Streetwise Professor

It is common to speak of “oil” as a homogeneous commodity, but it is anything but.  Oil produced from different fields differs on myriad dimensions, including most notably sulphur content and density.  Some oil is light and “sweet” (i.e., has little sulphur).  Some oil is heavy and sour. What’s more, refineries are configured to process particular kinds of oil.  A refinery equipped to process very heavy Venezuelan crude is not suited for processing something light and sweet, like WTI.  Much domestic oil production was in light and sweet varieties like WTI, and many foreign crudes are heavier and sour, so with the decline in US output refineries upgraded to refine the heavier imports.

So when you read stories about the fracking-driven oil boom in the US, you have to keep in mind that it’s not just the amount of oil that’s being produced–which is truly remarkable–but the type.  The oil gushing from the Bakken, Eagle Ford, and the Permian is very light, and sweet.  It has displaced imports of of lighter crudes, like those from Nigeria, but capacity best configured to refine it–especially on the Gulf Coast–is running pretty much full out.  So even though the US is still a net importer of oil, most of that is heavy and sour crude, and we have a surplus of light sweet.

Price signals tell the tale.  Light sweet crudes on the Gulf (like Louisiana Light Sweet) are selling at a substantial discount to lighter foreign crudes, notablyBrent.  These price signals are screaming “export light sweet oil”, but with limited exceptions, under laws passed in the 1970s, such exports are banned.

Those laws never made much sense, but they were never much of an issue as US production continued its inexorable decline until the mid-00s.  But the stunning reversal in this trend now means that the law is a seriously binding constraint. Just as of last week, moves are afoot to relax the restrictions on exports.

Economically, this is a no brainer.  The price gap between domestic and foreign light crudes means that there is a gain from trade to be realized.  But exploiting that gain from trade will not make everyone better off. It will tend to cause the price of crude to increase in the US.  It will also cause the price of refined products to decline overseas, as the cheaper American crude is run through foreign (notably European) refineries.  This would bad news for US refiners, especially those oriented to processing lighter crudes.  These refiners are making money hand over fist (especially compared to their lackluster historical financial performance) refining the new Texas and Dakota production, and exporting large amounts of refined products (notably gasoline), primarily to Europe.  Relaxing the export ban would shrink their margins, by raising the crude price and reducing prices of refined products in foreign markets (as they increase their output using US oil.)

So this promises to be a rough and tumble political fight, as the upstream and downstream segments of the US oil industry slug it out.  No doubt this fight will be heavy on the demagogy, if the early salvo from New Jersey Senator Robert Menendez, who claims that ending the export ban would be a win for “big oil” and would hurt American consumers, is any indication.  The foregoing analysis makes it plain that “big oil” is not a single entity with a single interest, but has factions (refiners, producers) whose interests are at odds.  This is mainly a battle between these factions.  Insofar as US consumers are concerned, Menendez’s claim is unpersuasive.  The marginal barrel of products is being exported, and the price of that barrel is being driven by prices in export markets.  Exporting US crude should reduce foreign prices, and lead to lower exports of products, which should actually put downward pressure on the prices of refined products in the US.

No, this isn’t about helping US consumers.  This is basically a battle over the margins of US refiners, especially the independents.  I have no idea how the politics are going to play out.  Some sort of compromise, no doubt, rather than an outright repeal of the export ban.

I note that Russia uses various means to attempt to reduce exports of crude oil, in order to bolster domestic refining.  Let’s not follow their example.

So what’s the moral of the story?  Perhaps that it is possible to have too much of a good thing, especially if you can’t trade it to someone who values it more.

Robert Gates has set off a mini-frenzy in DC, with leaks from his memoir Duty. Some of the frenzy relates to his slamming of Joe Biden, which led the White House to respond that Joe is a great “statesman.”  Thereby revealing that in the White House Thesaurus, “statesman” is a synonym for “buffoon.”

