Streetwise Professor

November 26, 2021

Boris’ Big Short

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — cpirrong @ 8:09 pm

Due to the immovable object of price caps and the irresistible force of spiking natural gas and power costs, about 20 retail energy suppliers in the UK have gone toes up. Most of these have been addressed using what is called the Supplier of Last Resort (SoLR) mechanism, whereby customers of the failed firm are transferred to another supplier. (SoL sounds about right!) This mechanism effectively socializes losses:

Energy suppliers that rescue customers via the supplier of last resort can recoup their costs through an industry levy that is funded by bills.

Although the foregoing suggests that all UK energy consumers share in the costs, energy market regulator Ofgem suggests that the customers of failed firms may bear some of the costs:

Could bills go up?

When we appoint a new supplier using the Supplier of Last Resort process, we try to get the best possible deal for customers.

Suppliers we appoint will likely put you on a special ‘deemed’ contract when they take on your supply. This means a contract you haven’t chosen. A deemed contract could cost more than your old tariff, so your bills could go up. However, they are covered by the energy price cap Ofgem sets, which ensures you get a fair price if you are put on one. 

When contacted by the new supplier, it’s best to ask to be put on their cheapest tariff or shop around if you want to. You won’t be charged exit fees. This is a challenging time in the market and we know that there may not be many tariffs available when shopping around right now.

Deemed contracts can cost more because the supplier takes on more risk. For example, they might have to buy extra wholesale energy at short notice for new customers. So they charge more to cover these costs.

Up to last week, all the failures had been dealt with using this mechanism. But the failure of Bulb (Dim Bulb?) was evidently too big for Ofgem to deal with using the SoL mechanism. Instead, it resorted to a “Special Administration Regime” which basically nationalizes Bulb. This regime permits the government to “make grants and loans to the company in administration and may also give guarantees for any sum borrowed while it is in administration.”

That is, SAR is essentially a bailout/nationalization of losses and risk.

Ofgem notes:

The energy price cap, which sets a maximum price for customers on standard default tariffs, will remain in place to protect millions of people from the sudden increases in global gas prices. 

(Aside: It is impossible to protect millions of people from the sudden increase in global gas prices. It is only possible to determine–based on political mechanisms–which millions pay and how much. So this statement is typical government bullshit.)

Thus, given the price cap and the fact that Bulb is now owned by the UK government, Boris now has a big short position in natural gas. So how is he going to manage it?

I have heard that the government approached Vitol, which told them to fuck off. So . . . what next?

The company still has to procure energy at market prices and sell them at fixed prices. Since the government is now the residual claimant, it has a short exposure and can take this exposure on the balance sheet, as it were, and essentially run a naked short.

Or it can try to hedge by buying gas forward. But this is not a trivial problem. This is not a position of fixed size that faces only price risk that could be hedged using fixed quantities of swaps/forwards/futures. There is volumetric risk as well: cold weather increases both the price of gas and the amount of gas that must be supplied. A sophisticated hedge would involve both forward fixed price purchases and weather derivatives. Or through the purchase of a sophisticated structured product that has payoffs that depend on both volumetric and price variables.

I’m guessing that the government is not into sophistication, or frankly, capable of it. As a result, it is likely to be at a severe disadvantage in negotiating a price on a structured product or weather derivatives or long dated forwards.

It is also likely sweating out the hedger’s hindsight dilemma. If it doesn’t hedge and prices spike it will catch hell because of the large losses passed on to taxpayers. But if it hedges and prices don’t spike or in fact decline, it will catch hell too: you idiots overpaid!!!! Both of these judgments are based on hindsight, but even though hedging decisions should be evaluated ex ante on the basis of how they effect risk, inevitably they are evaluated ex post based on how they pan out.

Consider California in the aftermath of its 2000-2001 electricity crisis. It entered into long term contracts at what retrospectively was the height of the crisis, and thus paid higher prices than it would have had it procured on a short term basis. Of course, California attempted to recover by suing the contract sellers, claiming it was a nefarious manipulative scheme. Alas, it succeeded to some degree.

The best solution would be to do what clearinghouses do when a big member collapses–auction off the positions. This is what NYMEX did when the hedge fund Amaranth collapsed due to natural gas futures and swap losses in 2006: JP Morgan and Citadel assumed the positions in exchange for consideration. Similarly, when Lehman collapsed in 2008, the CME auctioned off its futures portfolio.

