Why afraid? Because recall that Putin and Medvedev said in September 2008 that Russia was an “island of stability.”
Yeah. That worked out. Russia had the biggest decline of any major economy in 2008-2009, and has experience moribund growth since.
Expressions of Russia’s ability to weather world economic storms are delusional. Russia is a high beta economy, due to its extreme exposure to highly pro cyclical commodity prices, meaning that if the taper (and the fraught situation in China) lead to an economic slowdown. Indeed, the relatively steep declines in Russian stock prices in the tumult of the last days illustrates this point.
But this was not the most risible part of Sulianov’s statement. This was:
Russia is also investing $70 billion into its upcoming global sports events, the Sochi Winter Olympics 2014 and the 2018 World Cup. However, Siluanov told CNN said the investment was not purely designed for growth.
Sochi, the cost of which is reportedly $50 billion and rising, was “never meant to be a purely economic growth stimulating initiative,” he said. “It was always an infrastructure project.”
According to Siluanov, “it is designed to improve life in the region,” and “make it more popular and attractive for our citizens.”
I’m dying here. Seriously. Improving life for whom in the region? The corruptocrats? That I can believe. As if the typical “citizen” of “the region” is going to see anything but crumbs, while many billions disappear into bureaucratic and oligarchic rat holes.
“They have taken over the most productive, efficient set of energy assets in Russia and many in the market fear Rosneft are already starting to impact them negatively,” said Michael O’Flynn, managing director of UFG Asset Management, which has $1.5 billion under management in Russia and doesn’t hold Rosneft shares.
. . . .
“Depriving the minority investors of their rightful dividend is penny-wise but extremely pound-foolish,” said Kraus, who doesn’t hold any Rosneft shares. “If this is how they treat minorities when they are trying to drum up interest in a privatization, how will they treat them once they have their cash?”
Rosneft named BP’s Bob Dudley to the board, where he can watch the value destruction up close and personal. An important matter to BP, since it has a big stake in Rosneft as a result of the TNK-BP sale. Well played again, BP.
There’s no doubt a silver lining in all this for Sechin. The Russian government has proposed privatizing 20 percent of the company, something that Sechin has always opposed. He’s always argued that the company’s stock price is too low, and that it is necessary to wait until it gains in value. The price decline has given him more ammunition to fire in that battle.
A recurring pattern since Putin’s reelection has been for him to issue some ukase, which results in . . . nothing happening. Then he vents, and rants and raves, sometimes in public, and . . . nothing happens.
Most of Russia’s state-controlled companies have refused President Vladimir Putin’s appeal to raise dividends, providing a fresh reason for investors to avoid the cheapest emerging-market stocks.
Russian stocks’ discount to the MSCI Emerging Markets gauge grew to 2.1 times net assets in May, the highest in four years, as 11 of 17 Kremlin-backed companies included in the benchmark Micex Index (INDEXCF) ignored the government’s November rule mandating a payout equal to at least 25 percent of net income. The Micex is down 9 percent this year, the worst performance of the BRIC markets after Brazil’s Ibovespa. (IBOV) State-controlled OAO Rosneft and OAO Inter RAO UES both fell more than 20 percent.
“The unrealized dividend promises have a negative impact on the market, especially since this was one of the key growth triggers,” Victor Bark, who oversees about $2.8 billion as the head of asset management at Alfa Capital in Moscow, said by phone on May 27. “This is bad news in a situation when there are no sources for economic growth.”
Putin has targeted dividends in a drive to boost budget revenue and lure foreign and domestic investors wary of an economy that grew at the slowest pace since 2009 in the first quarter. Capital outflows amounted to as much as $4 billion in April, according to the Economy Ministry.
Putin wants more of the money from state companies to go into state coffers so he can meet the promises he’d made to increase state spending on everything from pensions to weapons. The management of these companies, of course, would much rather tunnel out the money using lavish investment expenditures. Or in Gazprom’s case, pipe out the money-with a good chunk of the money going into the pockets of Putin’s judo buddies, and pipe manufacturers, the Rotenbergs. So Putin will command, and rant, but he shouldn’t wait by the mailbox for the dividend checks to start rolling in.
