Streetwise Professor

February 27, 2018

Well Played Igor, Well Played–But Not Well Paid, Collateral Notwithstanding

Filed under: Economics,Energy,Politics,Russia — The Profesor 2 @ 7:33 pm

I recall being quite amused at those who panicked over Rosneft investing large amounts of money in Venezuela’s cratering national oil company PDVSA, thinking that it gave the Russians a vital foothold in America’s back yard. They’ve outsmarted us again! said this lot.

My thought was the exact opposite: they were utter fools for plunging billions into a country and a company run by socialist lunatics (excuse me, “Bolivarian” lunatics), and figured that it would not go well:

Rosneft lent large money to a deadbeat. It’s not going to get paid back so it is seizing assets, and will end up losing money. Playing repo man is hardly the road to riches. It just mitigates the losses from making a bad loan, and it is the bad loan that is the real story here.

But it gets better!  Repo Man Igor outsmarted himself by getting Rosneft’s collateral in the US in the form of a lien on Citgo’s US refineries.  But given sanctions, the probability that he will be able to repossess them can be rounded up to zero.

Now oil trading firm Mercuria senses weakness, and is involved in an effort to take the collateral off Igors hands:

Commodity trader Mercuria has asked the US Treasury for permission to buy out a $1.5bn loan between Russia’s Rosneft and Venezuela’s state oil company, which had raised the prospect of Moscow taking control of refineries on US soil.

. . . .

“Rosneft would have faced an uphill struggle to get approval to exercise a stake in Citgo so this avoids a potential diplomatic strain between the US and Russia if this deal goes ahead,” said Mr Mallinson.

“If this signals that Russia is looking to reduce its loans to Venezuela rather than offering more support that leaves Caracas with nowhere obvious to turn.”

Rosneft has said it is unwilling to extend further loans to PDVSA, many of which have been secured against crude supplies, as the country’s economic crisis starts to hit oil output from the country. The Russian company is seen as keen to reduce its exposure to Venezuela as oil output falls, with the country seen as precariously close to defaulting on its debts.

Well played, Igor. Bravo! The move was so brilliant, that now he’s desperate–sorry, “keen” doesn’t quite cover it–to get out.

Rosneft’s bargaining leverage is pretty much nonexistent.  PDVSA is circling the drain, with a collapse in oil output and revenues.  It can’t pay back the Russians. The collateral is off limits to them.  So Rosneft faces a choice between a big fat zero, and whatever Mercuria et al deign offer it. Perhaps Rosneft can scare up other bidders, but the company holds a very weak hand, and will be lucky to walk away with kopecs on the ruble.

Keep this in mind whenever anyone tries to convince you of Putin’s or Sechin’s strategic brilliance. In this case, they have brilliantly succeeded in flushing several billion into the Venezuelan cesspool, with no real recourse or exit strategy.

They can take some comfort, though, having lent Venezuela a mere $5 billion. The even more brilliant Chinese lent 11 times as much. So there’s that, Igor!

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January 2, 2018

Buyer Beware: Bart Does Crypto

Filed under: Commodities,Derivatives,Economics,Energy,Regulation — The Professor @ 8:08 pm

Back in the day, Bart Chilton was my #2 whipping boy at the CFTC (after Gary Gensler AKA GiGi). Bart took umbrage (via email) at some of my posts, notably this one. Snort.

Bart was the comedian in that dynamic duo. He coined (alert: pun foreshadowing!) such memorable phrases as “cheetah” to criticize high frequency traders (cheetah-fast cheater–get it? Har!) and “massive passives” to snark at index funds and ETFs. Apparently Goldilocks could never find a trading entity whose speed was just right: they were either too fast or too slow. He blamed cheetahs for causing the Flash Crash, among other sins, and knocked the massive passives for speculating excessively and distorting prices.

But then Bart left the CFTC, and proceeded to sell out. He took a job flacking for HFT firms. And now he is lending his name (I won’t say reputation) to an endeavor to create a new massive passive. This gives new meaning to the phrase sell out.

Bart’s massive passive initiative hitches a ride on the crypto craze, which makes it all the more dubious. It is called “OilCoin.” This endeavor will issue said coins, and invest the proceeds in “reserve barrels” of oil. Indeed, the more you examine it, the more dubious it looks.

In some ways this is very much like an ETF. Although OilCoin’s backers say it will be “regulatory compliant,” but even though it resembles an ETF in many ways, it will not have to meet (nor will it meet, based on my reading of its materials) listing requirements for ETFs. Furthermore, one of the main selling points emphasized by the backers is its alleged tax advantages over standard ETFs. So despite the other argle bargle in the OilCon–excuse me, OilCoin–White Paper, it’s primarily a regulatory and tax arb.

Not that there’s necessarily anything wrong with that, just that it’s a bit rich that the former stalwart advocate of harsher regulation of passive commodity investment vehicles is part of the “team” launching this effort.

I should also note some differences that make it worse than a standard ETF, and worse than other pooled investment vehicles like closed end funds. Most notably, ETFs have an issue and redemption mechanism that ensures that the ETF market price tracks the value of the assets it holds. If an ETF’s price exceeds the value of the assets the ETF holds, an “Authorized Participant” can buy a basket of assets that mirrors what the ETF holds, deliver them to the ETF, and receive ETF shares in return. If an ETF’s price is below the market value of the assets, the AP can buy the ETF shares on the market, tender them to the ETF, and receive an equivalent share of the assets that the ETF holds. This mechanism ties the ETF market price to the market prices of its assets.

The OilCoin will not have any such tight tie to the assets its operators invest in. Insofar as investment policy is concerned:

In addition to investing in oil futures, the assets supporting OilCoin will also be invested in physical oil and interests in oil producing properties in various jurisdictions in order to hold a diversified pool of assets and avoid the risk of holding a single, concentrated position in exchange traded futures contracts. As a result, OilCoin’s investment returns will approximate but not precisely track the price movement of a spot barrel of crude oil.