Even in these situations, however, there is always controversy about whether the price is right. Assertions that the buyers of Lehman’s futures positions received a windfall (i.e., bought on the cheap) led to litigation (filed by the Lehman bankruptcy trustee) and considerable controversy. (Here’s my take on the issue.)

Note that the factors mentioned above mean that the pricing in any putative auction of Bulb obligations is likely to be more discounted, and thus subject to more controversy, than the Lehman positions. As in the Lehman case, the positions will be auctioned in a stressed market. Moreover, as noted above, the exposures are far more complex and difficult to manage than Lehman’s rather vanilla (though large) futures positions. That complexity will bring a discount. Furthermore, apropos California circa 2001, the bidders realize that they are subject to government attempts to clawback any gains that result ex post due to favorable fundamentals (e.g., an unexpectedly warm winter). That is, the bidders may fear that the government will actually acquire a long option position, and hence they will be short an option: if prices spike, the auction “winner” will bear the brunt, but if they don’t the government will claim that it was exploited and over payed.

That is, unless the government can credibly commit to adhering scrupulously to the results of the auction, the auction may well fail to attract any bidders.

NB: credible commitment is not one of most modern governments’ strong suits. (This is likely one of the reasons Vitol told the government to bugger off. It realized that it was assuming a totally skewed position–heads they lose, tails they don’t win.).

According to the FT article linked above (amazingly factual and informative for a current day FT article, BTW) the government rejected two offers to assume the Bulb portfolio. I surmise that the bids were discounted heavily to reflect the factors mentioned above and Ofgem accordingly rejected them.

So I’m guessing the government will wear the risk. Perhaps it will try to manage it–and do it badly. Or more likely it will just let it ride. Maybe it will bet on Covid, thinking that the new variant or the new variant after that or the new variant after that will cause governments (stupidly) to lockdown again and crater economic activity and hence gas demand.

I note that Bulb might not be the end of the story. As noted above, the price caps remain in force, meaning that other suppliers may fail in the future–including those that have already gone through the SoL process. The government would be the ones SoL then. That is, the government not only has the Bulb liability–it has a big contingent liability that could dwarf Bulb.

Ofgem has already hinted at this:

In a letter to Kwarteng justifying the decision to pursue a special administration for Bulb, published on Wednesday, Ofgem’s chief executive Jonathan Brearley said the supplier of last resort mechanism was already “under considerable” strain from managing the failure of 20-plus other energy companies in recent months.

So Boris’s already big short could get bigger.

And perversely, it could influence government policy on COVID. Doing something (like lockdowns) that would crush energy demand would benefit its short energy position (existing and contingent). Talk about moral hazard.

Good luck with that Boris! Or should I say, good luck with that, Limeys?

November 21, 2021

The Rittenhouse Rorschach Test

Filed under: Politics — cpirrong @ 5:45 pm

The Kyle Rittenhouse trial has ended as it should, with his acquittal on all charges. Any fair viewer of the evidence would reach the same conclusion as the jury, namely, that Rittenhouse shot, and shot and killed, in self-defense.

That is an encouraging outcome, but it must be said that the case did not begin as it should have: it never should have begun at all. The prosecutors were in possession of all this evidence, and indeed (outrageously) in possession of other exculpatory evidence that they concealed from the defense. Absent the hyper-political atmosphere that prevailed after the August 2020 riots in Kenosha during which Rittenhouse shot three people, a fair-minded prosecutor would not have brought charges at all.

That’s the way I see it. It is obvious, however, that many do not see it that way. Like some modern Dreyfus case, Rittenhouse’s has proved a political Rorschach Test: for every person like me that sees it my way, there is another (perhaps more than one, alas) that sees it completely differently. Instead of an unjust prosecution resulting in a just verdict, these people see this as a righteous prosecution resulting in a travesty of justice. Indeed, a travesty of justice that demonstrates that white supremacy indeed reigns supreme in America, and that white supremacist vigilantes can kill with impunity.

