony being that Chicago means “stinky onions” in the Miami-Illinois Indian language.)

In 1955, demand was inelastic because onions are perishable (i.e., they can’t be stored). In a way, the lack of storage space makes oil perishable. Even if that analogy isn’t perfect, the economics are the same: an economic constraint (the non-storability of, or the lack of storage space) leads to extremely inelastic demand that makes short market power manipulation possible.

Tomorrow is the last trading day for CLK20. Strap it up! It’s going to be a wild ride.

April 18, 2020

Burn Down the Lockdowns

Filed under: Uncategorized — cpirrong @ 3:30 pm

The Declaration of Independence states:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.

Due to an extremely exaggerated threat to life, our liberty and ability to pursue happiness are under grave threat from lockdowns and other severe impositions on civil liberties.

I have been a lockdown skeptic from very early in their imposition in the US. As more data regarding the virus, and the economic and social impact of responses to the virus come in, I am becoming a lockdown radical: burn them down before they burn us down.

Insofar as the impact on “life” part of the life, liberty, pursuit of happiness trilogy is concerned:

  • Daily evidence arrives demonstrating that the infection fatality ratio (IFR) of covid-19 is of the same order of magnitude as influenza, and not an order of magnitude higher, as initial estimates (propagated by the execrable WHO, among others equally execrable) suggested.
  • This is due to the evidence that the virus is much more prevalent than suggested by the case numbers alone (numbers which are wildly misleading as I have been saying for weeks). This reflects the fact that most of those infected are asymptomatic. The most revealing data points in this regard are systematic testing of the crews of the US aircraft carrier Roosevelt and the French aircraft carrier de Gaulle. Other semi-random samples provide supporting evidence, as does a systematic study in Santa Clara County, CA–a study conducted by eminent scientists at Stanford.
  • Unlike the Spanish Flu of 1918-1919, which is repeatedly (and tiresomely) trotted out as a precedent for the Wuhan Flu of 2020, the current virus is not a major health threat to the young. And by “young,” I am flexible in my definition: anyone under 70. In contrast, in the Spanish Flu outbreak, people in their 20s died in their millions.
  • The epidemiological models that were the basis for lockdown policies have proved wildly exaggerated.
  • Honest epidemiologists” acknowledge that lockdowns merely kick the can down the road until they are relaxed, and that due to the delay in achieving herd immunity, total fatalities are likely to be higher as a result of doing so. Viruses gonna virus. We can pay them now, or we can pay them later. It is hubristic to think that humans have much power over the relentless progress of pathogens.
  • But, but, but . . . we need to flatten the curve to prevent the healthcare system from being overwhelmed, right? Er, not even in hotspots like New York have ICU resources operated at capacity. Further, as I noted in an earlier post, capacity is a choice not a fate: in NY and the UK and elsewhere, capacity has expanded rapidly. Overwhelming of the health care system has proved to be another chimera.
  • Case in point: ventilators. The Great Ventilator Shortage has rapidly transformed into the Great Ventilator Glut: even NY acknowledges it has way too many. (Some weeks ago I was thinking that I wished there was a ventilator futures contract that I could short. That bet would have paid off handsomely.) (To which I would add that the clinical benefits of intubation/ventilation are dubious for most patients, at best.)
  • There is clearly evidence of excess deaths–this has been a notably deadly outbreak, though not as yet more deadly than some extreme flu outbreaks such as 2017-2018 (which we weathered without shutting down the world). However, the variation in excess death rates across countries is virtually identical, regardless of policies that they have adopted, or the timing thereof.
  • Excess deaths have peaked, and are trending downwards. Again, pretty much everywhere and at the same time regardless of policies adopted.
  • In the US, and in some hard-hit countries (e.g., Italy), there are substantial variations in the severity of the outbreak. New York City has less than 1/3 the population of Texas, and 1/4 the population of California, but has experienced multiples of cases and deaths over these larger jurisdictions. In Italy, south of Florence covid-19 has had a minor impact. These variations suggest that local factors (e.g., pollution, population density) have a first order impact on the effects of an outbreak. This further suggests that one-size-fits-all policies make little sense.

