Streetwise Professor

In one of his famous papers, Durability and Monopoly, Coase conjectured that a durable goods monopolist could not exercise market power because he could not credibly commit to reduce output.  Let’s say that the monopolist had a stock of the good equal to X.  He sells the monopolist quantity of .5X.  Once he does that, he has an incentive to sell half of the remaining half.  Then he has an incentive to sell half of the half of the remaining half.  And on and on.  Understanding this, consumers believe that the monopolist will eventually sell all X units, and hence will pay no more than P(X)-which just happens to be the competitive price.  Due to the inability to precommit, the monopolist cannot charge a monopoly price and extract a monopoly rent.  (Stokey and others have proved Coase’s conjecture formally.)

The other day I was speaking to someone in the aluminum business.  He related a conversation with a Russian guy who traded for Rusal-Oleg (“The Living Neanderthal”) Deripaska’s aluminum company.  Since the Crisis, huge stockpiles of aluminum have built up.  These stocks weigh on prices.  Rusal and others are keeping these supplies off the market, but that still doesn’t support prices because consumers realize that they will eventually be released.  Rusal (and others) cannot credibly commit not to sell these ingots in the future.

What a dilemma.

But the Russian Rusal trader had a solution.  He said: “If only there was a way to make all this aluminum radioactive! Then all our problems would be solved!”

And he’s right: once contaminated, the metal would be unsaleable. Credibility problem solved.

Call it the Aluminum Meets Polonium Solution to the Coase Conjecture.

The world petroleum market is undergoing substantial organizational changes, with private oil companies become progressively less vertically integrated and increasingly focused on the upstream.  The latest indicator of this trend is that Chevron is investigating the possibility of divesting its midstream operation.  This follows hard on the heels of the sale of Shell’s midstream and downstream operations in Australia to Vitol (bonus SWP quotes in the linked Reuters article).

This represents an interesting case study in transactions cost/Coasian economics.  In particular, the development of vibrant spot and forward markets for crude oil and petroleum products, and the growth and development of specialized trading firms (like Vitol, Trafigura, and Glencore) have reduced the costs of transacting on the market via the price system relative to the costs of conducting transactions within integrated firms.  Given the existence of thick, liquid, and active spot markets, and the development of logistical expertise by trading firms, assets at a particular stage of the value chain are less subject to holdup by owners of assets at adjacent links of the chain.  For instance, the existence of highly competitive spot markets for crude means that a refinery is  not locked into a small number of upstream suppliers, and thus need not be integrated with a source of crude supply to avoid contractual hazards.  The existence of active product markets has a similar effect.

It is interesting to note that much of the recent disintegration is occurring in smaller markets, and emerging markets, where contracting hazards have historically been particularly acute.  But this is precisely where the trading firms (notably Trafigura and Vitol) have stepped in and acquired assets from oil majors.

This evolution allows the majors to free up capital that they can employ in higher returning-and massively expensive-upstream exploration, development, and production activities.

I said that this was an illustration of transactions cost/Coasian economics in action.  As in most things economic, Adam Smith should really get the credit.  He noted that the division of labor (i.e., specialization) is limited by the extent of the market: Stigler used this insight to explain vertical integration.  The past thirty years have seen the development of a very extensive and vibrant market for oil and refined products (with Marc Rich deserving much of the credit for starting the process).  This spot market facilitates specialization, with the petroleum markets being increasingly characterized by firms that specialize in upstream, midstream, or downstream activities.

Interestingly, this development creates political and regulatory battles, as specialized firms at different segments of the value chain use political and regulatory means to capture a bigger share of the value of a barrel (pace the new battle over US crude oil exports).

Markets in action are a beautiful thing to behold.  Politics not so much.

Bloomberg Business Week has a long profile of Igor Sechin that illustrates perfectly why Putinism is an economic dead end.  Huge, inefficient state companies run by Putin cronies who have no clue about economics or how to create value.  But you’ll say: “Sechin has a PhD in economics!”  Well, a PhD in economics from a Soviet university is best described as an advanced degree in idiocy.

The piece describes Sechin as having an encyclopedic knowledge of Communist Party congresses dating from before the Revolution. So yeah, that definitely comes in handy in maximizing the value of the largest oil reserves of any publicly traded oil company.

Sechin refused to be interviewed for the article (probably a wise idea), but Putin’s Carney, Dmitri Peskov shared this description of Sechin’s penetrating economic philosophy:

“Sechin is a believer in the role of the state in his economic philosophy while at the same time not excluding a free-market approach. And he is firm in pursuing his viewpoint.”