This quote from the article is priceless:
“The Russian corporate sector would do almost anything on earth to be seen as modern and transparent,” Eric Kraus, a managing director at Nikitsky Capital in Moscow, where he manages about $200 million in assets, said by e-mail on May 28. “Anything but pay fair dividends, respect minority interests in corporate transactions, or allow truly independent directors. There is a disconnect between the rhetoric and the reality.”
Banks that helped Russian oil company Rosneft finance its $55 billion buyout of rival TNK-BP have been left waiting for their payback – a share in $15 billion in asset sales expected to follow the deal, sources familiar with matter said.
State oil company Rosneft’s takeover of TNK-BP this year aimed to create a major oil group producing more oil than Exxon Mobil, but it also tightened the Russian government’s grip on the country’s energy sector.
The asset sales promised by Rosneft Chief Executive Igor Sechin would offload less-profitable businesses to turn the company into the major oil player the CEO has said he wants it to be. The delay shows Rosneft has a lot on its plate integrating TNK-BP and that the sales are on the back burner.
Rosneft had dangled the juicy divestment mandates at the banks in exchange for a $29.8 billion loan – the largest in Russia’s history – on good terms, three out of four sources with direct knowledge of the loan talks said.
“All the lending banks are waiting,” said one of the bankers who asked not to be named because the talks are private.
And they’ll probably be waiting a very long time.
I really don’t blame Sechin here. He is just doing what he does. But because he’s doing what he does, that should have been perfectly predictable, I do blame the banks for being so gullible-no, make that stupid-for falling for his bait-and-switch. (And to reprise a theme from above, Sechin has little incentive to unload bad assets because even bad assets can create good tunneling opportunities.)
Perhaps you’ve been asking yourself: Who trusts a grown man with a mullet when billions of dollars are at stake? (Seriously: have you checked out Sechin’s ‘do lately? Hockey Hair hardly does it justice.)
Well, now you know: executives from the world’s biggest banks. They think that Sechin is thinking like a western CEO who at least faces some pressure to maximize shareholder value. In reality, Sechin’s objective function is quite different. Mirror imaging is a very bad idea when western managers and financiers deal with Russians. The Russians are marching to a very different drummer. But Sechin apparently realized that the banks were mirror imaging, and used that to get them to offer attractive financing terms in exchange for future business he had no intention of sending their way.
Of late the news has been full of stories of the stagnating Russian economy, faltering investment, and continued capital flight. These two stories illustrate a big part of the reason for those headlines: a colossally corrupt and inefficient state corporate sector.
And again, the irony here is too rich. I noted the other day that Putin’s rant against defense contractors was ironic because he created the behemoth state enterprises that he now rages against. He has also been a proponent of the huge state enterprises that he now fulminates about because they won’t pay dividends.
There’s an old expression: be careful what you ask for, because you just might get it. I’m sure Putin could relate to that right now, if he’s capable of honest self-appraisal.
A group of senators from western states, led by Diane Feinstein, have sent Gary Gensler a missive accusing the CFTC of violating the letter and spirit of Frankendodd by failing to register major energy companies (e.g., BP, Shell) as swap dealers. Each paragraph of the letter is more risible than the one before.
They set the scene by recounting the western electricity crisis of 2000-2001. This is utterly irrelevant to the swap dealer designation, because swaps had nothing to do with what happened then and there. Indeed, at its core the crisis was driven by a combination of fundamentals and flawed market design, and even the suspect trading strategies involved physical market transactions rather than swaps. For instance, none of the Enron strategies like “Fat Boy” or “Ricochet” involved swaps or OTC derivatives generally in any way, shape, or form. (It’s also rather ironic that one of the things that wreaked havoc with California utilities was that they were precluded by law from engaging in forward transactions to hedge the short position forced upon them by the retail price caps in the restructuring legislation.)
Parts of the letter made me laugh. Most notably, the senators attack the $8 billion de minimus exemption from the registration requirement. Their “logic” is that since commodity swaps represent a small fraction (less than one percent) of total OTC derivatives activities, the de minimus level for energy swaps activity should be lower than for financial swaps. Not just lower: “vastly lower.”
They say this “stands to reason.” Whenever anyone says something “stands to reason” s/he really means: “I can’t give you an actual reason, so I’ll just assert that my conclusion is obvious.”