But the most explosive opinion that Gates expresses is that Obama did not believe in his strategy in Afghanistan in 2009-2010, was deeply suspicious of the military, and devised a military strategy that attempted to straddle two stools.  That Obama chose to surge (but with a sell-by date) for political reasons.  He did this with no conviction about the rightness of the policy, except for domestic political considerations.

It’s not like this was news.  Type in “Afghanistan” in the search bar, and scroll through my posts–including those which discuss Gates specifically–and you’ll see that was the gravamen of my criticism in 2009-2011.  For instance:

In other words: go large, or go home.   (Holt wrote this, note well, in 2003.)   Half measures, like those in Obama’s plan, are likely doomed to failure.   This is especially true inasmuch as Obama’s “other path” (building on Bush’s “other path”) depends heavily on transferring responsibility and control to an Afghan government and army in a period of months; Holt provides chapter and verse on how this is almost certainly an exercise in futility, given Afghan history, and the nature of its society (or more accurately, societies).

As I’ve written before, there are no good options in Afghanistan.   But by far the worst is the “middle path,” especially when it is not sold to the American people honestly.   The “time line” has short-term, domestic political considerations written all over it.

There’s more.

And it’s not just Afghanistan.  As I posted a few days ago, riffing off a WSJ article, this was Obama’s MO in Syria.  He didn’t want to take decisive action, but he didn’t want to make it look like he was abandoning the opposition.  So he took half-measures to support the rebels, and ostentatiously drew a red line–until Assad called his bluff, and left Obama scrambling for a face saving exit, which Putin oh-so-graciously provided.

This is beyond dispiriting.  The office of president carries with it awesome burdens and responsibilities.  Obama shirked those burdens, attempting to avoid politically unpalatable choices by deciding not to decide, or taking middle paths that were doomed to failure.  And doomed to cost thousands of American lives for no purpose in Afghanistan, not to speak of many more thousands of Afghan lives.  And doomed to cost tens-of-thousands of lives in Syria, not to mention the imponderable costs associated with making the United States appear hopeless and feckless in a region where such appearances encourage the wolves. (Not to mention the effect this has on, say, China.)

Obama has not taken his awesome responsibilities seriously, treating them instead as ancillary to his domestic political concerns.  Tens of thousands are paying the price in Southwest Asia.  Who knows what price is to be paid in the future.

Gates has only had the temerity to call attention at this very late date to what was obvious to those that had been paying attention, but which the political class had collectively decided to avert its eyes from.  Note the attacks that are being directed his way.  Such are the wages of lèse-majesté, no matter how deserving the majesté is of the lèse.

Felix Salmon posed several questions for David Kocieniewski about his scurrilous article about Scott Irwin and me.  And-shockingly!-David Koscieniewski refused to answer a single one.  Not. A. Single. One. So if you don’t win that Pulitzer, Dave (and we know that’s what you want, isn’t it?), there’s always the Royal Order of the Weasel ready to be claimed.  You should be a runaway. Emphasis on the Runaway!

Instead of actually answering direct questions posed to him, our dear David doubled down on insinuation, innuendo, and ad hominem.  That’s our boy: go with what you got, eh?

I will respond more fully later, through multiple channels, but a few comments are in order now.