Watch any establishment media coverage, and you will see the Supremacist Narrative on display virtually 24/7. I could provide literally hundreds of examples, but this is sadly representative:

Needless to say, I find this utterly delusional–and mendacious. Virtually the entire narrative was built on lies–and things proven to be lies at the trial. Or more pointedly–things that were demonstrable lies before the trial, but which the establishment media repeated ad nauseum–and continues to repeat, verdict notwithstanding. The basic case for Rittenhouse’s alleged white supremacism–a slander repeated by Biden while a candidate in 2020–appears to be that he was white, and shot people at a (mostly peaceful?) “protest” of a police shooting of a black man. He shot three honkeys–kind of weird for a white supremacist, no? Never once has the establishment media presented direct evidence of white supremacist beliefs: no emails, texts, TikToks, tweets, Facebook posts, etc., etc., etc. They have made the weakest circumstantial argument ever to accuse Rittenhouse of being another Dylann Roof. Yet they believe (or at least assert) that their beyond flimsy circumstantial case is God’s truth.

The slander reached its heights when Rittenhouse took the stand (quite courageously, and against the near universal judgment of legal pundits) and broke down in tears. Oh, but those were “white tears” dontcha know according to scumbags like LeBron James and Joy Reid. A manipulative dog whistle that rallied all the defenders of the white race to the defense of one of their legion.

Apparently an 18 year old Olivier has been born. And one canny enough to know how to call forth the white phalanx to save him from the consequences of his actions.

It is disgusting and incredibly divisive that this trial was turned into racial issue. Indeed, it is disgusting precisely because it is so divisive–and because the racial narrative has absolutely nothing to do with the facts.

Many commentators have said that Rittenhouse should not have been there in the first place. From a legal perspective, that matters not a whit. Given that he was there, did he act in self-defense? is the only legal issue, and the one that the jury settled in the affirmative.

My take is that Rittenhouse was extremely naive, and was in Kenosha for reasons that he considered noble and idealistic. Funny, isn’t it, that leftist teens (or somewhat older young people) who act out of self-identified noble reasons with bad consequences are lionized (e.g., Rachel Corrie), but a conservative kid is demonized? Simply because his idea of a noble cause is an anathema to the left.

There’s also the question of whether the people he shot, or shot at (namely, the “jump kick man”), should have been there. Let’s put aside the quite real possibility that Rosenbaum, Huber, Grosskreutz, and Jump Kick Man should have all been in jail or a mental institution, rather than on the streets of Kenosha. Let’s just ask whether since they were at liberty they should have been there wreaking havoc? They were not engaged in anything remotely resembling peaceful protest. They found a place where they could wrap their antisocial pathologies in a gauze of social righteousness–something that the establishment media was fully complicit in.

The left believes its violence is speech, and your speech is violence. But that’s depraved: those who died by violent means were engaged in violence that was not Constitutionally protected speech, regardless of what you think about the Blake shooting. Their psychopathic and sociopathic behavior was encouraged by and validated by the establishment media, making them accessories. In contrast, Kyle Rittenhouse was behaving far more responsibly prior to the confrontation with the child rapist Rosenbaum than Rosenbaum was.

In other words, no riot, no Rittenhouse. So if you want to push back the causal chain to before Rosenbaum started to chase Rittenhouse, push it back to the riots, not to the time that Kyle Rittenhouse perhaps quixotically decided to protect Kenosha from the rioters.

Which brings us to who should have been there, but were not. The civil authorities were completely AWOL: they should have been there but they utterly failed in their duties. In particular, the mayor of Kenosha and the governor of Wisconsin consciously declined to take the measures necessary and sufficient to maintain civil order in Kenosha. They decided–like the “leaders” of many cities in the United States in the summer of 2020 (e.g., Portland, Chicago, Minneapolis, Seattle, and on and on and on)–to capitulate to mob rule. Because social justice. Or something.

If there is blood on anyone’s hands, it is on theirs, first and foremost, if you follow the chain of causation to its logical origin.

I know the foregoing makes the left apoplectic. And perhaps that’s the one solace of this whole sorry, depressing affair. The trial has proved to be the most reliable IFF (identify friend or foe) system I have ever seen. You know whether someone is your friend or foe based on the response to the trial and the verdict: and yes, that goes both left to right and right to left. No bogeys here. Only bandits and friendlies, and you know which is which with certainty. That’s quite useful information to have.