This gets to the issue of just what the swap dealing designation is intended to achieve. That’s always been somewhat hazy, but the most charitable interpretation is that swaps dealers are deemed potential sources of systemic risk that require extraordinary regulatory scrutiny. The risk a particular firm poses to the financial system as a whole depends on its size relative to the entire financial system, rather than to any particular market, so even accepted the premises of Frankendodd the swap dealing designation should not vary by market. (Indeed, from a systemic perspective, even $8 billion/year on a flow basis is ridiculously small.)
The senators also fret over the possibility that allowing the Shells and BPs of the world to escape the designation will limit the CFTC’s ability to deter manipulation and fraud. Hardly. Those things are still illegal, and swap dealing designation will have no impact whatsoever on the CFTC’s ability to detect and deter. (Which may not be saying much, because all too often the CFTC wouldn’t know a manipulation if it hit the CFTC in the face with a waffle iron.) (I consider it ironic that these Solons refer to the BP propane manipulation, which was discovered, prosecuted, and punished when the swap dealer designation was not even a twinkle in Barney Frank’s eye. Bad mental image, I know.)
Relatedly, the senators worry about “transparency”, but all swaps trades will still be reported to central repositories. The only way the dealer designation matters in this regard is it affects/determines who has to report. (I shall pass over in silence the fact that the CFTC is at present utterly incapable of utilizing the data reported to the repositories, as Commissioner Scott O’Malia has repeatedly pointed out.)
But most importantly, the senators miss the elephant in the room. No major energy firm has registered as a swaps dealer because energy firms have shifted trading from swaps to futures. Another premise (flawed, but there it is) behind Frankendodd is that swaps are somehow more dangerous to the system than futures. The legislation and the rules under it imposed more onerous requirements on swaps than futures, in large part to encourage the movement of trading to futures markets.
So if these senators actually applied reason, rather than just hiding behind a stand-in for it, they should be overjoyed that no major energy firm has applied to be a swap dealer. This should be a feature, not a bug. It means that market activity has shifted to the venue that these very same senators and others who voted for Frankendodd considered to be the preferred model for trading derivatives: open, transparent, and subject to a rigorous regulatory regime. Most notably, from a systemic risk perspective, futures are cleared, and one of the major requirements imposed on swap dealers is a clearing requirement. So the specter of the swap dealing designation, with its associated burdens, has actually led firms to transfer trading activity from the satanic swaps markets to the sainted futures exchanges. Yay!
But arriving at this understanding would require actual, you know, reasoning. Not much, but some.
And that is a bridge too far when it comes to the World’s Greatest Deliberative Body. Which may be a correct description: if so, God save the world.
The term “squeeze” is used rather imprecisely in financial markets. To me, the term means an exercise of market power in a financial market, usually a derivatives market, like a futures market, options market, or the securities loan market.
One commonly advanced explanation for the runup in Tesla’s stock price is a squeeze of the shorts. That is, those who short sold the stock by borrowing it and selling it in anticipation of buying back at a lower price. In this context the term “squeeze” is not usually used to refer to a purposeful exercise of market power, but it is difficult for the liquidation of short positions to affect prices-and distort them-in the absence of the exercise of market power.
Tesla is a heavily shorted stock: In March, about 40 percent of the float was short. The stock has experienced a big runup, and one widely advanced explanation is that the shorts have been squeezed. Given that I wrote the book on manipulation (#4,345,667 on Amazon! But now in paperback! Only $275!-of which I see exactly $0.00! Also on Kindle for a mere $220! How can you pass that up?), I thought I would take a rigorous, data-based look at the subject.
In the absence of manipulation, the forward price of a stock should be the current spot price plus the cost of financing the position at the prevailing interest rate until the delivery date on the forward. In the absence of a squeeze, the cost/fee to borrow the stock should be small. However, in a squeeze, it is costly to borrow the stock: the bigger the squeeze, the bigger the cost of borrowing. This borrowing cost depresses the forward price. Thus, during a squeeze, the forward price is below the spot price plus financing costs. The differential between these is a measure of the severity of the squeeze.
I can’t observe borrowing costs directly, and there is no explicit forward market for Tesla stock. But there is an options market that trades fairly actively. Given put and call prices, and the associated strike prices, I can use put call parity to estimate an implied forward price:
F=(1+rT)(c-p)+K
where c is the call price, p is the put price, K is the strike price, r is the interest rate (I use Libor), and T is the fraction of a year to expiration of the option. I do this for every strike on Tesla options expiring in May, June, and September: there is one implied forward price for every strike. I then use the median and average across strikes (for each expiry) to estimate F. I then compare F to the no-squeeze forward price, which is (1+rT)S where S is the current price on the stock. (There is little disparity in my estimate of F across strikes, and the mean and median are virtually identical: this gives me confidence that the numbers are solid.)