I note the potential illiquidity in “physical oil” and in particular “interests in oil producing properties.” It will almost certainly be very difficult to value this portfolio. And although the White Paper suggests a one barrel of oil to one OilCoin ratio, it is not at all clear how “interests in oil producing properties” will figure into that calculation. A barrel of oil in the ground is a totally different thing, with a totally different value, than a barrel of oil in storage above ground, or an oil futures contract that is a claim on oil in store. This actually has more of a private equity feel than an ETF feel to it. Moreover, even above ground barrels can differ dramatically in price based on quality and location.

Given the illiquidity and heterogeneity of the “oil” that backs OilCoin, it is not surprising that the mechanism to keep the price of the OilCoin in line with “the” price of “oil” is rather, er, elastic, especially in comparison to a standard ETF: the motto of OilCoin should be “Trust Us!” (Pretty funny for crypto, no?) (Hopefully it won’t end up like this, but methinks it might.)

Here’s what the White Paper says about the mechanism (which is a generous way of characterizing it):

OilCoin’s investment returns will approximate but not precisely track the price movement of a spot barrel of crude oil.

. . . .

In order to ensure measurable intrinsic value and price stability, each OilCoin will maintain an approximate one-to-one ratio with a single reserve barrel of oil. [Note that a “reserve barrel of oil” is not a barrel of any particular type of oil at any particular location.] This equilibrium will be achieved through management of the oil reserves and the number of OilCoin in circulation.

As demand for OilCoin causes the price of a single OilCoin to rise above the spot price of a barrel of oil on global markets [what barrel? WTI? Brent? Mayan? Whatever they feel like on a particular day?], additional OilCoin may be issued in private or open market transactions and the proceeds will be invested in additional oil reserves. Similarly, if the price of an OilCoin falls below the price of a barrel of oil, oil reserves may be liquidated with the proceeds used to purchase OilCoin privately or in the open market. This method of issuing or repurchasing OilCoin and the corresponding investment in or liquidation of oil reserves will provide stability to the market price of OilCoin relative to the spot price of a barrel of crude oil and will provide verifiable assurances that the value of oil reserves will approximate the aggregate value of all issued OilCoin.

OilCoin’s price stability program will be managed by the OilCoin management team with a view to supporting the liquidity and functional operation of the OilCoin marketplace and to maintaining an approximate but not precise correlation between the price of a single OilCoin and the spot price of a single barrel of oil [What type of barrel? Where? For delivery when?]. While maintaining price stability of digital currencies through algorithmic purchase and sale may be appropriate in certain circumstances, and while it is possible as a technical matter to link such an algorithm to a programmed purchase and sale of oil assets, such an approach would be likely to result in (i) the decoupling of the number of OilCoin in circulation from an approximately equivalent number of reserve barrels of oil, and (ii) a highly volatile stock of oil reserve assets adding unnecessary and avoidable transaction costs which would reduce the value of OilCoin’s supporting oil reserve assets. Accordingly, it is expected that purchases and sales of OilCoin and oil reserves to support price stability will be made on a periodic basis [Monthly? Annually? When the spirit moves them?] as the price of OilCoin and the price of a single barrel of oil [Again. What type of barrel? Where? For delivery when?] diverge by more than a specified margin [Specified where? Surely not in this White Paper.]

[Emphasis added.]

Note the huge discretion granted the managers. (“May be issued.” “May be liquidated.” Whenever they fell like it, apparently, as long as there is a vague connection between their actions and “the spot price of crude oil “–and remember there is no such thing as “the” spot price) A much less precise mechanism than in the standard ETF. Also note the shell game aspect here. This refers to “the” price of “a barrel of oil,” but then talks about “diversified holdings” of oil. The document goes back and forth between referring about “reserve barrels” and “barrels of oil on the global market.”

Note further that there is no third party mechanism akin to an Authorized Party that can arb the underlying assets against the OilCoin to make sure that it tracks the price of any particular barrel of oil, or even a portfolio of oil holdings. This means that OilCoin is really more like a closed end fund, but one  that is not subject to the same kind of regulation as closed end funds, and which can apparently invest in things other than securities (e.g., interests in oil producing properties), some of which may be quite illiquid and hard to value and trade. One other crucial difference from a closed end fund is that OilCoin states it may issue new coins, whereas closed end funds typically cannot have secondary offerings of common shares.

Closed end funds can trade at substantial premiums and discounts to the underlying NAV, and I would wager that OilCoin will as well. Relating to the secondary issue point, unlike a closed end fund, OilCoin can issue new coins if they are at a premium–or if the managers feel like it. Again, the amount of discretion possessed by OilCoin’s managers is substantially greater than for a closed end fund or ETF (or an open ended fund for that matter). (There is also no indication that the managers will be precluded from investing the funds in their own “oil producing interests.” That potential for self-dealing is very concerning.)

There is also no indication in the White Paper as to just what an OilCoin gives a claim on, or who has the control rights over the assets, and how these control rights can be obtained. My reading of the White Paper does not find any disclosure, implicit or explicit, that OilCoin owners have any claim on the assets, or that someone could buy 50 percent plus one of the OilCoins, boot the existing management, and get control of the operation of the investments, or any mechanism that would allow acquisition of a controlling interest, and liquidation of the thing’s assets. (I say “thing” because what legal form it takes is not stated in the White Paper.)  These are other differences from a closed end fund or ETF–and mean that OilCoin is not subject to the typical mechanisms that protect investors from the depredations of promoters and managers.

A lot of crypto is all about separating fools from their money. OilCoin certainly has that potential. What is even more insidious about it is that the backers state that it is a different kind of crypto currency because it is backed by something: in the words of the White Paper, OilCoin is “supported” by the “substantial intrinsic value of assets” it holds. The only problem is that there is no indication whatsoever that the holder of the cryptocurrency can actually get their hands on what backs it. The “support” is more chimerical than real.

So my basic take away from this is that OilCoin is a venture that allows the managers to use the issue of cryptocurrency to fund totally unconstrained speculations in oil subject to virtually none of the investor protections extended to the purchasers of securities in corporations, investors of closed end funds, or buyers of ETFs. All sickeningly ironic given the very public participation of a guy who inveighed against speculation in oil and the need for strict regulation of those investing other people’s money.