Clear as mud. Problem is, I am sure that  it is an accurate characterization of Sechin’s muddled thinking.

Peskov is actually quite revealing, though almost certainly unintentionally so, in revealing the “thinking” that is propelling Russia into an economic cul de sac:

“For example, in shipbuilding it’s absolutely pointless to carry out privatization,” he says. “You can privatize enterprises, but they won’t be competitive; they will be doomed to failure. So consolidating the assets under the state’s wing is the only way to preserve key sectors of the economy.”

The reason for relying on markets, and privatization, is to determine the industries and firms that are economically viable.  The ones that generate more value than it costs to produce it.  Propping up those that would otherwise fail using state resources-which, never forget, are extracted by force from the citizenry-destroys wealth.   If Russian shipbuilding can’t compete against the Chinese or Koreans, it’s because Russian costs are higher.  Since costs are driven by the value of resources in alternative uses, the losses suffered by Russian shipbuilders in open competition means that the resources the Russian companies use would generate more value if deployed elsewhere.

That is, the success or failure of firms in the market is the mechanism that communicates where resources should be deployed, and where they shouldn’t be.  But that’s not the way statists-and Putinists-think.   Rather than having the market reveal which firms and industries should survive, the Putinists stand things on their head: they decide what industries they think are important, and provide the state resources necessary to ensure their survival. Their determination of the importance of industries is driven largely by history and political economy: the managers (and some workers) of legacy industries importune the state for support, and through personal and political connections largely succeed.  Thus the dead hand of the past rules the present and the future.  Rather than embracing the creative destruction of unviable firms and sectors, Putin embraces the destructive maintenance of legacy companies and industries.

It is a fundamentally uncreative system, because it is bounded by the cramped imaginations and interests of those who benefit from the status quo.  The interests of those who run the state are inherently biased to the status quo.  The more dominant the state becomes, the greater the tendency to stasis, and the greater the resistance to dynamism and change.

This affects even industries that are viable: the Russian oil and gas industries are clearly viable, due to the the capriciousness of nature which has endowed the country with bounteous reserves.  But the statist, Putinist system squanders that bounty.  The statistics don’t lie:

Compared with non-state-owned energy giants such as Exxon, Rosneft is inefficient. Even though Rosneft’s lifting costs — the cost of getting oil out of the ground — are less than a third of Exxon’s, the Russian company’s workforce is less productive.

Net profit per employee at Rosneft was $70,815 in 2012, versus $620,026 for Exxon. Rosneft’s price earnings ratio was 5.4, compared with Exxon’s 13.2 as of Jan. 13. Rosneft shares fell 6.87 percent in 2013, while Exxon shares rose 16.93 percent during the year.

But many find the company’s reserves to be an irresistible allure:

“The main reason to hold Rosneft is the reserves,” Greenwich Capital’s Snykov says.

But the point is that the value of these reserves is radically diminished by putting them under the control of a mullet-headed ex-KGB mouth breather.

The mental world of Sechin and Putin and the like was shaped in the USSR.  They don’t want to recreate it down to every last detail, but they do want to restore its broad outlines.  This is a recipe for stagnation.

And it will only get worse.  There is no mechanism for changing the leadership: indeed, Putin’s priority project in the past several years has been to neuter-or worse-any possible challenge to the incumbents.  So the current gang-and it is a gang, in all essential features-will remain in control for the foreseeable future.  And as they age, they will become even more resistant to change, and more sentimental about the world of their youth.

I still shake my head at those who understood the problems with the existing system, and assumed that Putin would too, and would be forced to institute changes and reforms to prevent the system from lapsing into senescence. How can one be so oblivious to the implications of the interests of the rulers of a system combined with the conservative impulses of aging men? Together, these forces work relentlessly to resist change and reform, and to attempt to maintain the status quo–or even roll back the clock.

Indeed, just this week, one of the few tepid reforms instituted by Medvedev has been rolled back.  The eunuch prime minister announced that state officials will be allowed to serve on the boards of state corporations, reversing a policy instituted a few years ago.  Remember when Medvedev’s original announcement was viewed as a dire defeat for Sechin, in particular?  Hardly.  Medvedev is being kept around to serve as the sacrificial lamb to pay for Putin’s mistakes, and Sechin is the second most powerful man in Russia.

So read the BW profile to understand Russia’s past, present, and future in a single story.  For Igor Sechin is the poster boy for Sovokistan, and Sovokistan is what Putin has created.