This figure depicts the spreads between the no-squeeze forward price and the actual forward price: positive values indicate that there is a squeeze:
The figure does provide evidence of the exercise of market power. The spreads widened starting in late-February, and then remained elevated throughout April and into May. Some of the drift down observed in the spreads derived from the May and June options is a time to expiration effect: the number of days that short has to pay the borrowing cost caused by the squeeze declines as the option nears expiration, leading to a decline in the spread. This effect is less pronounced for the September options, which is why its spread remains elevated.
On a per day basis, for the June option, the borrowing cost went from about 1.7 cents per day in mid-March and topping out at 4.6 cents/day on 22 April.
Thus, there is pretty compelling evidence of a squeeze during this period.
This can also be illustrated in percentage terms. That is, the borrowing cost can be converted into an annualized percentage rate, like an interest rate. This figure illustrates that:
The decline in the May and June percentage rates reflects primarily the increase in Tesla’s stock price. But the numbers are pretty eye-popping. At the peak, the “interest rate” paid to borrow Tesla stock ranged from between about 25 percent (to borrow until 21 September) and 45 percent (to borrow to 17 May). Not quite loan-shark levels, but pretty damn high.
This is further evidence of a squeeze. And note particularly the substantial rise in the spreads, measured both absolutely and in annualized percentage terms from late-February through mid-April. Obviously, the squeeze was building during this time.
The peak of the squeeze, as measured by the spreads (absolute and percentage) was in mid-to-late-April, which corresponds to data on short sales. Short open interest declined from a peak of 32 million shares on 15 March, and then declined to 27.5 million shares on 30 April.
One other thing stands out. Note the spike in spreads on 13 May. Which just happens to be two days before Tesla announced its secondary public offering.
Interesting. Very interesting. I wonder if the SEC is interested. It should be.
When? There’s the rub. Once a squeeze occurs, people are reluctant to short for fear that they may be squeezed again. In the absence of the countervailing effects of short selling, the fan boys can drive the price to insane levels. Moreover, as I’ve shown in my academic work, the stock price is increasing in the probability of a squeeze: if (as is plausible) this probability is higher in the aftermath of a squeeze, this means that Tesla’s stock price currently embeds a squeeze premium.
Eventually this squeeze premium will go away, but given the recent experience, in which shorts were squeezed hard, it is possible that this premium will remain in the price for some time.
There is obviously one big question here: Who is doing the squeezing? I have no idea. Theories involving obvious suspects, but no evidence to back it up, and no real means to develop that evidence. The SEC could figure it out, if it had a mind to. Sadly, based on past experience I’m doubtful it will find the mind, despite the fact that manipulation (including squeezes) is a violation of the securities laws.
And if it bestirs itself, the SEC should look at another Musk company: Solar City. It has been on a dizzying ride too, and there is evidence of a squeeze here too. Indeed, the evidence of the squeeze is even more pronounced here. Note the huge spike in borrowing costs starting at the beginning of the month, after a period of relatively little movement. Very, very strong evidence of a squeeze:
Very strong.
Is anybody home at the SEC? I guess we’ll see.
The takeaway from this is that what are sometimes referred to as “technical factors” are present, with a vengeance, in TSLA and SCTY. Put less euphemistically, both stocks have been squeezed, and pretty hard. Squeezed, as in manipulated.
The big question: who has the squeeze box? Anybody home at the SEC who might try to answer that question?
My main issue with Elon Musk and Tesla is government subsidies. (An issue the WSJ shares, apparently. Though if commenter David Hoopes is right, they did not arrive at their opinion independently of me, given the echoes between my post and the WSJ’s subsequent oped. There are definite echoes.) If Tesla can make it on its own, all power to it.
But I do have my doubts about its ability to deliver, standing on its own two feet. Though in expressing those doubts, I have to acknowledge that I am in conflict with Mr. Market, who is continuing to push TSLA on its hyperbolic path-up 13.65 freaking percent today. On what news? Got me.