I could go on. For a useful summary of additional facts, I suggest this. I could suggest more such resources, if you are interested.

Insofar as the economic and social impacts are concerned, it’s hardly necessary to go into detail. The consensus now is that the economic collapse will exceed that of the Great Depression: the only question is whether the collapse will endure as long–which, since the collapse was created by policy, will be the result of policy (which does not make me optimistic). (The Great Depression in the US was “Great” not so much because of the severity of the initial decline–1920/1921 was as severe–but for its duration. Monetary and other policy errors caused the extended misery. Will we repeat them?)

Insofar as liberty is concerned, just look around. People arrested for surfing, FFS. Police departments declaring that protest is a “non-essential activity.”

Take the crackdowns on outdoor activities. What evidence whatsoever is there that such activities pose risk of spread of the virus? So as not to keep you in suspense, let me answer: none. Ditto gyms or restaurants. The biggest risk? Close and extended contact with an infected individual. So by all means keep everyone locked down at home, except for occasional forays to say, buy food. From people.

This economic collapse will cost lives. Many of them. It will cost futures. The futures of young people with their lives ahead of them.

We are constantly hectored by those who claim to be acting on the basis of SCIENCE. I note that many of those hectoring are clearly utterly incapable of discussing intelligently any scientific topic. Self-selection–those who are capable of doing actual science have far better things to do than become politicians or bureaucrats–is one major explanation of this.

But those who scream SCIENCE the loudest are little more than Wizards of Oz, trying to intimidate us little Dorothies, and warning us not to look at the little man behind the curtain. Men plural (and women) actually–the modelers with the risible models, the if-it-bleeds-it-leads journalists repeating bullshit data that they do not comprehend, and the politicians aping both.

Some countries are starting to relent. Germany, for example. Trump and some governors have laid out plans to ease the lockdowns, but these plans are timorous and built on the same faulty foundations as the lockdowns themselves.

Consider Texas, where Governor Abbot will open state parks and permit stores to reopen–but only if they offer curbside service. (Can I get a curbside haircut? How does that work, exactly? Tough luck for barbers, I guess.)

Schools will remain closed, even though (a) children are not vulnerable, (b) other countries have either not closed schools, or have reopened them, and (c) exposing children is the most effective way of building herd immunity which is key to suppressing the virus in the longer term.

Here’s an interesting tidbit:

The governor’s second executive order focuses on Texas’ medical staff affected by limitations placed on surgical procedures. The order eases restrictions on surgeries starting April 22. The goal of this order is to allow doctors to diagnose patients without an exception. The governor specifically used diagnostic tests for cancer as an example.

So cancer screening and surgeries have been stopped. That hasn’t cost any lives, surely.

Abbott’s “plan,” like Trump’s (largely irrelevant one because it’s governors and hick and hack local mayors and judges and police chiefs whose decisions really matter) is based on widespread testing. Testing has become a mantra, a totem.

As a practical matter, the availability of tests will be a binding constraint for the foreseeable future. The UK, as an example, promised tens-of-thousands of tests–and has been able to deliver only a fraction of those. Availability of tests in the US has grown only slowly. If setting us free depends on availability of tests, we shall remain in bondage for a very long time to come.

And what is the purpose of the testing? I keep reading “test, track, and isolate” like some kind of mantra. But for a disease that is potentially spread by casual contact (unlike, AIDS or venereal disease) tracking contacts is utterly futile. “Who were you in contact with Mr./Ms. Positive?” “I was on the Blue Line” or “I was on the Metro.” Yeah, that sure helps. A necessary (but not sufficient!) condition for test, track, and isolate to work to control a ubiquitous pathogen is that the testing be almost as ubiquitous. But that just runs into the constraints mentioned earlier, i.e., if testing is a necessary condition to participate in civil life, we are not going to be able to participate in civil life for a long time to come.