After years of wending through to what is to an American an incomprehensible legislative process that involves a three body problem (the trialogue of the Commission, the EU Parliament, and member states), Europe has agreed on its version of the trade execution portion of Frankendodd: Mifid II.  (The clearing and OTC collateralization equivalents are covered under a different law, EMIR.)  A good summary is here.

It contains many of the objectionable features of Frankendodd, namely, a mandate that swaps be executed on SEF-like entities (Organized Trading Facilities, or OTFs, in Euro parlance), and commodity position limits.  The former were pretty much a done deal after the Pittsburgh G20 meeting, the latter a reflection of the global suspicions of “speculation” in commodities, but intensified by European NGO convictions that speculation in food is evil.  (The shade of Adam Smith is shaking his head, noting that his observation about the equivalence between the popular terrors and suspicions against speculation and  the popular terrors and suspicions involving witchcraft is as apt today as it was in 1776.  Except that witchcraft is probably much more socially acceptable these days.)

But the EU has added its own idiosyncratic idiocies to its law.  Two things stand out.

First, the EU has mandated open access to derivatives exchange CCPs, in an attempt to demolish the vertical silo model.  Yes, the mandate is delayed-by as much as 5 years-but “I will wait 5 years to be stupid” hardly seems to be much of  a defense.  As I’ve written for years-a year or two before SWP began, in point of fact-the vertical silo makes economic sense (from a transactions cost economics perspective), and the pro-competition justification for it (namely, to encourage competition in execution) is inconsistent with what economists have known since the 1960s (the “one monopoly rent” theorem).

Second, and even more inanely, Mifid II caps the dark pool share in the trading of any individual equity at 8 percent.  Overlooking the operational difficulties of enforcing a collective constraint on volume across multiple venues, this reflects a suspicion of dark pools (a pejorative name in itself) that is again not grounded in good economics.  In a second best world, where competition between exchanges is imperfect, off-exchange venues (block markets in the old days, internalization, dark pools) can be welfare enhancing.  The fact that many market participants find them the lowest-cost venue to transact in should at least give pause to regulators, and ask them to inquire why this is true, and do the appropriate cost-benefit analysis of the trade-offs involved.  But no, fools rush in.

It strikes me that the  Euros have created a new Pixar character.  Buzz Darkpool: “To stupidity and beyond!” Derivatives trading mandates and position limits are stupid, but they’ve decided to go beyond that.

Meaning that the US can perhaps adopt what I’ve often said is the Russophile motto: “Not the worst!”

I have studied manipulation for going on 25 years now, and one of my pet peeves is the promiscuous and imprecise use of the term.  I often quote a cotton broker, William Clayton, who in Congressional testimony said “The word ‘manipulation’ . . . in its use is so broad as to include any operation of the cotton market that does not suit the gentleman who is speaking at the moment.”

Case in point: a story from a couple days ago about the FBI investigating the trading of interest rate swaps:

Wall Street traders may be manipulating a key derivatives market and front running Fannie Mae and Freddie Mac, hurting the US-owned mortgage giants in the process, according to an FBI intelligence bulletin reviewed by Reuters.

. . . .

Disclosure of the suspected manipulation and front running came in an FBI intelligence bulletin that was distributed last week by the bureau’s field office in Charlotte, North Carolina, to security officers at financial services firms.

Front running  is not manipulation.  Manipulation distorts prices, and causes them to move away from where they should be (at least temporarily, although the effects can be highly persistent).  If anything, front running causes prices to move where they were going to go anyways, but faster.   Front-running is a source of information leakage.

Front running raises the trading costs of the entity that is front run–allegedly Fannie and Freddie in this case.  It results in a redistribution of wealth away from those who are front run to the front runner.  But these effects are notably different from real manipulations, like corners and squeezes, or banging the close/settle, or the release of false information.

In the stock and futures markets, front running by a broker or specialist is a violation of the agency relationship with the client.  In securities markets in the US it is a violation of Section 10(b) of the 1934 Securities Exchange Act.  I don’t know, and don’t have time to research at the moment, whether front running of interest rate swaps falls afoul of any law or regulation.

But it ain’t manipulation, as the term should be construed as conduct that distorts prices.  Although everything that is manipulative is bad, not everything that is bad is manipulative.  But as William Clayton noted 80 odd years ago, that distinction is almost universally overlooked.  Especially now, in media coverage of financial markets.

Scott Irwin has provided his responses to David Kocieniewski.  Read the whole thing.