There is a litany of electric car failures. Perhaps Musk/Tesla can be the exception that proves the rule, but color me skeptical.
Tesla has made waves with its high end Model S. But Daimler and BMW are about to introduce high end models of their own, and they can certainly beat Tesla on manufacturing cost and quality (given their long history of building luxury vehicles and Tesla’s manufacturing teething problems). Moreover, the technology is pretty standardized. People rave about the acceleration of a Tesla, but that’s purely an artifact of electrical motors: the new Daimler vehicle (described in the Bloomberg piece linked above) also has stellar acceleration.
Tesla plans to launch more affordable vehicles, but no one-no one-has succeeded in that space. The problems inhere in the technology:
“EVs are a really difficult sell today,” the CEO of Toyota’s North American business, Jim Lentz, said in an interview. “Until we see substantial change in battery technology it’s going to be difficult to see EVs really take off.”
Both articles-and many more, to boot-point to a fundamental issue: range and recharging capability. Here, the failure of Better Place should be truly sobering to the Tesla fan boys. It was specifically intended to address the range problem through battery switch technology, but sales of electric autos-even in the cherry-picked markets-were too small to make Better Place viable.
And this points out a fundamental chicken-and-egg aspect to electric cars, which in turn helps explain a good part of Musk’s strategy.
The demand for electric cars depends on the availability of charging facilities. Or, more accurately, the expected availability of charging facilities. It also depends on the expected speed of recharge, and the expected duration of a charge.
Charging stations seem to be a constant returns to scale technology. It is easy to expand capacity to reflect demand, just as it was/is easy to expand filling station capacity to accommodate the number of gasoline-powered cars on the road. Moreover, entry is relatively easy. That suggests the following simple model. The number of charging stations will adjust to accommodate the number of electric vehicles. But this leads to an indeterminacy resulting from a self-fullilling prophecy effect: if a small number of vehicles are sold, there will be a small number of charging stations. If a large number of vehicles are sold, there will be a large number of stations. If potential buyers suspect there will be a small number of other buyers, they will anticipate a small number of charging stations, and they will be less likely to purchase (or, more precisely, their reservation price will be low). If potential buyers think a lot of others will buy, they will anticipate a large number of charging stations, and they will be more likely to purchase (high reservation price).
Thus, there is a bandwagon effect in electric vehicles. The bandwagon works in part through the expected availability of charging services. This has a self-fullfilling element: if a lot of people jump on the electric car bandwagon, it will be profitable for people to invest in recharging facilities.
There are multiple equilibria in these circumstances. You can have low sales equilibria and high sales equilibria.
This is the perfect situation for a Music Man. A promoter who gets the bandwagon rolling. And this is exactly what Musk is trying to do.
Using Twitter in particular, he is trying to convince potential consumers that there will be a huge infrastructure of charging stations, and that these stations will be highly efficient, permitting a recharge in less time than it takes you to fill your SUV with gas.
Several problems here. The first is that the bandwagon effect may never kick in: it hasn’t so far, despite aggressive efforts by governments to get it started. The second is that creating a bandwagon is a public good in this instance: even if Musk starts an electric car bandwagon going, given the ability of myriad other auto manufacturers to enter the market, Tesla will only be able to capture a fraction of the sales resulting from the bandwagon.
You might find this analogy a stretch, but I am convinced it is apt: Elon Musk faces the same challenge as Ben Bernanke, and is using the same strategy. (And hey, the differences aren’t that great. Without a hair transplant, or plugs, or whatever he did with his pate, by now Musk would be a chrome-dome like Ben!) Bernanke wants to generate inflation. His ability to do so depends on his ability to shape inflationary expectations. There is a self-fulfilling prophecy aspect to this too, and as a result, there are multiple equilibria: you can have low inflation and high inflation equilibria, depending on whether people expect inflation to be low or high. So Bernanke and the Fed have resorted to various public statements to try to shape these expectations.
That is, there is a bandwagon effect in inflationary expectations, just as there is a bandwagon effect in the sales of electric vehicles. One strategy to get a bandwagon going is the Tinker Bell Strategy: I believe! I believe! Musk is attempting to get people to Believe! in electric cars through Twitter and other public pronouncements. Bernanke and the Fed are attempting to get people to Believe! in increasing inflation through public announcements and guidance.