Some proposals regarding testing–namely, the requirement of a certificate of immunity to obtain full civil rights–are positively Orwellian, not to mention almost certainly unconstitutional. (And I surely hope that Orwellian is a strict subset of unconstitutional, though I am having my doubts.)

Based on these quavering, tentative proposals to relax constraints, Lockdown Nation ain’t ending anytime soon.

And Trump and Abbott and a few others are quite the aggressive ones. Leftist governors in particular–Gulag Gavin in California, Coonman in Virginia, Governor Ratched in Michigan, and their confreres in places like Minnesota, Washington, and Wisconsin–give every indication that they quite like the way things are going, thank you.

Why is this? Not to go all Freudian, but this is overdetermined. A big part of it is the let no crisis go to waste mentality, combined with a will to power. The virus has proved to be the perfect Trojan Horse to justify outrage after outrage against liberty, and to seize control over the daily lives of citizens in ways that they only dreamed about before.

Another part is a refusal to admit error. These policies were justified on the basis of apocalyptic–and hysterical–predictions from models that have proved to be utterly unreliable. What politician is willing to play Emily Litella, and say “Nevermind”? None, to a first approximation. So now they warn us about the “second wave.” Which will occur inevitably whenever the lockdowns are relaxed if the theory of the lockdowns (“flatten the curve”) is correct in the first place.

The question now is how much longer will Americans who are watching their livelihoods and futures disappear put up with this. Although I see glimmers of hope, they are only glimmers. The deference to authority, no matter how demonstrably incompetent, opportunistic, or corrupt, appears to be very deeply ingrained indeed. Depressing.

What we need are policies that target the most vulnerable (especially the elderly), and vary with local conditions. Instead, we have indiscriminate approaches that have created immense harm to our livelihoods and liberties, with little demonstrable public health benefit in return. It’s time to rise up and speak out against the petty tyrants who wreak havoc and and add insult to injury by insisting that they are doing it for our own good.

April 13, 2020

Vladimir and Igor Tap Out and Turn Down the Oil Taps

Filed under: CoronaCrisis,Energy,Politics,Russia — cpirrong @ 6:36 pm

A little more than a month ago, when the China virus was first wreaking havoc in the oil market, Vladimir Putin and Igor Sechin demurred when the Saudis requested an extension of OPEC+ oil cuts. Furious, the Saudis retaliated by promising to ramp up oil production by more than 1mbpd, and prices truly cratered.

No problem!, said Vladimir and Igor. This is part of our master plan to destroy US shale! (Never mind such “logic” is right out of Economics for Mouth Breathers.) Furthermore, Russia has ample financial reserves, and its government can ride out a long stretch of low prices. (The Russian people? Ha! Demonstrating the state-centric nature of Russian policymakers.) The ruble crashed. No worries! In fact this is GREAT for Russian oil producers, because their costs are in rubles and the weakening of the currency cushions the impact of a lower dollar oil price on revenues. (The Russian populace? Again Vova and Igor DGAS.)

But despite the bold talk (which in some ways reminded me of the old story about G. Gordon Liddy holding his palm over an open flame to prove how he could take pain without cracking), the magnitude of the collapse, and the possibility that it would endure, obviously caused considerable consternation in the Kremlin.

The first indication was when the Russians claimed that the Saudis had taken their action to harm US oil producers, a complete flip for Russia’s bragging that that’s why they were taking the hard line.

In the past few weeks, Trump cajoled the parties to the bargaining table, and yesterday–after overcoming a Mexican holdout–the parties agreed to a deal. And what a deal it is, involving Russia agreeing to cut production by 2.5mbpd–almost 23 percent–an amount 4 times what they refused to accept a little more than a month ago. (I also note that it flies in the face of repeated Russian statements over years saying that it was operationally impossible for them to cut more than trivial amounts.)

The Russians had insisted on formal commitments from the US to cut. Trump–who brokered this deal–said that US production would fall due to price declines. (True dat–I’ll try to provide some estimates tomorrow.). The Russians said that wasn’t good enough (apparently demonstrating an ignorance of the limited ability of the US government to force output reductions)–they wanted mandated cuts. But in the end, the deal was done, absent any formal US commitments.