My suggestion is that if you are really hot for an ICO backed by a blonde, buy whatever Paris Hilton is touting these days, and avoid BartCoin like the plague.




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December 4, 2017

Bitcoin Futures: What? Me Worry?

Filed under: Clearing,Commodities,Derivatives,Economics,Energy,Exchanges,Regulation — The Professor @ 9:53 pm

The biggest news in derivatives world is the impending launch of Bitcoin futures, first by CBOE, then shortly thereafter by CME.

Especially given the virtually free entry into cryptocurrencies I find it virtually impossible to justify the stratospheric price, and how the price has rocketed over the past year. This is especially true given that if cryptocurrencies do indeed begin to erode in a serious way the demand for fiat currencies (and therefore cause inflation in fiat currency terms) central banks and governments will (a) find ways to restrict their use, and (b) introduce their own substitutes. The operational and governance aspects of some cryptocurrencies are also nightmarish, as is their real resource cost (at least for proof-of-work cryptocurrencies like Bitcoin). The slow transaction times and relatively high transaction fees of Bitcoin mean that it sucks as a medium of exchange, especially for retail-sized transactions. And its price volatility relative to fiat currencies–which also means that its price volatility denominated in goods and services is also huge–undermines its utility as a store of value: that utility is based on the ability to convert the putative store into a relatively stable bundle of goods.

So I can find all sorts of reasons for a bearish case, and no plausible one for a bullish case even at substantially lower prices.

If I’m right, BTC is ripe for shorting. Traditional means of shorting (borrowing and selling) are extremely costly, if they are possible at all. As has been demonstrated theoretically and empirically in the academic literature, costly shorting can allow an asset’s price to remain excessively high for an extended period. This could be one thing that supports Bitcoin’s current price.

Thus, the creation of futures contracts that will make it easier to short–and make the cost of shorting effectively the same as the cost of buying–should be bearish for Bitcoin. Which is why I said this in Bloomberg today:

“The futures reduce the frictions of going short more than they do of going long, so it’s probably net bearish,” said Craig Pirrong, a business professor at the University of Houston. “Having this instrument that makes it easier to short might keep the bitcoin price a little closer to reality.”

Perhaps as an indication of how untethered from reality Bitcoin has become, the CME’s announcement of Bitcoin futures actually caused the price to spike. LOL.

Yes, shorting will be risky. But buying is risky too. So although I don’t expect hedge funds or others to jump in with both feet, I would anticipate that the balance of smart money will be on the short side, and this will put downward pressure on the price.

Concerns have been expressed about the systemic risk posed by clearing BTC futures. Most notably, Thomas Petterfy sat by the campfire, put a flashlight under his chin, and spun this horror story:

“If the Chicago Mercantile Exchange or any other clearing organization clears a cryptocurrency together with other products, then a large cryptocurrency price move that destabilizes members that clear cryptocurrencies will destabilize the clearing organization itself and its ability to satisfy its fundamental obligation to pay the winners and collect from the losers on the other products in the same clearing pool.”

Petterfy has expressed worries about weaker FCMs in particular:

“The weaker clearing members charge the least. They don’t have much money to lose anyway. For this reason, most bitcoin interest will accumulate on the books of weaker clearing members who will all fail in a large move,”

He has recommended clearing crypto separately from other instruments.

These concerns are overblown. In terms of protecting CCPs and FCMs, a clearinghouse like CME (which operates its own clearinghouse) or the OCC (which will clear CBOE’s contract) can set initial margins commensurate with the risk: the greater volatility, the greater the margin. Given the huge volatility, it is likely that Bitcoin margins will be ~5 times as large as for, say, oil or S&Ps. Bitcoin can be margined in a way that poses the same of loss to the clearinghouses and FCMs as any other product.

Now, I tell campfire horror stories too, and one of my staples over the years is how the real systemic risk in clearing arises from financing large cash flows to make variation margin payments. Here the main issue is scale. At least at the outset, Bitcoin futures open interest is likely to be relatively small compared to more mature instruments, meaning that this source of systemic risk is likely to be small for some time–even big price moves are unlikely to cause big variation margin cash flows. If the market gets big enough, let’s talk.

As for putting Bitcoin in its own clearing ghetto, that is a bad idea especially given the lack of correlation/dependence between Bitcoin prices and the prices of other things that are cleared. Clearing diversified portfolios makes it possible to achieve a given risk of CPP default with a lower level of capital (e.g., default fund contributions, CCP skin-in-the-game).

Right now I’d worry more about big markets, especially those that are likely to exhibit strong dependence in a stress scenario. Consider what would happen to oil, stock, bond, and gold prices if war broke out between Iran and Saudi Arabia–not an implausible situation. They would all move a lot, and exhibit a strong dependency. Oil prices would spike, stock prices would tank, and Treasury prices would probably jump (at least in the short run) due to a flight to safety. That kind of scenario (or other plausible ones) scares me a helluva lot more than a spike or crash in Bitcoin futures does while the market is relatively modest in size.

Where I do believe there is a serious issue with these contracts is the design. CME and CBOE are going with cash settlement. Moreover, the CME contract will be based on prices from several exchanges, but notably exclude the supposedly most liquid one. The cash settlement mechanism is only as good as the liquidity of the underlying markets used to determine the settlement price. Bang-the-settlement type manipulations are a major concern, especially when the underlying markets are illiquid: relatively small volumes of purchases or sales could move the price around substantially. (There is some academic research by John Griffen that provides evidence that the settlement mechanism of the VIX contracts are subject to this kind of manipulation.)  The Bitcoin cash markets are immature, and hardly seem the epitome of robustness. Behemoth futures contracts could be standing on spindly cash market legs.

This also makes me wonder about the CFTC’s line of sight into the Bitcoin exchanges. Will they really be able to monitor these exchanges effectively? Will CME and CBOE be able to?

(I have thought that the CFTC’s willingness to approve the futures contracts could be attributable to its belief that the existence of these contracts would strengthen the CFTC’s ability to assert authority over Bitcoin cash exchanges.)