It is a rational strategy for both to follow, given their objectives. I must say, though, that starting an inflation bandwagon is likely far easier than getting an electric car bandwagon going. Addressing the recharging issue is a necessary, but not sufficient condition to overcoming consumer reservations about electric cars. There are so many other limitations on performance that will make people reluctant to adopt.
But I get the strategy. If you are long Tesla, or contemplating going long, you need to understand what that strategy is and what must happen for it to succeed. If you buy Tesla, you are essentially buying an option on Musk being able to start a bandwagon, and get the self-fulfilling prophecy to work.
This also explains the need to build a cult of personality around Musk, all the better to enhance his oracle-like status: hence the employment of a Sock Puppet Army, the aggressive attacks on anyone who calls BS on the cars, or the company, etc.
It will either succeed wildly, or crash in humiliating failure. I think the fundamentals favor the latter, but in a multiple equilibrium world, I can’t rule out the former.
Last week it looked like the Obama administration had decided to be sensible on at least one energy issue-the export of LNG. It approved a new license (for Freeport LNG) for export to countries with which the US has no free trade agreement. But the WSJ reports that new Energy Secretary Ernest Moniz is thinking of putting on the brakes again. Because we need more studies. No. Seriously:
Mr. Moniz showed caution about the existing studies. Speaking to reporters after a speech to an energy-efficiency conference here, he said he was “committed to doing a review of what’s out there in terms of impact analyses” before approving more applications to export U.S. natural gas. Critics have said last year’s study didn’t rely on the best data available.
“Right now we have no plans of commissioning new studies, but everything is on the table until I have done my analysis,” Mr. Moniz told reporters after his first public remarks as energy secretary
Sorry. We don’t need no steenkin’ studies. The whole idea smacks of central planning. The presumption should be that if firms are willing to risk their private capital, the benefits exceed the costs. Any analysis should be restricted to potential externalities. Real externalities. Not pecuniary ones.
But these “impact studies” are all about pecuniary externalities. Namely, they focus on the effects of exports on prices of natural gas, and the effects of natural gas prices on consuming industries (like petrochemicals). But these price effects are not true externalities that lead to inefficient allocation of resources. Indeed, restricting exports because of these effects would cause a misallocation of resources.
Pecuniary effects do have distributive effects. In the case of LNG exports, they affect the distribution of rents between gas producers in the US and foreign consumers on the one hand, and domestic gas consumers on the other.
And that’s what the need to get an export permit does: it permits the government to affect the distribution of rents. That, in turn, gives rise to rent seeking. And corruption.
In this context John Cochrane mentions the Indian “permit raj”: there you need to get a permit for everything. This gives those with the authority to grant permits incredible power. Power they use to enrich themselves and secure political support.
That is exactly what can go on here. Those hoping to get a permit have an incentive to exert influence, through lobbying, campaign contributions, and supporting public campaigns on issues favored by the administration. They also realize that they face substantial risks if they oppose the administration on other issues: “Nice little LNG terminal proposal you have here. Would be a tragedy if something happened to it.”
The government has no business being in this business, beyond perhaps-perhaps-addressing real externality issues. But even there, other mechanisms (e.g., liability for pollution) may be preferable to a permitting process. (Look at how Russia used environmental regulations to drive Shell out of Sakhalin II: any power to permit can be used to expropriate of hold up the party seeking the permit.)
In the US, energy, and particularly the international trade of energy, is particularly raj-like: Keystone II is another example. This destroys value in myriad ways. Beneficial investments are delayed, or not made at all, either because the government stops them directly, or the risks and costs of getting approval undermine the economics. Real resources are used to influence policy. Since energy investments involve big dollars, the losses can be big too.
People often lament the lack of an American energy policy. I disagree. We do have an energy policy, and the Energy Raj is a big part of that policy. A better policy, by far, would be no policy at all. Would that the DOE adopt the motto: “Don’t just do something! Stand there!”
I’m not holding my breath, though. The benefits of the raj to the rajahs are far too great.
My main beef with Tesla Motors is that it is a major beneficiary of government largesse masquerading as a free market success story. The company received a $450 million loan from the Federal government to set up operations. It has just paid back that loan, but does not justify granting the loan in the first place: indeed, it illustrates the heads-Musk-makes-a-lot-of-money-tails-the-taxpayers-eat-it aspect of the loan. It socialized the risk of loss, and privatized the gains. That’s bad, on principle. (Things might have been ameliorated had the warrant the government received allowed it to participate in the upside, but the exact opposite happened: the warrant went away precisely when the stock price went parabolic.)