1. Kocieniewski insinuates that I have violated the American Economic Association disclosure guidelines.  Fail, Dave. Pure fail.  The AEA guidelines require disclosure of any support (financial, in the form of data, etc.) on submissions to peer reviewed publications.  I have not submitted any work to a peer reviewed publication that has been supported by any party with an interest in the speculation debate.  I told you this during our interview.  So what is it?  Is David ignorant, stupid, or dishonest?  I can’t answer that.  Those are all observationally equivalent.
2. I responded to all FOIA requests, forwarded to me via the University of Houston’s general counsel’s office, in a timely fashion.  Any suggestion to the contrary is false.
3. My work for “one of the largest commodity exchanges” had nothing to do with speculation, and occurred after my positions on speculation were public.  Years afterwards.  Years.  As in plural.
4. My work for “one of the largest commodity trading houses, Trafigura” occurred years after my positions on speculation were public.  Again, years plural.  I had no contractual relationship with Trafigura until September, 2013.  Um, I testified before Congress on speculation-testimony which gives dear David the faints-in July 2008.  You know, five freaking years before. And that’s not even the best part! Trafigura is not a speculator.  It is a hedger.  It routinely sells massive quantities of futures to hedge its massive quantities of oil transactions.  But-correct me if I’m wrong (but I’m not)-Kocieniewski’s article focuses on how speculators drive prices up by buying futures.  Hedgers. Speculators. Buy. Sell.  Up. Down. Whatever, eh? It’s all the same to our Dave. So again: David Kocieniewski: ignoramus, idiot, or liar? I say again: Observationally equivalent.
5. Kocieniewski explicity refers to  the fact that “this debate [over speculation] began more than five years ago.”  Excuse me, but I wrote my first blog post on this in August, 2006.  I know you are math challenged, David (I read your piece on Goldman’s warehouse operations), but using the fingers on your left and right hands, you should be able to cipher that that works out to about 7 years (and about four months, but hey, let’s round down!).  So I weighed in on this before “the debate began.”  Just call me prescient.  But here’s the point: how did my (non-existent) consulting work on speculation years later affect my opinions?  Do you have issues with the concept that the cause must precede the effect?

More later.  I’m just getting warmed up (spits into palms, old school style).

Thanks again, Felix.  The cat caught the weasel.

David Kocieniewski of the NYT is answering questions this week about his deep thoughts on “issues ranging from the role of Goldman Sachs in the global aluminum market to academics who have reaped financial benefits while defending some of the largest players in the commodities business.”  (Bonus opportunity! Gretchen Morgenson is teaming with DK to answer!)

Have at it, folks. I am sure you have inquiring minds that want to know the answer to some questions about Kocieniewski’s journalism.

Update: Please leave a comment to this post if you ask a question and it is not answered.  Also let me know what your (unanswered) question was.

The Wall Street Journal reports that the Obama administration has put any additions to the Magnitsky List on hold.  The administration has always disliked the list, because it didn’t want it to interfere with its fabulous Reset.  It resisted the list for as long as it could, and then grudgingly implemented Congress’s directive.

The desire to appease Russia is disturbing.  But I could see a realpolitik justification for slow walking it now.  Putin and the Russian elite hate the list.  Hate, hate, hate.  We could presumably extract something tangible, something highly advantageous to US interests.

The sad thing is that the administration thinks it has:

Why veto the expanded Magnitsky list? Russia’s human-rights record hasn’t miraculously improved. In his interview with Itar-Tass, Mr. Rhodes suggested the answer. He praised Moscow’s role in striking a deal with Syria’s Bashar Assad to give up his chemical weapons stockpile in return for removing any Western threat to attack his military forces, who are now liberated to try to finish off the rebels. Mr. Rhodes also noted Russian support for nuclear talks with Iran.

For crying out loud.  Seriously.  It got nothing from Putin.  Putin has played us like a drum on Syria, and is content to watch us give away the store to Iran.

Obama was desperate to avoid having to cash the check his big mouth wrote (“redline”) in Syria.  Putin bailed out Obama, and has achieved all of his objectives in Syria.  The chemical weapons deal leaves Assad in power, and effectively makes the United States his partner.  So Syrians won’t be killed by chemical weapons.  Yay! They are just continuing to die, at a rate of about 150 a day, felled by barrel bombs, bullets, artillery bombardments and the blades of ISIS head choppers.  The country has descended into a hell of warlordism akin to China in the ’20s and ’30s, with the government holding sway in a rump state near the coast and a horrifying collection of Islamist groups (with ISIS being the most horrific) controlling patches of territory in the north and east.  The war is spreading into Lebanon, which is seeing a major car bombing a week.  The country is a running sore, and will continue to be for years to come.  No one has the strength to prevail, so things will be stalemated for the foreseeable future.

And Putin doesn’t care.  Every Chechen that goes to Syria on jihad is one less that he has to deal with in the Caucasus.  And every one that is killed is just a bonus.  His client survives.  The United States looks pitiful.