Sisyphus Does Energy Policy

Filed under: Commodities,Economics,Energy,Politics,Regulation — cpirrong @ 4:39 pm

For well over twenty years in my various energy pricing and policy classes I have pointed out that every energy price spike leads to accusations of manipulation and gouging and a call for an FTC investigation . . . which is always announced with great fanfare but never finds anything–something that is announced sotto voce, if announced at all.

And lo and behold, right on cue, due to the rise in energy prices in recent months Biden (or more likely, Howdy Joe’s ventriloquists) has asked the FTC to investigate rising gasoline prices:

President Biden called on the Federal Trade Commission to investigate whether oil-and-gas companies are participating in illegal conduct aimed at keeping gasoline prices high, in the latest effort by the White House to respond to public concerns about costs for everything from fuel to groceries.

Sisyphus would understand the drill. “Time to roll the price gouging rock up the hill again.”

And for the most idiotic, demented hot take, let’s turn to Lizzie Warren, speaking on Joy Reid’s show (talk about a singularity of stupid*):

Recall, this is about a change in prices. So if the change in prices is due to gouging by oil companies, it would have to be due a change in gouging behavior. (I think even Joy and Lizzie should be able to follow this, it’s so basic: but maybe I’m too generous.)

But let’s follow that thread. It would imply that until recently, oil companies were not exploiting the opportunity to “double their profits” by price gouging.

So what happened? Did one day a few months ago the CEO’s of Chevron and ExxonMobil et al have a V8 moment, and slap themselves on the forehead and say “Wow! I could have doubled my profits by jacking up prices!”

So if they could screw consumers at a whim by jacking up prices why did they let oil prices go to single digits in 2020? Why does the urge to gouge seem to wax and wane?

This is so incandescently stupid. But I guess I should consider the sources, and remember that this sort of incandescent stupidity spikes every time oil prices do.

If the FTC exhibits the integrity it has in the past, this investigation will end the way all the others have, with a whisper not a bang, stating that fundamentals are the driver. But there is no guarantee that the current FTC will indeed exhibit such integrity, given how degraded government institutions have become (not that they were ever paragons, but everything is relative). Political imperatives and narratives, not realities, rule the day.

* Lizzie was dean of Harvard Law School, and a professor of law there. Joy Reid went to Harvard. God save us from Harvard.

November 15, 2021

And . . . We’re Back

Filed under: Uncategorized — cpirrong @ 9:05 pm

Pardon the interruption. As several loyal readers informed me yesterday morning, the site was inaccessible due to a “bandwidth limit exceeded” error. Apparently, SWP was subject to a DDS attack that commenced shortly after I posted a crypto-skeptical piece. Go figure. I guess I got some crypto weirdos bent out of shape. Or maybe it was the deep state 🤣 whom I also fingered.

You can tell a lot about a person from his/her enemies.

Regardless, in a way “bandwidth limit exceeded” is accurate in other ways. I am hip deep in testifying at a trial and have other deadlines looming, so my bandwidth is definitely challenged. I’ll post ASAP. Subjects of interest including a disturbing move to transform the United States Marine Corps into the United States Woke Corps, and the utter insanity of the Rittenhouse prosecution.

Stay tuned and be well.

November 7, 2021

You Can’t Spell “Cryptocurrency” Without “Crypt”

Filed under: Cryptocurrency,Exchanges,Politics,Regulation — cpirrong @ 7:25 pm

The libertarian/anarchist roots of cryptocurrency, especially Bitcoin, are well known. The supposed allure is that crypto would allow individuals to transact without requiring on state issued fiat currencies (which are subject to various government controls and monitoring) or state-sanctioned financial institutions. Crypto is in theory anonymous, decentralized, and peer-to-peer, outside of the purview or control of the state. A way to Go Galt, virtually.

In the early days of crypto, which of course are not that long ago, I expressed extreme skepticism about that vision. It could be realized only if crypto remained unimportant and utilized by few: if it were ever to become close to realizing the vision on a broad scale, it would be a threat to governments and they would intervene to control it, neuter it, co-opt it, or destroy it.

There’s an irony here. If you believe the ideological argument for crypto–that it is justified as a means of escaping a tyrannical government-sanctioned and controlled financial system–you also have to understand that governments would not permit crypto to survive as the true believers desire it to.

And we are at that point. Crypto has flourished in the last several years. Not surprisingly, governments are moving to crack down on it.