But the loan isn’t the biggest source of government support. The $7500/vehicle federal subsidy to purchasers and California’s Zero Emissions Vehicle (ZEV) credit program are. When you look at the value of these subsidies, they dwarf the much ballyhooed profit Tesla reported for the first quarter (and those profits were driven by the write-down of the warrant and non-repeatable gains on yen exposure).
I’ve done some back of the envelope calculations to estimate just how much these subsidies benefited Tesla’s shareholders. The basic idea is to calculate profits with and without the subsidies based two assumptions about the demand for Teslas: a constant elasticity demand curve and a linear demand curve.
The linear case is easiest to explain. The equation is P=A-bQ, where P is price and Q is quantity sold. A and b are constants that need to be solved for. P and Q are known for the first quarter: I’ll use $75K for P (the average price of a Model S) and Q is 4750. If Tesla was maximizing profits, it would set its marginal revenue equal to marginal cost, where the marginal cost nets out the subsidies. The relevant equation is C-S=A-2bQ. I derive C from the cost of generating revenue reported in the 10Q. I divide this sum by Q, and then multiply by .6 because the cost number includes some fixed costs (e.g., tooling) and I want marginal cost: it turns out that the results I derive aren’t that sensitive to the multiple. For S I add $7500 and Tesla’s ZEV credit revenues (reported in the 10Q) divided by the number of vehicles sold. I now have 2 equations, and can solve for the unknown constants A and b.
I now have all I need to know to figure out revenues (including subsidy payments) net of variable costs. This totals $206 million. I can also figure out the price and quantity of Teslas sold without the subsidy. Absent subsidy, Tesla would choose Q to satisfy: C=A-2bQ, which gives Q=(A-C)/2. This can be plugged back into the price equation.
Doing this gives a no-subsidy quantity of 3558 (about 70 percent of the with-subsidy sales) and a price of $91K. Using these numbers, and the assumed unit cost gives a no-subsidy profit (before fixed costs, etc.) of $116 million.
In other words, in this specification, Tesla pocketed about $90 million due to subsidies in one quarter alone. That represents about 18 percent of its auto sales revenues, and dwarfs its profit even including the one-time boosters.
In the constant elasticity specification, I need to solve for the demand elasticity and the constant multiplying the Q raised to the elasticity. Given the price, quantity, cost, and subsidy numbers, I can solve for these two constants using the demand equation and the marginal revenue equals marginal cost equation. Given these constants, I can figure out profits with and without subsidies.
In the constant elasticity case, profit with subsidies (before fixed charges) is again $206 million, and profit without the subsidies is estimated to be $139 million. So in the constant elasticity specification, subsidies pad Tesla’s profits by $67 million.
These are numbers for one quarter, folks. This is money out of your pockets, or the pockets of shareholders of Ford, Toyota, etc., who have to buy ZEV credits. Tesla would still be drowning in red ink absent the fat subsidies.
I sure hope you are enjoying Mr. Musk’s Wild Ride at your expense. Your enjoyment being completely vicarious, of course, expect for the paying for it part. That’s something you experience personally.
I would hope that these figures put the hype in perspective. Tesla cars are fueled by electricity. Telsa Motors is fueled by government money. Your money.
One more thing. Tesla and Musk are neck deep in a relationship with Goldman-Sachs, aka Government Sachs. Think that it’s just maybe possible that Goldman will deploy its notorious political heft to keep the rain of government manna going? If you doubt that, can I interest you in a bridge connecting two boroughs in NYC? Which makes it doubly ironic-and nauseating-that many of the Tesla Kool Aid Gang also declaim against crony capitalism. Well, so do I, except I at least do so with a modicum of consistency.
The Commodity Futures Trading Commission has issued a “special call” asking Wall Street banks and other traders to provide documents that would prove recent derivatives transactions known as “exchanges of futures for swaps” were legal. Lawyers at the CFTC enforcement division are also scrutinising the trades for possible violations.
. . . .
The new inquiry centres on whether large traders and market-makers used unregulated over-the-counter swaps markets to trade what were in fact futures, strictly regulated contracts that are economically identical to swaps.