In other words, Putin and Sechin cried uncle. Hell, they tapped out like an MMA fighter in a chokehold. This makes a mockery of their bold front of a month ago. I think it reveals that they were truly shocked by the Saudi reaction, and were desperate to find a way out, but they didn’t want to show it. They needed some sort of fig leaf, and Trump gave them one.

Now this is being spun as some sort of Putin master plan to curry favor with Trump to gain negotiating leverage on other issues.

All together now: Suuuurrrre it is, Vova. Suuurrrre. Trump don’t owe you–you owe him.

I oppose the deal, despite the fillip it will provide to the US oil industry. Artificially boosting oil prices will harm already devastated consumer economies (including the US). Further, this will potentially rejuvenate OPEC post-crisis. Again that would be good for the US oil industry, but not for the US.

I also wonder whether Putin (and the Saudis) will come back later with proposals to get the US government to take measures to reduce output in a coordinated fashion. Just how that would be done is rather mysterious. The only plausible measure that I could think of would be some sort of tax (either on production, or on exports). But this would require Congressional action–it’s not something Trump or any president could negotiate unilaterally–and I don’t see that happening.

But that’s for the future. In the present, Putin and Sechin reaped what they sowed. They thought they could force the Saudis into bearing the brunt of supporting oil prices, while they could continue to produce at capacity. The Saudis responded like it was 1986, and the resultant collapse in prices brought the brilliant schemes of the KGB masterminds crashing down. In the end, they had to capitulate. No matter how hard they try to spin it, it’s obvious that they did.

April 11, 2020

A Cultural Revolution in the Corps?

Filed under: China,Military,Politics — cpirrong @ 5:25 pm

The Marine Corps credo is that every Marine is a rifleman. This credo reflects, and is reflected in, the Corps’ history of and excellence at close combat. From Belleau Wood to Guadalcanal to Tarawa to New Georgia to Peleliu to the Marianas to Iwo Jima to Okinawa to Inchon/Seoul to Chosin to I Corps (in Vietnam) to Kuwait and to Iraq and Afghanistan, the Marines have closed aggressively with the enemy and killed them, often at very high cost to themselves. Aggressive close quarter combat has been the Marine way of war for more than a century, and they think (with reason) that they do it better than anybody, ever.

The new commandant of the Marine Corps, General David Berger, has announced a radical new vision that is diametrically opposed to this historical tradition. Rather than close and kill, General Berger aims to reshape the force in order to permit it to operate in enemy held regions, and attrite the enemy’s air and naval forces with fires, primarily anti-ship and anti-aircraft missiles.

And for enemy number one, read “China.” Enemy number two? There is no enemy number two. This is all about China, and the South China Sea.

This would involve a dramatic change in Marine force structure. Fewer infantry battalions. Less tube artillery–but more missiles. No tanks. Zip. Zero. Nada.

Somewhat unaddressed in Berger’s vision document is how the “small Marine forces” that he envisions will “deploy” to islands “in close and confined seas in defiance of adversary long-range precision ‘stand-off capabilities.’” Presumably they will have to fight their way in–just like they did across the Pacific 1942-1945. How this is to be done remains very unclear, especially if close combat capability is reduced.

One of the most striking things about this document is the laser-like focus on China. In some respects, this is encouraging, because China is and will remain the primary threat to the US and US interests. And the Chinese anti-access/area denial plan of creating strategic depth by contesting a ring of island defenses (and indeed, even building the islands) bristling with missiles does require a major shift in US doctrine in response.

The document also demonstrates an admirable appreciation of the complementarity between air and naval forces, especially in the vast Pacific theater. Berger’s vision clearly entails close cooperation between the Navy and Marines to fight and dominate a powerful enemy in the western Pacific.