What will be the outcome of the competition between the two Chicago exchanges? As I’ve written before, liquidity is king. Further, liquidity is maximized if trading takes place on a single platform. This means that trading activity tends to tip to a single exchange (if the exchanges are not required to respect price priority across markets). Competition in these contracts is of the winner-take-all variety. And if I had to bet on a winner, it would be CME, but that’s not guaranteed.

Given the intense interest in Bitcoin, and cryptocurrencies generally, it was inevitable that an exchange or two or three would list futures on it. Yes, the contracts are risky, but risk is actually what makes something attractive for an exchange to trade, and exchanges (and the CCPs that clear for them) have a lot of experience managing default risks. The market is unlikely to be big enough (at least for some time) to pose systemic risk, and it’s likely that trading Bitcoin on established exchanges in a way that makes it easier to short could well tame its wildness to a considerable degree.

All meaning that I’m not at all fussed about the introduction of Bitcoin futures, and as an academic matter, will observe how the market evolves with considerable fascination.

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November 23, 2017

Igor Is Not Available. Please Leave Your Name and Number, and He’ll Return Your Call as Soon as Possible.

Filed under: Economics,Energy,Politics,Russia — The Professor @ 10:27 pm

Who knew that Igor Sechin was such a shy and retiring type? He has been summoned thrice to testify at the Ulyukaev bribery trial, and thrice he has failed to appear. One time he apparently dodged the summons by hiding in his office, and having his staff refuse to accept it. The other times he has said his busy travel schedule precludes him from attending. He has been summoned yet again to appear on 27 November, but the judge in the case said that Sechin indicates that his schedule wilt allow him to testify before the end of the year.

What will his next excuse be? “Sorry. I’m washing my hair that day”? Alas, “I’m scheduled to have my mullet trimmed” is no longer credible.

So why is Igor so reticent? After all, it is because of him, and a sting in which he participated, that Ulyukaev is in the dock. I discussed the issue with a Russian who follows the situation closely–perhaps too closely for comfort, in fact–and we pretty much agree on three possible explanations.

First, embarrassment. Transcripts, then audio, and now video of the sting have been released. Sechin does not come off well in these, and his offer of sausages in a hamper has become something of a running joke in Moscow. Relatedly, Sechin’s behavior violates the norms of inter-elite interaction (sort of like violating the mafia code), and this is there for all to see.

Second, there have been inconsistencies in the prosecution story. Sechin may dread cross-examination that will expose the episode as entrapment or fraud.

Third, Sechin may be testing the limits of his power and autonomy, or deliberately flouting the rules to show that he is an untouchable.

Will we ever learn the truth? This being Russia, there is considerable room for doubt. But one thing we can be sure is not the truth is that Sechin is a respectable figure. He is either an arrogant thug who operates outside the law–or wants to do so. Or he is a buffoon who played out a charade–badly–in order to punish someone who tried to thwart him.

Come to think of it, I’m going with “both”.

And it is not that Sechin’s performance as head of Rosneft compensates for his buffoonish thuggery (or is it thuggish buffoonery?). Indeed, the last earnings report was a disaster, and there are still many questions about the whole Rosneft-Glencore-QIA-Intesa-VTB-CEFC-Ivan Doesky* deal, and just how money from that deal made it (or didn’t) to the Russian budget to fulfill Putin’s privatization promise.

Rosneft’s stock price has been lackluster, at best. Yet the company has been on an acquisition binge overseas. (And how is that Venezueula thing working out? Pouring money down a corrupt rathole–sheer genius! What strategic vision!)

Things have gotten so bad–and so impossible to ignore–that even Sberbank released a scathing criticism of the company:

In the 64-page research report, dated October 2017, Sberbank’s division Sberbank CIB called on Rosneft to change its strategy “markedly” after the energy company incurred huge debts following an acquisition spree at home and abroad.

“Rosneft has been touting its top-down efficiency effort, complete with Stalinesque tales about employees being confronted with charges of malfeasance at management meetings and marched straight into police custody,” the initial report said.

. . . .

The report’s authors, in a section titled “Rosneft: We Need to Talk About Igor”, also said Rosneft’s powerful Chief Executive Igor Sechin “almost single-handedly sets the company’s strategy”.

They calculated that since purchasing oil and gas producer TNK-BP for around $55 billion in 2013, Rosneft had spent a net $22 billion on acquisitions, “with no clear focus”.

“Assuming he remains in charge, the company will continue to pursue volume growth. In doing so, its heft will push it further out of Russia and perhaps further out of oil. This will only disappoint its shareholders,” the report said.


Actually, Sberbank wasn’t laughing, because Igor and Rosneft took extreme exception to the snarky criticism. Sberbank subsequently withdrew the report and reissued it, minus the offending language.

One can imagine what transpired in order to achieve that result.

Thus the management of the world’s largest publicly traded oil company (by volume, NOT by value, to be sure). Run by–indeed dominated by–a strategic imbecile who attempts to compensate for his managerial incompetence by strong-arming his domestic rivals into giving up their resources, and engaging in clownish masquerades to frame up those who have attempted to thwart him.

There are larger lessons here too. Keep Igor in mind whenever anyone shrieks about Putin’s fearsome juggernaut. If the management of a national champion in the largest and most important industry in Russia is any indication, the colossus has feet of clay–and a head of brick.

* And no, Donald Trump is not one of the Ivan Doeskys, dossier notwithstanding. I am referring to the unknown party or parties who (a) chipped in the difference between what Glencore, QIA, and Intesa cop to have paid, and the amount that Rosneft claim to have received, and (b) indemnified Glencore against loss.

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September 25, 2017

Whoops, They Did It Again! After the German Election, the Establishment is 0-for-3.