All in all, a big win for Putin, and a loss for the US.  We didn’t get anything on Syria for forbearing on Magnitsky: we gave Putin everything he wanted.

And on Iran, Obama doesn’t need Putin’s help.  Obama is evidently willing to make any concession to get a deal with the mullahs.

In sum: Obama got bupkus for caving on the Magnitsky List.

Back to Syria.  The WSJ ran a long story detailing the sorry, sorry tale of American policy.  Read the whole thing, but it is readily summarized.  The administration wanted nothing to do with Syria, but didn’t have the stones to says publicly.  It gave out aid to the rebels in penny packets to appease frantic allies appealing for American support.  The result: the aforementioned stalemate in which the most radical and bloodthirsty survive. I cannot think of a comparable example of American fecklessness in the 226 years of the history of the Republic.

Obama’s reluctance to get involved in Syria is understandable.  There was no easy choice.  But the administration made the worst choice of the lousy ones available.  A robust intervention on behalf of the rebels would have probably resulted in their victory, with an outcome similar to the final scenes of Lawrence of Arabia, with squabbling rebels and tribes making a hash of things in Damascus.  But that would have been better than the current and future situation, with Islamist warlords ranging from the psychotic to the extremely psychotic face off against one another and the remnants of a blood-soaked Baathist regime.

By trying not to choose, Obama made a choice.  Millions of Syrians-and Lebanese-are paying the price.  Such are the wages of fecklessness.

To get back to the substance of the speculation debate, let me reprise something I’ve discussed for years to illustrate the vapidity of many of the arguments about speculation.  I’ve been making this point for more than 6 years: it was a focus of a presentation I made at a conference in Champuloc, Italy in January 2008.

It relates to the use of position data to attempt to identify the price impact of speculation.  You know the drill.  Speculators are huge net long, so they must be driving up prices, right?  We’ve seen that argument repeated over and over and over again.

But here’s the thing.  For every long, there’s a short.  So how do you know the net long speculators are driving prices up?  Why aren’t the net short hedgers driving down prices?

Here’s the example I keep coming back to that illustrates the stupidity of using net speculative positions to claim that prices are too high or too low.

Back in the 1990s and early 00s, gold prices were low.  Very low.  $300 and below.  Back then, the hue and cry was that prices were artificially low because . . . wait for it . . . producers were massively short because of hedging programs.

Well, if producers were massively short that means that speculators were massively long.  So if speculators drive prices, why weren’t gold prices stratospherically high in the late-90s early-00s?  After all, supposedly in 2008, and the last couple of years, the massive long speculative positions were inflating prices.  Why didn’t the massive long speculative gold positions a decade ago inflate gold prices?  Flipping things: If short commercial positions were depressing gold prices a decade ago, why didn’t they depress oil prices in 2007-2008, and over the last couple of years?

Hence the danger of superficially examining net positions and claiming that one side of the market is inflating (or depressing) prices: an equally legitimate argument is that the other side of the argument is depressing (or inflating) prices.

But the point is that neither argument is legitimate: both are equally illegitimate.  Derivatives positions net out to zero.  Derivatives are in zero net supply.  Looking at one side of the market, and ignoring the other, makes no sense.

Basic finance theory says that if anything, net positions should predict risk premia, and price trends.  In a simple Keynes-Kaldor model, if speculators are net long, prices should drift up.  Or not: if the price of the commodity in question is uncorrelated with the pricing kernel and markets are well-integrated, prices won’t drift at all even if speculators have a net position.