But one thing that history has demonstrated is that you often don’t get the war you plan for–in part because that’s not the war your enemy wants to fight precisely because that’s what you want him to do. Having a force specialized to execute a single operational concept provides little capability to fight other kinds of wars. And one thing that has helped the Marines survive the budget wars of the 20th and 21st centuries is its demonstrated flexibility in carrying out myriad different missions, from fighting furtive guerrillas in Central American jungles to digging out entrenched Japanese on Pacific islands to making hell-for-leather armor and infantry attacks across desert landscapes in the Middle East. Berger’s proposed force will not be able to perform such varied missions, or at least will have far less capability to do so. Is this a wise choice? Tough call.

One challenge Berger will face is in DC. I seriously doubt the appetite of the Pentagon, or especially the Congress, to embrace and fund such a dramatic transformation.

Another challenge will be from the Corps itself. This proposal is at odds with Marine tradition and self-image and culture. Closing with the enemy and killing him is what Marines do. More importantly, it’s what they believe they do better than anyone in the world, or anyone in history, for that matter. Remaking Marines from riflemen into missileers involves more than swapping out old weapons for new, or writing new operational manuals. It involves inculcating a whole new mindset. This is difficult to do in any organization, but is particularly difficult in one with such a deep commitment to and a well-justified pride in a traditional way of waging war.

April 9, 2020

Bullshit Numbers

Filed under: CoronaCrisis,Economics,Politics,Regulation — cpirrong @ 3:00 pm

You are seeing a lot of covid-19 numbers thrown around. Virtually all of those numbers are bullshit.

The death rates are bullshit. In a given country, there is considerable subjectivity regarding how deaths are qualified. The Great Scarfini* (Dr. Deborah Birx) pretty much let that cat out of the bag when she acknowledged that not only are the decedents who test positive (regardless of other co-morbidities) declared as covid-19 deaths, but those who have some colorable connection to covid-19 (clinical presentation, exposure to someone who tested positive) are declared to be covid-19 deaths.

It is likely that hospitals and physicians–and politicians–have an incentive to attribute deaths to covid-19. These incentives can be financial (a hospital could get greater compensation from covid victim than someone dying of something else) or power (death numbers are being used to justify draconian restrictions).

Further, different countries use different methods to count deaths.

What we are really interested in is people who would not have died but for covid-19. The official death statistics do NOT do this. And the fact that virtually all of the dead are aged and/or have multiple serious health problems, a but for attribution is dubious even in the presence of a positive test.

The only rigorous way to estimate these but for deaths is excess deaths (i.e., deaths in excess of expected deaths, conditioning on time of year, demographics, etc.). And preferably excess deaths from respiratory illness (or at least excess deaths from non-accidental causes). This is a good template for the analysis. This also presents some good cross-country data, which shows that in Italy and Spain there is evidence of excess deaths. Elsewhere? Not so much. Of particular interest is Sweden, which has implemented mainly voluntary social distancing measures, to the hysterical response of those deeply invested in mandatory lockdowns.

Do this for a variety of jurisdictions (countries, states in the US) and you would have enough cross-sectional and time series variation to do some real analysis that could provide reasonable support for policy decisions..

The case numbers are bullshit, at least if you want to measure infection rates. As I’ve been saying for weeks, there are so many selection biases that the numbers tell you NOTHING about the prevalence of the virus in the population, either at a point in time or crucially over time. Indeed, the CDC guidelines could be titled “How to Produce a Wildly Biased Sample”:

This testing protocol could be justified on clinical and diagnostic grounds, but it is a disaster from the perspective of generating data that is useful in shaping policy.

Further, trends in positive test numbers is driven to a considerable degree by . . . a greater number of tests.

The graphs that you see depicting trends deaths or cases across countries over time are bullshit. They are bullshit because the inherit all the flaws of the data discussed above (exacerbated by the fundamentally different data reporting methods across countries), and they almost fail to adjust for population size or demographic characteristics.

Chinese numbers are obviously bullshit. No need to elaborate this point.