Filed under: Energy,Politics,Russia — The Professor @ 11:36 am

I am experiencing considerable–what’s that word? oh yes!, schadenfreude–at the German election results. Although Angela Merkel’s party received the largest share of the vote, the results were a shocking setback for her. The CDU/CSU won the largest share of the vote, but this share was the lowest since WWII and represented a double-digit drop from the 2013 vote. Further, the CSU’s leader is mooting a split from the CDU. Merkel is almost certain to have to craft a coalition including three other parties–including the Greens–and this will be time consuming and constrain her power even once the coalition is in place. But the biggest setback at all was due to the stunning surge of Alternative for Deutschland (AfD), the nationalist (and typically referred to as “far right”) party, which not only surpassed the 5 percent hurdle for parliamentary representation, but garnered 13 percent of the vote.

On Friday, Merkel was lionized. Now she is a greatly diminished figure. So much for the New Leader of the Western World, the Tamer of Trump, the Vanquisher of Populism.

And it’s not like this should be surprising. This is at least the third major replay of the movie–first Brexit, then Trump, now Merkel/AfD. Like the Remainers and the Democrats, Merkel condescended to the broad strain of popular (and populist) unease at her policies, most notably her immigration policy. Indeed, she and the rest of “elite” German (and indeed, Western) opinion could barely contain their disdain, and indeed revulsion, at any of the hoi polloi who dared question the wisdom of admitting a million plus immigrants from Muslim countries, or who expressed so much as concern at the criminality (especially sex crimes) and terrorism risk associated with the immigration wave: such people were the German version of The Deplorables. To the contrary: Merkel et al used this criticism as an opportunity to engage in a spasm of virtue signalling, not to say moralistic onanism. Those who agreed with them were morally elevated: those who disagreed, or even questioned, were knuckle dragging crypto–or not so crypto–fascists.

And as in the UK and the US, the knuckle draggers had the vote–and used it to take their revenge.

It is hard to discern from biased media coverage just what AfD really is. Perhaps David Goldman (AKA Spengler) is right that it is “an America-hating ethnic nationalist monster crawling with Nazi nostalgia.” I seriously doubt, however, that most of those who voted for it fit that description. But in some ways the party’s alleged ugliness, and the scorn and derision heaped on it by Merkel and the establishment, were a feature and not a bug to those looking to express opposition to the establishment’s policies. In a parliamentary system, voting for a fringe party is a way of sending a message, and what better way to send a message to Angela et al than by voting for a party that makes them recoil in horror because of its often extreme views? The only way to snap them out of their virtue signaling and self-pleasuring reveries is a 2×4 upside the head: voting for an AfD that elite opinion considered beyond the pale did just that. For that purpose, the more reprehensible the party, the better.

Such a smack may be necessary, but it may not prove sufficient. For what the post-Brexit and post-Trump reactions of the elite demonstrate is that they are incapable of reconsideration or self-examination or self-doubt. They are so convinced of their own superiority (especially moral superiority) that they tend to double down on the derision and condescension. Thus, electoral shocks tend to be merely the first battle in a protracted and increasingly hysterical war between the soi disant elite and those they believe it is their right to rule. We see that in the US today, with no respites even on the Sabbath, as the current frenzy over the NFL demonstrates.

My schadenfreude is only increased by the fact that Germany lapped France  as the most annoying country in Europe some time ago. German annoyingness was the product of two currents, one of which is longstanding, the other more recent. The longstanding current is that of various German national neuroses, most notably the need to cope with the awesome responsibility for the greatest catastrophes of the 20th century, the two World Wars, and in particular the crimes committed in the second of these. To prove that they are different now, the Germans have long held themselves out as morally superior judges of everyone else. Notable examples include virulent German criticism of Israel (especially useful because if Israelis are no better than Nazis, the moral valence of the Holocaust is diminished) and of the US in Vietnam, and latterly Iraq. German criticism of lazy southern Europeans is a somewhat less egregious, but nonetheless notable, example of this tendency. Virtue signaling is a natural pastime.

The second current is Germany’s economic ascendance, especially in the context of the EU. Germany emerged from the Financial Crisis as the dominant economy in Europe, by far. Its main rival within the EU, France, fared not nearly so well, and this combined with British exit has left Germany preeminent in the EU. And they have not been shy to exercise this dominance–nor should they have been expected to, given the aforementioned belief in their moral superiority. Germany–with Merkel in the lead–has been the biggest force pushing for MOAR Europe, because in their current circumstances, More Europe means More German Power.

Of particular relevance in light of the election results, one of the most appalling manifestations of this has been Germany’s insistence on imposing its open borders policy on other countries, especially in eastern Europe (notably Poland). For its part, the Polish government knows how to hit Germany where it hurts (in its swollen sense of superiority) by threatening to demand trillions in reparations for WWII. (The issue of WWII illustrates Churchill’s aphorism about the Germans being either “at your throat or at your feet” very well. It is interesting to note how the Germans have been at times groveling to the Russians in recognizing their depredations in Russia during WWII, but have not behaved similarly to Poland, even though German crimes there were probably greater, and Polish responsibility for the war far less than Russia’s.)

German energy policy is another example. The Germans have been intent on forcing Nordstream I and now II on Europe because it benefits Germany, even though it leaves eastern Europe in the Russian energy thrall. Related to this is the schizophrenic German policy on Russia. On the one hand it has insisted on maintaining sanctions on Russia for Ukraine, but on the other hand it freaked out when the US tightened sanctions on Russia because this undermined German attempts to secure gas supplies from the Russians.  The Germans insist on sending a signal–as long as they don’t have to pay a price.

So even if–or especially if–AfD is as bad as Spengler says, its shockingly strong performance yesterday will have major political effects outside of the borders of Germany. It has proven that Merkel has feet of clay. It will lead to a protracted negotiation over a coalition that in the end will leave Merkel diminished and constrained. It will probably spark a vicious political battle in Germany over immigration and Europe that will derail Germany’s attempt at world domination by other means.

And as much as the western establishments will wail, these are good things. In fact, the wailing is probably the best indication of that which one could imagine.

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September 19, 2017

Motivated Seller

Filed under: Economics,Energy,Politics,Russia — The Professor @ 8:18 pm

I conjectured that Qatar’s sale of half of its Rosneft stake reflected at least in part the dramatic change in the emirate’s circumstances between December (when it initially bought in) and September (when it sold off), specifically the cold war with Saudi Arabia, the UAE, and the rest of the Gulf Cooperation Council (oxymoron alert!) that broke out over the summer. This conflict has put substantial financial strains on Qatar, which would suggest it bailed on Rosneft (at what price???) to raise cash and reduce risk.