Trading futures off an exchange is illegal, and regulators are concerned that traders may have used these deals, known as EFSs, to agree prices that did not reflect the market.
“They’ve made information requests to everybody that’s ever traded an EFS. They’re saying, ‘prove to us that the swap was legitimate’,” said a recipient of a CFTC document request
The only thing that makes sense is that the CFTC believes that market participants engaged in EFS transactions without having a legally binding swap agreement in place first, meaning that the parties would have engaged in futures trades off-exchange. Or something.
Note that even if the parties had entered a swap, it may have been in effect a very short period of time-just as long as it took to execute the deal and submit it to Clearport for clearing.
I also find it curious that the article mentions that the CFTC is looking only at deals done post-Frankendodd, even though deals have been done this way since the 2002 time frame, if memory serves. One explanation is that CFTC believes the alleged conduct was permissible under CFMA, but not under DFA. Another guess on my part.
If there is a violation here, it seems to be a highly technical one. The end result is pretty much the same if they did or they didn’t execute a binding swap first: each party has futures positions obtained at a privately negotiated price.
CFTC has a lot on its plate already: is this really a priority? Really?
Moreover, the party that usually screams the loudest about off-exchange trading of futures is the futures exchange. But Clearport is a CME system, and EFS is a CME procedure, and it seems that CME is totally fine with this. Actually, if the following quote relates to the EFS issue (and it’s not clear that that’s the case from the article), CME is actually hacked at this:
Terry Duffy, CME executive chairman, said in a letter to CFTC last week: “In our view, nothing is served by piling on duplicative reporting mandates.”
For certain, though, CME was perfectly satisfied with the way market participants were doing EFS deals.
So who is the victim here?
It’s actually ironic that EFS was the CME’s way of implementing clearing for energy and metals. And the CFTC is rah-rah about clearing. But it is looking askance at the CME’s way of implementing clearing. I guess it’s a case of that was then, this is now.
CFTC also effectively killed EFS as a mechanism for facilitating OTC clearing by determining that a swap, no longer how short its existence before conversion into futures, counted towards a firm’s annual $8 billion (to be reduced to $3 billion) de minimus swap volume for the purpose of determining whether it is a swap dealer. As a result, market participants are moving to block futures trades rather than EFS to clear energy transactions: block futures trades that are negotiated away from the central market, just as the allegedly phantom swaps were. So this is last year’s war. If traders weren’t doing papering officially a swap deal, they were effectively engaging in block futures trades, which is what they are doing now. If it’s OK now, other than the technical violation, was it so horrible then that it requires a full blown investigation?
So what’s up? A burdensome, intrusive “Special Call” to investigate a possible technical violation that the exchange that would be hurt by a violation doesn’t seem to care about, and which is of little relevance going forward.
Wow. That seems like a totally reasonable use of scare resources-resources Gensler claims he doesn’t have nearly enough of.
What, haven’t heard about that report? Well, that’s the main point of the story. The report was spiked by the GFMA, a banking trade association, which commissioned it. According to Javier:
However, the report was never completed and remained in a “draft” status, after its conclusions went against the interest of the lobby group, three people familiar with the matter said.
So yes, perhaps you’ve guessed by now that the academic in question is me (though you have to read 2/3s of the way through the story to get to my name). And yes, that’s pretty much what I understood to have happened, though I was never told that in so many words. It’s nice to have it confirmed by “three people familiar with the matter”, even though it was blindingly obvious to me at the time. *
I call them like I see them. GFMA didn’t like that. I wouldn’t change the call, so they sat on the report. So it goes.
I think GFMA handled this badly even from the perspective of its own interests, though I guess I am not really surprised: this is the way organizations like this tend to behave. I am sure this has given the report more visibility than it ever would have achieved otherwise, and makes GFMA look bad in the bargain, at least in my (probably biased) opinion. The regulatory body they were trying to influence-the FSB-was briefed on the findings, and had a draft of the report, so deep-sixing the report only signaled to the FSB that GFMA didn’t like the results, which it probably knew anyways. Spiking the report also serves to validate the independence of the findings-and of the finder of the findings. That’s definitely an upside for me.
Working on the report helped me learn a good deal more about the global commodity trading firms, so that’s also a good thing. I look forward to learning and writing more in the future.
*For the record, the copy of the report “seen by the Financial Times” didn’t come from me.