The models that are being used to drive (or at least justify) lockdowns are bullshit. Their predictions went from apocalyptic to well, a small fraction of apocalyptic. Sometimes between one day and the next. Models should be evaluated on predictive accuracy. The predictions of these models have proved to be excessively pessimistic, i.e., bullshit.

And don’t buy the line that the lockdowns reduced the death tolls. For one thing, many of the models’ predictions included the effects of social distancing–and still came out way too high. For another, many countries’ death and case rates (above caveats apply) peaked before the lockdowns could have had any effect.

I keep hearing the IHME model referred to as the “top model.” Who says? On what basis? Basically because somebody else said it. And oh, Bill Gates is somehow involved. So that claim is bullshit too.

Also be very suspicious that the modelers are very opaque. We don’t see their assumptions or their methods. Notoriously, the most influential modeling team (at least initially) that did more than any to spark the panic, has not released its modeling code.

At least the honest modelers admit that social isolation and shutting down the economy doesn’t change the integral under the curve (i.e., the total number of deaths) but merely the time pattern of those deaths. And some epidemiologists claim that extending the period of time before the burnout may result in a higher number of total deaths.

But even putting that possibility for a higher total toll aside, the argument is made that it is necessary to “flatten the curve” in order to reduce the burden on the healthcare system. Well, one thing the models vastly overpredicted hospitalization/ICU visits as well. And I have yet to see any evidence of systematic shortages of ICU beds/ventilators. Yes, there are hotspots. But that just means that we need to understand the hotspots–and the non-hotspots–better.

Along those lines, I can’t say the numbers on ICU utilization are bullshit–because the numbers are largely non-existent. Instead we’ve had anecdotal journalistic (i.e., “if it bleeds it leads”) accounts that provide no objective quantitative standard by which to evaluate how binding the constraints are in the healthcare system.

But again the issue is cost-benefit. Basically what lockdowns do is discount future deaths/cases relative to present deaths/cases (since they accept an approximately equal number of future deaths for each death that does not occur today). And the discount rate is huge. We are losing trillions of dollars in lost output/income to push some deaths into the future. The interest rate is astronomical. Put differently, we are paying an immense price to kick the can down the road.

I understand the the supply of ICU beds, ventilators, physicians and nurses is pretty inelastic over the short run. But even given pretty substantial inelasticity, it would be far more efficient to throw billions at expanding capacity in the short run than to sacrifice ~25 percent of world income to reallocate the deaths over time. Capacity is not a fate. It is a choice.

And the fact that well into the crisis the foretold capacity disaster in hospitals has not been realized, the additional capacity required may well be quite small.

There is also the issue of how much the temporal pattern of deaths will really change. This depends on a variety of factors, including when the virus first spread and its virulence. The more we learn, the more likely it is that the virus has been spreading since late-fall/early-winter 2020. Which means that the lockdowns are reactive, not proactive, and that they have little impact even on the time pattern of deaths let alone the number: they are the proverbial locking the barn door after the horse done bolted.

In brief: our betters are destroying futures based on bullshit data. It’s as simple as that. And they are vastly increasing their power as a result, so they are destroying freedoms too.

In an earlier post I said that we have to grasp the nettle and decide what price are we willing to pay to save a life (usually of an aged, ill person). But it’s actually worse than that. It is very likely that the real question is: how much are we willing to pay to defer a death (of such a person) a few months? The cost that those who govern (or rule) us (and those who support them) are apparently willing to pay is astronomical.

*Dr. Birx is always adorned with a scarf. On my first trip to NYC in 1978, when NYC was near its nadir, I saw an obviously psychotic individual dancing on near Grand Central Station waving around a long scarf. Every once and a while he would shout “I AM THE GREAT SCARFINI” and then start dancing again.

April 5, 2020

The Case of Captain Crozier and the Coronavirus

Filed under: China,Military,Politics — cpirrong @ 3:33 pm

Ex-Global Super-Regulator on Lunch Break asked me to opine on the relief of Captain Crozier from command of the USS Theodore Roosevelt, CVN-71. At present, I don’t have the information to make a firm judgment one way or the other. Depending on circumstances that I (and anyone else not in the Department of the Navy or Captain Crozier himself) cannot observe, I can see things going either way. (And I note, that even if I was a principal, the lessons of Rashomon should be kept in mind.)