This story from Bloomberg is consistent with that: private depositors have been fleeing Qatar’s banks, and the state is stepping in, putting about $11 billion into these banks. Liquidating investments like the Rosneft stake is one way of raising that cash, and reducing debt. (This raises the possibility that if the crisis drags on, Qatar may sell the rest of its 4.7 percent share of Rosneft.) That is, Qatar could have been a very motivated seller–war clouds can do that to a country. And if it was a motivated seller, CEFC probably obtained its position at a good price, perhaps even a fire sale price. That’s not evident from the reported terms of the transaction, which means that there are side deals.

One other thing about the Qatar-GCC standoff. There are reports that Trump kept the cold war from going hot:

Saudi Arabia and the United Arab Emirates considered military action in the early stages of their ongoing dispute with Qatar before Donald Trump called leaders of both countries and warned them to back off, according to two people familiar with the U.S. president’s discussions.

The Saudis and U.A.E. were looking at ways to remove the Qatari regime, which they accused of sponsoring terrorism and cozying up to Iran, according to the people, who asked not to be identified because the discussions were confidential. Trump told Saudi and U.A.E. leaders that any military action would trigger a crisis across the Middle East that would only benefit the Iranians, one of the people said.

Donald Trump, peacemaker. Not that he’ll get credit. Note that early on, Trump’s pro-Saudi message clashed with Tillerson’s more neutral approach. This story suggests that Trump’s private and public positions may have been different, and that he was really on board with Tillerson all along. Alternatively, Trump initially tweeted his gut reaction, but Tillerson and others quickly persuaded him to moderate his course. Either way, the outcome conflicts with the prevailing narrative about Trump.


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September 16, 2017

The Rosneft Farce Gets More Farcical

Filed under: Energy,Politics,Russia — The Professor @ 11:39 am

A Reuters piece today provides even more evidence of the farcical nature of the Rosneft “privatization.” Specifically, it reports that (a) the CEFC deal was heavily leveraged, and (b) more importantly, a good part of the leverage was from a Russian bank (VTB). The remainder of the debt was provided by the Chinese Development Bank.

Remember Putin’s original injunction to Sechin: the deal should be a real privatization, without participation by Russian banks, and western investors must participate. Remember the triumphant statements of Putin and Sechin at the time of the original deal, and when he awarded Medals of Friendship to two of the big players in the deal: to hear them tell it, the participation of a major western bank, Intensa, was a validation of the legitimacy of the transaction, and an endorsement of Rosneft and Russia as a place to invest.

Of course, those statements were lies when made: Russian banks guaranteed at least Glencore’s debt, so even if they did not provide any funding, they did bear the risk, which is what really matters. Further, the unaccounted for difference between the alleged purchase price and the funds provided by Intesa, Glencore, and QIA also makes it quite possible that Russian banks even chipped in some funding. (VTB was likely one. Gazprombank is another.) And don’t forget that VTB provided bridge financing until Russia cadged Intesa into the deal.

But now the falsity of the original narrative, and original plan, is laid bare. There is not a western entity in sight, unless you count Glencore and its piddling .5 percent stake–which is more than compensated for by generous off take deals and a seat on the Rosneft board. The deal was clearly structured–almost to the kopek–to make Intesa whole, and allow it to flee snowy Russia for sunnier Mediterranean climes (with its CEO Carlo Messina getting a cool Medal of Friendship as a pre-parting gift). A major Russian bank ends up exposed to Rosneft by stepping into Intesa’s place, along with a Chinese state bank. Not a private western investor or lender in sight.

So yes. The Rosneft deal indeed speaks volumes about the company, and about Russia as a place to invest. And what it says is exactly the opposite of the message that Putin trumpeted in December 2016, and again in April (when the friendship medals were awarded).

Think about it. Russia cannot entice private investors to buy into an oil company with access to some of the greatest oil properties in the world. How damning is that?

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September 9, 2017

The Rosneft “Privatization”: The Farce Continues

Filed under: China,Commodities,Energy,Politics,Russia — The Professor @ 3:32 pm

The Rosneft deal involving Qatar and Glencore, announced with such fanfare in December, and commemorated with Putin awarding medals a few months later, has been undone. A Chinese conglomerate, CEFC (not exactly a giant name in the energy business) has agreed to invest $9.1 billion. As a result, Qatar’s stake will fall by more than half to less than five percent. Glencore, which notionally owned half of the nearly 20 percent stake sold in December, but which went to great pains to point out that it was at risk to the tune of a mere $300 million, will retain only .5 percent of Rosneft. The Italian bank which funded the deal, Intesa, will be paid off and exit the transaction. And as Ivan Tkachaev notes in RBC, it also lets the heretofore unknown Russian banks who provided guarantees to Glencore (and perhaps provided some funding too, given the gap between the price of the deal and the contributions by Intesa, QIA, and Glencore) to eliminate their exposure to Rosneft. (Exposure that Rosneft/Sechin/Putin never admitted, and which was allegedly not supposed to exist in this “privatization.”)

Like the original transaction, this one raises many, many questions. And like the original transaction, no doubt few (if any) of these questions will be answered.

The most notable issue is that the transaction clearly was not done at a market price. The amount invested exactly pays off the Intesa loan, plus about $100 million to cover costs and fees: it would be miraculous if a market-price deal exactly paid off existing loans. Thus, the deal was clearly done to save Intesa from its predicament, which was quite dire given that it could not syndicate the loan, and its association with the deal put the banking some sanctions-related binds.

Further, the deal is a boon to Qatar, which is embroiled in a standoff with the Saudis and the rest of the GCC, and which has suffered some economic difficulties as a result. The deal helps its balance sheet, which was under pressure due to the economic conflict. Further, Qatar needs all the friends it can get right now, and being a major investor in Rosneft did not help its relations with the US.