China–again not surprisingly–was the first to attack crypto in a systematic way, implementing a blanket ban on crypto transactions. But other governments are not far behind, including the US.

Indeed, perhaps you didn’t know this, but the marvelous “infrastructure” bill just passed by the House includes a provision mandating reporting of crypto transactions. The language is unsurprisingly murky, but the intent is quite clear: to bring crypto into the view of the federal government’s Panopticon, especially its tax Panopticon.

In both China and the US the regulatory/legal attack is focused on intermediaries (e.g., exchanges, brokers) that facilitate transactions. In theory, true peer-to-peer transactions (e.g., transactions between anonymous wallets) can be used to circumvent this, but the very fact that intermediation has proved so integral to the operation of the crypto market (which is in itself a refutation of the anarchist vision, as I pointed out in a post about Ethereum creator Vitalik Buterin) demonstrates that the regulations will seriously compromise the ability of crypto to achieve that vision. Moreover, this is just a first step, but one which strongly indicates intent: if non-intermediated transactions flourish, governments will devise means to bring them to heel too.

There’s also something else to keep an eye on: central bank digital currency. It is no coincidence, comrades, that the first country to crack down on non-government crypto–China–is also in the lead in implementing–mandating, actually–a government digital currency.

Private crypto is a competitor to government digital money. Governments don’t like competition. So they do their best to destroy it. Furthermore, the Chinese government truly desires to create an actual Panopticon that permits monitoring, rewarding, and punishing all aspects of individual behavior. Government digital currency greatly advances that objective, and private digital currency impedes it. So to advance the former China destroys the latter.

Governments world wide have cognitive dissonance when it comes to cash. On the one hand, it provides a source of revenue–seigniorage. On the other hand, it provides a way to circumvent the tax system as a way of generating revenue–and of monitoring and controlling behavior. Government digital currency allows states to resolve that dilemma. They can have their revenue cake and eat your privacy too.

China is open and unapologetic about its social credit system and its view that government digital currency will allow it to extend and deepen the operation of that system. Other governments are not so blatant, but there have been discussions in the US and Europe and elsewhere about not just the adoption of central bank digital currency, but how that system could be used to compel desired behavior.

A retired Swiss banker friend once held up a 100 CHF note to me and said: “when I hold this, I feel free.” Well, that’s a feature to him, but a bug to governments. When you “hold” government digital currency, you will not be free. Its use can be monitored. It can be wiped out at the speed of light if you use it in a way that offends governments–or if you do other things that offend governments. Think that social credit can’t come to the US? If so, you are a trusting fool. Especially since government digital currency incredibly leverages the power of a social credit system.

In other words, government digital currency is a major step to the implementation of a dystopian Panopticon. Destroying, or at least severely hobbling, non-government digital currency is a crucial first step to the successful introduction of government digital currency. So this provision buried in the “infrastructure” bill, along with other strong signals from the Treasury, OCC, SEC, CFTC, and Congress of an intent to throttle private crypto should be viewed with alarm, and not just if you are a believer in the crypto dream.

There’s another thought that comes to mind, more speculative, but one that cannot be dismissed out of hand. Namely, that what we are seeing is a huge bait-and-switch. Bitcoin’s origins are incredibly murky. Its creation myth is an anarchist one–which makes it very appealing to those who value freedom and independence, and bridle at government coercion and control. What better way to identify and ensnare such people–who are an anathema to control-obsessed governments–than creating cryptocurrency with an anarchist creation story?

And even if governments did not create the bait, they are certainly not above exploiting an emergent phenomenon (if that’s what crypto really is) to advance their anti-liberty agenda. Crypto has gained a cachet in large part because of its anti-authoritarian aura. Once attracted to crypto by this aura, people are much more vulnerable to being seduced into the use of government crypto, with the loss of freedom that implies.

The poem The Spider and the Fly comes to mind.

But although these speculations would have important implications if proven true, in many ways they are beside the point. The point is that governments are turning the screws on anarcho-crypto and moving to create fiat-crypto. These actions are complementary, and bring closer the day in which fiat-crypto will supplant the fiat currency you can hold in your hand. And when that day comes, freedom will be on its death bed, if not dead already.

Remember, you can’t spell “cryptocurrency” without “crypt.”

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