Based on what is in the public record, the presumption must be that Captain Crozier’s actions in either leaking his letter, or disseminating it in a way that was almost certain to result in its leaking, were highly irregular, and prejudicial to good order and discipline.

But this is a rebuttable presumption. The problem is that the public does not have the information to rebut it, or to not do so. I can imagine realistic scenarios that cut either way.

I can imagine a scenario in which Captain Crozier had reasonable grounds to believe that the Navy Department (and the Pentagon generally) was insufficiently sensitive to the acute situation on the Roosevelt, and felt compelled to take extraordinary actions in order to make them aware. Bureaucracies frequently prefer to suppress information (cf. the CCP), or are so used to operating according to routine that they are incapable of handling the non-routine.

That said, if that was Captain Crozier’s belief, he should have resigned his command (and his commission) and stated forthrightly the reasons for doing so. Engineering a leak is unmilitary, and reeks of political calculation. I understand that is the way that DC plays the game, but that doesn’t make it honorable to play by corrupt rules.

I can also envision a scenario in which Captain Crozier’s understandable focus on his ship and his crew blinded him to measures that his superiors were taking to balance the interests of the crew and operational and strategic interests of the United States.

It is legendary that the first question that presidents ask during an international crisis is: “Where are the carriers?” They are the primary and most rapidly deployable asset in such crises. Making one unoperational is a weighty decision with major consequences, especially in fraught times: note China’s aggressiveness in the South China Sea at the very moment the world is gripped with the coronavirus panic.

Indeed, Captain Crozier alluded to this when he said in his letter that: “If required the USS Theodore Roosevelt would embark all assigned Sailors, set sail, and be ready to fight and beat any adversary that dares challenge the US or our allies.” If only it were that easy. It has taken days to disembark the crew and accommodate them in Guam. It would take that many days, or more, to reembark them and make the ship operational. Remember Kipling’s “unforgiving minute”? Patton did–and rightfully castigated his superiors for failing to do so.

Capt. Crozier then went on to say that conditions on the ship conflicted with CDC guidelines. But CDC (civilian) guidelines are created to address different situations with different trade-offs than the military must deal with.

And that is the fundamental tension (i.e., trade-off) here. Operational availability of one of the US’s most important military assets and a health risk to its crew. Captain Crozier understandably emphasized the latter. His superiors had to give much more weight to the former than did the Captain.

We don’t know what measures the Navy Department/Pentagon were taking to try to balance these very difficult considerations. Absent such information, I for one reserve judgment.

This episode implicates larger issues that I have mentioned several times.

The first is the shocking lack of data upon which decision makers have to act. What is the real health risk to the crew (which consists primarily of young, healthy individuals)? We don’t know. Why are we ignorant? In large part because of a failure to implement a random testing regime (which I outlined weeks ago) that would produce more reliable information. It is appalling that months after the risks began to crystalize that we still have to rely on data plagued with severe biases inherent in the method of collecting them.

The second is the grim calculus of trade-offs, never mind whether we have the information to make informed trade-offs. Of course we want to save lives–but not at infinite cost. To reprise a previous post, we don’t want to destroy the country to save it.

This is a grim calculus that wartime militaries must always face. They say there are no atheists in foxholes–but at the same time, there have to be utilitarians in headquarters.

Mind you that I do not write as someone who reflexively defers to command authority. The fact I chose not to remain in the Navy is the chief exhibit in that case: as I often say (including under oath in depositions) I left Navy because that’s where I learned I have issues with authority. Further, when a plebe at Navy, my final essay in the leadership course argued that disobedience of orders was justified in some circumstances: this did not go over well! (Which was a big part of my practical education that informed my decision to leave.) So I totally get that Captain Crozier may well be in the right. But I also get that he might not be. But what I get most is that I don’t know–nor do you–whether he is or not.

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