Not only was the deal not at a market price, it is highly likely that the Chinese overpaid. The price was at a 16 percent premium to the average of Rosneft’s stock price over the previous month. It is extremely rare to pay a premium, let alone that big a premium, for a minority passive stake–especially in a country where minority investors are routinely raped. (And Sechin is a multiple offender in this regard.) Indeed, most such deals are done at a discount, not a premium.

Note that the original deal was at a discount, and Putin explicitly acknowledged it was at a 5 percent discount. He claimed it was the “minimum discount,” but it was a discount nonetheless.

The Chinese are not notorious for overpaying. Thus, it is almost certain that there is some side deal that makes the Chinese whole. Or better than whole. The side deals could be in the form of cash payments from Rosneft (or maybe even Qatar), but I consider this the least likely. Instead, CEFC could obtain oil at preferential prices from Rosneft, or provide financial services to the Russian company at above market prices.

Ivan also reminds me that just days before the CEFC purchase, Rosneft and the Chinese company announced a “Strategic Cooperation Agreement and a contract for the supply of Russian crude oil at the 9th BRICS summit.” Rosneft describes the oil contract thus:

Rosneft and CEFC signed a contract for the supply of Russian crude oil, opening up new opportunities for the strategic partnership. This contract will lead to an increase in direct supplies of crude oil to the strategic Chinese market and ensure a guaranteed cost-efficient export channel for the Company’s crude sales.

Price is not mentioned, but this could provide a mechanism that would allow Rosneft to compensate CEFC for any overpayment on the purchase price of the stake. (Recall that Russia obtained funding for an oil pipeline to China by contracting to deliver oil at discounted prices.)

Again, we will likely never know the details, but there has to be more to this deal than meets the eye.

Here is how the investor describes its business:

In recent years, CEFC China has been accelerating its strategic transformation, focusing on building an international investment bank and an investment group specialized in energy industry and financial services, which has helped boost the Company’s sustained rapid development. The Company has under it two group companies at management level, 7 level-one subsidiaries as investment platforms and an A-share listed company, with a workforce of nearly 30,000.

Underpinned by its European oil and gas terminals, CEFC China secures its position by obtaining upstream oil and gas equities and interests, building professional teams of finance and independent traders and providing financial support with a full range of licenses. The profits in the financial and logistics sectors are driven by its energy operations and financial services. In addition, CEFC China has set up its second headquarters in the Czech Republic to conduct international banking businesses and investment, and acquired controlling shares in banks and shares in important financial groups with its investment focusing on airline, aircraft manufacturing, special steel and food, in order to facilitate international cooperation in production capacity.

Hardly a major oil player, and certainly not a strategic investor that brings to Rosneft any technical expertise or access to upstream resources outside Russia. It’s just a supplier of cash. And as such, and as one that is providing cash to help previous Rosneft investors/lenders get out of a sticky wicket, you can be sure that it got a pretty good deal. Thus, like so many Russian transactions, the interesting action is not that which takes place in plain sight, but that which takes place behind many screens and curtains.

Although Sechin now boasts that Chinese investors are always the ones he wanted, that’s not what he–and notably Putin–said in December and January. Then they were saying how the participation of a noted western company–Glencore–put a stamp of legitimacy on the deal, and showed that Russia was an attractive place for western companies to invest.

Well, Glencore never really invested anything substantial in the first place: if there was any doubt back in December and January that this was a Potemkin privatization involving western companies, there should be no doubt now. And of course, Glencore comes out a huge winner in this. The company earned a lot of goodwill from Putin and Sechin for saving them from the embarrassing situation that they faced in 2016, with a privatization deadline looming and no investors in sight. More tangibly, Glencore obtained–and retains after this deal–a lucrative concession to market Rosneft barrels. It took on very little risk in the first place, and has very little risk now. Glasenberg received a seat on the Rosneft board, and apparently retains it, even though Glencore’s equity stake is now trivial. And Ivan gets to keep that totally cool Order of Friendship medal.

But he better not fall in with the “wrong crowd,” like previous recipient Rex Tillerson, whom Putin is now very sore at! But since I doubt Ivan has any prospect or interest in becoming a diplomat, that’s probably not going to happen. Ivan knows a good deal when he sees one. And this deal was very, very good for him and Glencore.

For Rosneft and Russia, I’m guessing not so much.

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August 5, 2017

A Brief European Tour

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:46 pm

Emmanuel Macron’s popularity has come off considerably since his victory in May. This is to be expected. He was the beneficiary of metropolitan France’s giddiness at the vanquishing of Le Pen, and the perceived slap at Trump (more on this in a bit). That intoxication has passed, and France is still France, riven as it always has been by deep political divides even among the elite.

I must confess that I may have misjudged M. Macron. I pegged him as a cipher whom Merkel would dominate. But if anything, Macron is proving to lean more towards Napoleonic ambitions, labeling himself “Jupiter” who aims to overawe the petty squabbling political nation.

Macron left some angered, and others nonplused, by his bonhomie with Trump during the president’s visit to France on Bastille Day. This actually makes perfect sense, and is the best demonstration of his intent to be his own man, rather than a Merkel flunky. As Empress Angela’s pretensions continue to swell, Macron knows that he needs a counterweight. He further knows that Merkel disdains Trump, and Trump don’t think much of her either. So the clever thing to do is to build a relationship to Trump. It signals independence. It will aggravate Angela. And it will provide Macron with some muscle in his dealings with Germany, and with the EU.

Speaking of the Germans, they are in a lather over the recently passed, and grudgingly signed, US sanctions on Russia. (Socialist) Foreign Minister Sigmar Gabriel called the sanctions “more than problematic” and accused the US of using the sanctions to advance its economic interests.

Vats good for ze goose is good for ze gander, eh, Fritz? German policy is all about advancing the interests of Germany, Inc. (or more properly, Germany AG). So spare me the sanctimony.