But the basic point is that in standard finance speculation and hedging affect risk premia, not price levels.  The relationship between positions and risk premia depends the integration between the commodity market of interest and the broader financial markets, and the covariation between the commodity price and the pricing kernel.  If the “financialization” of commodities means anything, it means that commodity markets have become more closely integrated with the broader financial markets, and that this has impacted risk premia.  The evidence of Hamilton and Wu (and UH PhD student Bingxin Li) points exactly in this direction: risk premia in oil plunged to near zero in the mid-2000s, when index trading increased dramatically.  Any impact on the level of prices overall is due to indirect effects of risk premia: risk premia affect the costs of hedging which affect output and storage and consumption, which affect prices.  But whatever those knock-on effects are, whether prices rise or fall, they are likely efficiency enhancing: they reflect the consequences of a more efficient allocation of risk.  (By the way, I explained this to Chilton years ago.  Talk about pearls before swine.)  (I say “likely” because of the usual caveats about the difficulty of making welfare comparisons in incomplete markets.)

So word to the wise.  If you want to make a persuasive argument about the impact of speculation (or hedging) on the level of spot prices (rather than on the difference between spot and futures prices), don’t say anything about net derivatives positions.  Because the market as a whole has no net position.

Comparing the gold and oil cases has reminded me of this Escher drawing.  Who is drawing whom?  Which hand is the long?  Which hand is the short?

Now for something completely different-at least different than the subject of conversation here the last several days.  Not anything completely different at all with regards to Putin and Russia.

After a day of silence, and a New Years Day speech that omitted any reference to the Volgograd bombings when delivered in the Far East of Russia, Putin made a hasty trip to the city.  His delay was not quite as long as Stalin’s after the Germans launched Barbarossa, but it was weird that the US government made a statement before he did.

While on his visit, he announced that he would “annihilate” the terrorists.

He has been making the same threat since 1999.  One thing missing this time was a threat to “drown them in the shithouse.”  I guess he’s trying to keep it classy.  Blunt, but classy.  Or less vulgar, anyways.

The terrorist threat in Russia is less than earlier in Putin’s reign: nothing like Beslan or the Dubrovka Theater has occurred in recent years.  But Dagestan and to some degree Ingushetia remain running sores with chronic bombing and assassinations, and periodically this spills over into Russia proper, with Volgograd being a target three times in the last months.   Putin has threatened to annihilate.  He hasn’t.  The problem lives on.

The Russian response is predictable, and unlikely to be effective.  Indeed, it is likely to be counterproductive.  Further crackdowns in the Caucasus, including threats to carry out collective punishment on families.  (Note the collection of DNA of Muslims, ostensibly for the purpose of identifying suicide bombers, but also very useful in matching bombers back to their families.)  This has worked so well, hasn’t it?

In Volgograd, thousands of police swarmed over the city, focusing their attentions on migrants from the Caucasus and the ‘Stans.  Such an indiscriminate approach will only stoke resentments.  Moreover, it is particularly off-point because of the involvement of ethnic Russian converts in the last two bus bombings (one as the bomb maker, the other apparent as the bomber.)

Any government/administration/regime becomes stale and repetitive when in power for too long.  It fashions its hammers, and sees everything as nails.  Putin keeps pounding away, on economic policy, on terrorism.  For all his pounding, the economy is stagnating, and his efforts to eliminate terrorism are stagnating too.

Or, to return to an old metaphor, Putin’s Hamster Wheel keeps spinning, on terrorism as well as the economy.  Given that there is no credible mechanism for replacement of a stagnating-and failing-administration, the wheel will spin on and on.  And that means that bombs will continue to explode in Russia.

It’s New Years Eve, and perhaps a little game is in order to get ready for the turn of the calendar in about 3 hours.  Let’s play connect the dots.