It’s My Turn

The responses to the recent NYT article by David Kocieniewksi certainly make interesting reading.   I don’t want to belabor points already made so well by others in response to the numerous problems with the article (especially Craig).  Instead, I want to offer some additional points that I think merit further consideration or elaboration:

1. To start, it is important to clarify that the heart of the controversy is the trading activities of a new type of participant in commodity futures markets—financial index investors—during the 2007-2008 commodity price spikes.  The concern was that unprecedented buying pressure from index investors created massive bubbles in commodity futures prices, and these bubbles were transmitted to spot prices through arbitrage linkages between futures and spot prices.  The end result was that commodity prices far exceeded fundamental values during the spikes.  Dwight Sanders and I labeled this the “Masters Hypothesis” in honor (dishonor?) of the central role that hedge fund manager Michael W. Masters played in pushing this line of thinking.   It is crucial to understand the key features of the Masters Hypothesis.  First, it implies that index buying in commodity futures markets created massive price bubbles—20, 30, 50% overvaluations (take your pick).  Second, it implies the price bubbles were long-lived, measured in months if not years.  These features have driven the acrimonious debate about “speculation” in commodity markets that first erupted in 2008.  Without the charge of massive and long-lasting bubbles the intense public policy debate about speculation limits would not have taken place.
2. My position on the validity of the Masters Hypothesis has been consistent from the earliest days of the controversy.   In fact, in an ironic twist, one of my earliest publications on the controversy was an op-ed that Dwight Sanders and I jointly authored—drum roll please—yes, in the NYT in July 2008.   A few quotes:  “Over all, there is limited evidence that anything other than economic fundamentals is driving the recent run-up in commodity prices…The complex interplay of these factors and how they affect commodity prices is often difficult to grasp immediately, and speculators are a convenient scapegoat for the public’s frustration with rising prices. That’s unfortunate because curbing speculation — and hobbling the ability of businesses that rely on futures markets to reduce their risk — is counterproductive.{
3. If my work was somehow tainted by associations with “Wall Street,” then why the editorial endorsement by the Paper of Record in 2008?   It also seems convenient that this little fact was omitted in Mr. Kocieniewksi’s recent article.   I made sure he was aware of my previous NYT op-ed article when he interviewed me. I suspect he was already aware of it given his exhaustive background research on the two of us.
4. The academic research pertaining to the Masters Hypothesis since 2008 has been overwhelmingly negative.  I submit that there is very little credible academic research that is consistent with the basic tenets of the Masters Hypothesis.  That is, index buying is not associated with massive and long-lasting price bubbles in commodity futures markets.  There are no “accidental Hunt Brothers.”   Some unnamed persons (one has the initials GG) like to characterize academic research on the subject as being roughly equally divided between studies that find a positive impact of index positions on prices and studies that fail to find an impact.  This characterization is misleading.  Yes, some studies find evidence of a positive impact but the impacts are invariably small and fleeting or do not line up with the spikes of 2007-2008.  This type of evidence does not support the Masters Hypothesis.  So, when properly interpreted the evidence to date is not divided equally, but instead overwhelmingly rejects the Masters Hypothesis.  And this is what is important from a public policy perspective—small impacts do not provide much justification for costly new regulation of commodity futures markets.
5. My approach to research on the market impact of index investment has always been to go where the data lead.  My co-authors and I have sliced and diced the available data many different ways and we cannot find a smoking gun (a full list can be found here).  As I like to put it, if the Masters Hypothesis is true then the relationship between index positions and commodity futures prices should literally jump off the page.  It does not.  Importantly, there is also limited evidence of bubbles in commodity futures markets independent of whether or not they are associated with index investment.   My co-authors and I could not find evidence that bubbles have become larger or longer-lasting since index investment came on the scene.  If anything they have become smaller and less frequent.
6. If my research on speculation is slanted/biased/tainted then it sure has fooled a whole bunch of academics who serve as journal editors and reviewers.  I have published 13 papers since 2009 dealing directly with the speculation controversy in 9 different academic journals.  And several more are currently under review.  Yes, under review.  This means the articles don’t get published unless they first pass muster with reviewers and then a journal editor.  I don’t know exactly how many editors and reviewers I have dealt with on these papers (several were invited submissions but still subject to peer-review), but it is safe to say that it must be at least 20-30 people.  So, we are to believe that my biased research ran this gauntlet of editors and reviewers and the bias managed to go undetected the entire time?  Give me a break.