And as a factual matter, Sigmar is full of it. He states the US position to be “we want to drive Russian gas out of the European market so we can sell American gas.” This takes a very narrow and distorted view of the effect of sanctions on US companies, and energy companies in particular. The gains to US LNG are speculative, and would not be realized for some time. Other US firms–notably the oil majors–will suffer more with certainty, and suffer now, as a result of the new sanctions. Consequently, US energy firms fought the sanctions bill aggressively, and won some concessions.  So the idea that the sanctions effort was a Trojan Horse intended to advance US commercial interests is laughable. Congress proceeded with sanctions in spite of US economic interests, rather than because of them.

I think psychologists refer to what Herr Gabriel did there as “projection.”

One other thing about the sanctions bill. After it became law, Putin responded by ordering a reduction of 755 in staff at US diplomatic missions in Russia, and kicked the American diplomats out of some dachas. This is a good a confession of his strategic weakness. He really had no retaliatory measure available that would have really hurt the US without hurting Russia substantially more. So he was forced to resort to a purely symbolic measure. Something to think about the next time that you read about Putin the Colossus. Yes, he can be a pain, but when it comes down to it, he is playing with a very weak hand.

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July 26, 2017

Europe Has Always Been at War With the Diesel Engine!

Filed under: China,Climate Change,Economics,Energy,Politics,Regulation — The Professor @ 7:26 pm

Europe is at war with the diesel engine. Paris, Madrid, and Athens will ban diesels starting in 2025. Even Stuttgart (home of Daimler and Porsche) and Munich (home of BMW) are following suit. France and Britain have pledged to eliminate internal combustion engine cars by 2040.   The cars–diesel in particular–are too polluting, you see. And so the Euros are intent on replacing them with electric vehicles.

Europe has always been at war with diesel!

Um, not really. Like Oceania and East Asia, Europe and diesel were once fast allies. In its early days of the fight against climate change, Europe figured that since diesel engines burn fuel more efficiently than gasoline ones, they could reduce carbon emissions by forcing or inducing people to switch to diesel. They gave tax breaks and incentives that led to 1/3 of the European car fleet being diesel.

Then reality crept in. Diesels create more particulates, which create nasty pollution, particularly in urban areas. The Euros thought they could address this by strict emissions standards. So strict, that auto companies couldn’t meet them economically. So they lied and cheated. Brace yourself: even morally superior German companies lied and cheated! So Europe bribed people to pollute their cities. Well played!

Further, even by its own objectives the policy was a failure. Even though diesel has lower CO2 emissions, it has higher soot emissions–and soot contributes to warming. Whoops! Further, the CO2 advantage of diesel has been narrowing over the years, due to improvements in gasoline engine technology. So at best the impact of diesel on warming has been a push, and maybe a net bad.

But never fear! The same geniuses who forced diesel down Europe’s throat have a solution to the evils of diesel: they will force electric cars down people’s throats.

What could possibly go wrong?

Well, off the top of my head.

First, in the near term, a good portion of electric cars will be powered by electricity generated by coal. This is especially true if China goes Europe’s way.

Second, the green wet dream is for renewables to replace coal. Don’t even get me started. Renewables are diffuse and intermittent–they don’t scale well. They have caused problems in the power grid wherever (e.g., Europe, California) they have accounted for over 10 percent or so of generation. They consume vast amounts of land: air pollution (if you believe CO2 is a pollutant) is replaced by sight pollution and the destruction of natural habitat and foodstuff producing land. Renewables are a static technology (e.g., the amount of wind generation is limited by physical laws), whereas internal combustion technology has been improving continuously since its introduction in the 19th century. Really economic renewables generation will require a revolution in large-scale storage technology–a revolution that people have been waiting for for decades, but which hasn’t appeared.

Third, disposal of batteries is an environmental nightmare.

Fourth, mining the materials to produce batteries is an environmental nightmare–and is likely to benefit many kleptocrats around the world. Are greens really all that excited about massive mines for rare earths (notoriously polluting) and copper springing up to provide the materials for their dream machines? Will they pass laws against, say, blood cobalt? (And when they do, will they acknowledge–even to themselves–their culpability? Put me down as a “no.”)

Fifth, depending on the fuel mix, carbon emissions over an EV’s lifetime are not that much lower than those of an internal combustion car using existing technology–and that technology (as noted above) will improve.

Like I say, top of my head. But there’s an even bigger reason:

Sixth, unintended consequences, or more prosaically, shit happens. Just like the diesel box of chocolates was full of things the Euro better thans didn’t expect, and didn’t like upon consuming, the EV craze will also present unintended and unexpected effects, and in this type of circumstance, these effects are usually negative.

But they know better! How do we know? Because they keep telling us so! And because they keep telling us what to do!  Despite the fact that their actual record of performance is a litany of failures. (I cleaned that up. My initial draft had a word starting with “cluster.”)

Given such a track record, people with any decency would exercise some restraint and have some humility before embarking on another attempt to dictate technology. But no, that’s not the elite’s way. That’s not the bureaucrats’ way. They have learned nothing and forgotten nothing and will continue to prove that until someone stops them. Sadly, short of revolution it’s hard to see how that can happen.

Almost all attempts by states to dictate technology are utter fiascos. The knowledge problem is bigger here than anywhere, and the feedbacks are devilishly complex and hard to predict. Look at something seemingly as prosaic and well-understood as the production of oil and gas. Ten or twelve years ago, only a few visionaries glimpsed the potential of fracking, and I doubt that even they would admit that they foresaw the transformation that has occurred. Trying to dictate a technology that is dependent on myriad other technologies, and which may be rendered obsolete by technologies not yet developed, is something that only fools do.

But alas, there are many fools in high places.

The Orwellian switch from Europe and Diesel Have Always Been Allies to Europe Has Always Been at War With Diesel is particularly revealing because rather than recognize that the experience of Europe’s pro-diesel policy makes a mockery of policymakers pretenses of foresight, the failure of that policy is spurring them to embark on an even more speculative binge of coercion!

If you think CO2 is an issue, tax CO2 and let the market figure out the optimal way of reducing emissions: there are many margins on which to adjust, including technical innovation, fuel substitution, changes in lifestyle. Yet these madmen (and women) and fools insist on dictating technology right after their past dictates have proved failures. Worse than that: they are issuing new ukases because their old ones were crashing failures.

We are in the best of hands.

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