• In July, David Kocieniewski writes a big-totally incoherent, but big-article in the New York Times on the aluminum warehouse controversy involving Goldman Sachs, JP Morgan and others. The article focuses on Goldman’s Metro Warehouse in Detroit.
• On 1 August, 2013, the law firm Lovell, Stewart, Halebian and Jacobson LLC files suit against Goldman Sachs for violating Sections 1 and 2 of the Sherman Antitrust Act in its operation of the Metro Warehouse in Detroit.
• The Lovell, Stewart complaint cites the Kocieniewski article.  Numerous news articles state that Lovell, Stewart is the firm that filed the complaint.
• Lovell, Stewart is one of the leading plaintiffs’ law firms in the country.  It is indisputably the leader in manipulation class action lawsuits filed under the Commodity Exchange Act.  LSHJLLP has been the lead counsel or co-lead counsel in virtually every major manipulation lawsuit in the US, and has won hundreds of millions of dollars in settlements in such cases.  Its web page lists numerous past and current commodity manipulation cases, as well as other cases filed against financial institutions.
• I have worked as an expert in numerous cases for Lovell, Stewart (and its predecessor law firms) going back to 1994.  Many of these are manipulation cases.
• David Kocieniewski knew, before writing his hatchet job, that I had worked for Lovell, Stewart.
• Kocieniewski did not ask me about my work for Lovell, Stewart.  He did ask me about my work for trading firms and banks.  I did mention, on my own initiative, that I had been adverse to such firms in some of my work.
• Kocieniewski mentioned my work for trading firms and banks, but did not mention my work for Lovell, Stewart.

So there are the dots.  Help me connect them.

Seriously.  I would like you to tell me in the comments what you see when you connect those 8 dots: what inferences do you draw?  I know what I see, but I’d like to crowd-source this.  Maybe you all see something different.  Thanks in advance for your help, and have fun playing!

And to all my readers: have a Happy and Healthy New Year.  Your interest and continued support is what makes this a rewarding endeavor.  Cheers!

I have always admired Thomas Sowell greatly.  I read his Knowledge and Decisions during my first year of graduate school, and it had a profound effect on my thinking and way of looking at the world.  I also read most of his work on discrimination, and found his book on Marxism to be a classic in intellectual history: a truly fair and penetrating appraisal of Marx, and Marxists (the two things aren’t the same, which is one of the points of the book).  Conflict of Visions is a classic: there is no better book for understanding the intellectual roots behind the political divisions in the West.  Yes, Sowell has strong views, but he is like John Stuart Mill in his ability to characterize his opponent’s views fairly and objectively.

Sowell has also been the subject of some the the ugliest personal attacks directed against any scholar over the last 40 years.  For the progressive left, to be black and on the right is to be an anathema who must be destroyed.  Yet he has handled the vicious attacks on him with equanimity and humor, and has never been cowed.

It is therefore beyond humbling to have Dr. Sowell come to my defense, and take on the New York Times “hit piece.”

All I can say is that I am honored beyond words.  Thank you, Dr. Sowell.

The NYT hatchet job has elicited quite a bit of discussion on the web, and on Twitter.  Several major bloggers have saddled up and ridden to the defense of Scott Irwin and I.  Pride of place goes to Felix Salmon, who wrote a long and thoughtful post at Reuters. This is particularly gratifying, because Felix and I have had our differences in the past (e.g., over the empty creditor problem) but I have always found him to be extraordinarily fair and open minded.  Felix wrote his piece before I posted mine, meaning that his was based on publicly available information (including his past interactions with me) which confers a considerable degree of objectivity: most importantly, it shows that information that the NYT ignored or distorted was there in plain sight.  Felix is like a judge entering a summary judgment motion against the NYT, with prejudice, making it unnecessary for the defense even to present its case.  I think it’s correct to say Felix’s verdict is pretty brutal, but eminently fair.

Other members of the cavalry include Jeff Carter’s Points and Figures blog (who was the first to arrive on the scene), Peter Klein at Organizations and Markets, Sonic Charm (or is it Crimsonic?) at Rhymes With Cars and Girls (who always cracks me up, whatever he’s calling himself these days), and John Hinderaker at Powerline. Peter and John point out the double standard under which academics who work with private business are often accused of being corrupt, whereas the motives of those who accept money from the government are almost never questioned.   Peter focuses on the Fed, John on climate research.  The common conclusion of all is that the NYT piece was a deeply biased smear written in bad faith with ulterior motives.  Crimsonic calls for a retraction.  Interesting idea.

Felix’s post and mine also unleashed a torrent of tweets.

Thanks to all.  I’m sure this isn’t over yet.  So keep your horses watered and your powder dry.