7. Just for the record, I want to state in public that I did not even know about the Chicago Mercantile Exchange (CME) donations to the business school here at the University of Illinois when the donations were made.  I only became aware of them in the last year or so through conversations with our development staff.   (OK, I should actually be a little embarrassed by that last statement given my work on commodity futures markets.)   In any event, to draw an inference between the gifts to the business school from the CME and my research really is ridiculous.  I made this clear in my interviews with Mr. Kocieniewksi.
8. I do have a long working relationship with the CME, and before that, with the Chicago Board of Trade (CBOT).  This after all is my research area.   The CME has not funded any of my research since 2007.  However, I did work on a commissioned white paper for the CME in 2005 when the grain contract convergence problems first erupted.  My co-authors (Phil Garcia and Darrel Good) and I were paid a total of $15,000 for the work, which we split equally.   I did accept a position on a new Agricultural Advisory Council that the CME started in late 2013.  The council will meet three times a year at various locations around the country and serve as a sounding board for various issues that come up with regard to agricultural futures markets.  I will receive the same $10,000 annual stipend for this position as the other members of the council.   That is the sum total of my financial ties to the CME.
9. I have had numerous interactions with CME staff in recent years on a host of issues related to commodity futures markets, including, of course speculation.  Sometimes I have reached out to them and sometimes they reach out to me.  Most of the time it is the former and involves pretty obscure questions about things like how the grain delivery process works or help in getting some data.  My research would be far less interesting and useful without this help.  I have the utmost respect for the professionalism of the CME staff and I have never been asked for any type of quid pro quo.  Never.  When I have agreed to participate in presentations, write blogs, etc. I have done so because I believed my research and analysis contributed to better understanding of the issues.
10. My other research on commodity market speculation has been funded from three main sources.  First, the Laurence J. Norton Chair that I hold here at the University of Illinois provides earnings each year that go to support my research program (thank you U of I!).  Second, I have had two grants from the Economic Research Service of the USDA on commodity speculation related topics since 2008.  The first one included work directly on speculation while the second focused on convergence in grain futures contracts. Both have been completed.  Third, Dwight Sanders and I did a commissioned study for the OECD in 2010.  I lost track of the emails with the exact amount we were paid but I know it was only a few thousand dollars.
11. Yieldcast is a product of T-Storm Weather that I helped develop with a former graduate student, Mike Tannura, and Darrel Good.  Yieldcast provides “real-time” U.S. corn and soybean yield forecasts for subscribers.  My main role is to build the statistical models that form the basis of the forecasts and to prepare the weekly forecasts during the growing season.  As indicated in the NYT article I do not have direct contact with Yieldcast subscribers.  I am fortunate that side of the business is ably handled by Mike Tannura through T-Storm.  It is really laughable to think that I have somehow been rewarded through this channel by Wall Street as a payoff for my speculation research.  I know how hard Mike has worked to build the base of subscribers for this product, and if it only were that easy!  I have never seen one email, one voice mail, or absolutely anything that connects my research on speculation to taking out a subscription for Yieldcast.
12. As the NYT article indicated, Dwight Sanders and I did conduct a study in 2012 for Gresham Investment LLC on the market impact of index investment.   Given the political sensitivities surrounding the speculation issue, I gave considerable thought as to whether I ought to pursue the consulting project.  I knew some would see taking any funding from a commodity firm as being a conflict of interest.  But, the project provided access to detailed firm level position data that has previously been unavailable to researchers and this made it worthwhile in my mind.  Sure, I didn’t mind getting paid as well.  The NYT article got it wrong when it said I was paid the full $50,000.  Dwight and I split that equally so I was actually only paid $25,000.  We are working on several interesting papers based on this new dataset.
13. If the charges (really, innuendoes) in the NYT article are baseless, then readers might reasonably ask what does motivate my “defense of Wall Street”?  Good question.   I am indeed a “freshwater” economist that became convinced early in my career that commodity futures markets were an invaluable market institution that improved the discovery of prices and the ability of market participants to shift risks.  While these markets are by no means perfect (as Craig’s work on manipulation highlights), on balance, the good vastly outweighs the bad.  So, when the current speculation controversy erupted in 2008 I was struck by the similarity of the present controversy and those that have buffeted the industry in the past.  Change only the names and dates and not all that much is different.  This has been a reoccurring theme in my own writings since 2008 (including the July 2008 NYT article…could not resist).  And I admit that I made an intentional decision early on to play a more public role in the present controversy.  Three of my professional heroes are Holbrook Working, Tom Hieronymus, and Roger Gray, who spent much of their illustrious academic careers defending futures markets.  All the motivation I needed.

Scott Irwin

University of Illinois

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.

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.

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?