Streetwise Professor

My most recent contributions to the WSJ energy experts have been posted.

What is the most promising renewable? (This is the don’t-sweat-too-much-for-a-fat-girl piece.)

What should governments do to encourage conservation?

Putin caused a minor kerfuffle when he ostentatiously order Gazprom’s Alexi Miller to re-start the Yamal 2 gas pipeline through Poland.  Except Poland says, er, we’re not interested.

There’s no viable economic case for the pipeline.  South Stream is not commercially viable.  Nord Stream is operating at 27 percent capacity.   Gazprom’s European sales are stagnant (which is charitably putting it, because they fell 10 percent in 2012), because demand in Europe is stagnant and there are new supplies from Norway.  The potential for new supplies over the longer term means that Gazprom may soon pine for mere stagnation.

No.  This is about trying to squeeze Ukraine even more: Russian and Ukraine are in negotiations over control of Ukraine’s transmission network (Gazprom demands at least 50 percent) and the two sides are battling over billions in payments for gas that Ukraine contracted for under take-or-pay deals but didn’t take.

Poland refuses to play politics:

“Poland won’t participate in these political contexts,” Mr. Tusk [Poland’s prime minister] said. “For us, gas isn’t a tool to conduct politics and we very much want, in agreement with European Union laws, to keep gas issues free of politics.”

But Gazprom is Shocked! Shocked! at the very suggestion that Russia is playing politics:

Gazprom rejected any political overtones. “What politics?” said Gazprom spokesman Sergei Kuprianov, when asked to respond to Mr. Tusk’s statement. “It’s not aimed against anyone.”

And if you believe that . . .

Obama is on a roll.  A roll of idiocy.

I can hear you say: “Uhm, so what else is news?”

Let me tell you.

Item 1: in a political rally in Colorado, Obama offered us this disquisition in political theory:

“You hear some of these quotes: ‘I need a gun to protect myself from the government.’ ‘We can’t do background checks because the government is going to come take my guns away,’ Obama said. “Well, the government is us. These officials are elected by you. They are elected by you. I am elected by you. I am constrained, as they are constrained, by a system that our Founders put in place. It’s a government of and by and for the people.”

This, mind you, was from an alleged Constitutional Law professor.  For one thing, Constitutional Law is frequently abbreviated to “Con Law.”  Well, with Obama, that formulation fits, with an emphasis on the “Con”.  For another, he wasn’t a professor.  A lecturer.  (Read what Richard Epstein has written about Obama’s lack of intellectual engagement at Chicago.  Not a surprise.  He knew-knew-he was a pretender who had no chance of prevailing in an actual intellectual interchange at a Chicago workshop or lunch table.  No chance.  So he distanced himself from it. My ex-boss Dan Fischel offered Obama a professorship.  Which Obama declined.  Fischel obviously made the offer for political and AA reasons.  And by AA I don’t mean “alcoholics anonymous.”)

Where to begin?  This seems to presume that “us” is some monolithic, reified thing.  That there is some “will of the people.”

What about the tyranny of the majority? What about the tyranny of minorities that can occur in any democratic or representative system?

The whole freakin’ reason behind a bill of rights is that even in a democratic (or, more properly, republican) system, individual rights can be trampled and abused by a government responsive to the whims of a majority, or an empowered minority.  That’s why we have a Bill of Rights.

In Obama’s formulation, not only would the 2d Amendment be superfluous, but so would the 1st and 5th (and 3d and 4th etc. etc.) No one need fear the denial of their freedom of speech or worship or assembly or right to a fair trial, because hey, the government is just us, and we would never harm us, would we?

It is hard to overstate the cluelessness-or, more accurately, disingenuousness-of Obama’s formulation.  “We’re from the government, and here to help you, ‘cuz we would never ever hurt us, right?”

So I would ask Obama point blank: OK, Mr. Con Law Poser “Prof”, are you advocating the abolition of amendments 1-10 of the Constitution (or perhaps 1-27)?  Because under your “the government is us” theory, they are completely superfluous.  QED.

Let me state clearly: Too often, the government is not us.  The government is too often the anti-us.  Which is precisely why elections are an insufficient constraint on its predations, and why Constitutional constraints on the legislative and executive branches are imperative.

Obama traveled from Colorado to California to raise money from the Bay Area elite.  Mr. I’m Fighting For the Middle Class sucked up to the very, very small fraction of the 1 percent in order to raise money for the campaign to regain the House in 2014.

Put aside the truly risible things he said, like his remark that Nancy Pelosi never let ideology cloud her judgment: that would presume that she had judgment to begin with, and there is incontrovertible empirical evidence that she has no judgment-or brain-to speak of.

No, let’s look at the spectacle of his abasing himself before the execrable hedge fund billionaire Thomas Steyer, a hard core green, and opponent to the Keystone pipeline:

Appearing at the home of an outspoken critic of the Keystone XL pipeline, President Obama on Wednesday night told a group of high-dollar donors that the politics of the environment “are tough.”

. . . .

In the face of those pressures, at the fund-raiser on Wednesday — and at a second one at the home of the billionaire philanthropists Ann and Gordon Getty — the president sought to reassure his supporters that he would continue to fight for environmentally friendly policies.

Excuse me while I wipe away the tears.

The Steyers and the Gettys have theirs.  (The Gettys acquired their wealth by oil, ironically.  Not that Gordon actually did jack to create it.) They will live large regardless of whether energy is cheap of expensive.  Large, hell: they’ll live huge.

But I wonder.  Are they “us”?

So indulging enviro fantasies costs them nothing.  They are the very non-apocryphal modern embodiment of the apocryphal Marie “let them eat cake” Antoinette.  “They can’t buy gas?  Let them drive Teslas.”

But this is who Obama panders to, and who lionizes Obama.  They are ones who consider it only natural that they lord over “us”, and who quite openly attempt to buy influence.

Which is exactly why there needs to be constraints-hard, binding limits-on government power.  Contrary to Obama’s Schoolhouse Rock political theorizing, unconstrained democratic institutions are a threat to individual rights and liberties.  Not least because they are vulnerable to the manipulations of oligarchs.  Like Thomas Steyer, and Getty and Goldman spawn.

Gazprom claims that the Ukrainian proposal to import gas from Europe “smack[s] of corrupt schemes”:

Plans by Ukraine to import natural gas from the European Union “smack of fraudulent schemes,” said the chief executive of Gazprom, Russia’s largest gas producer.

“Now as regards the reverse supplies of gas from the territory of the European Union to Ukraine – we know about these plans very well, but we have suspicion that it isn’t about any reverse supplies. De facto, there would physically be no gas involved – the plan is to use Gazprom gas in a kind of virtual reverse direction,” Alexei Miller said in the “News on Saturday with Sergei Brilyov” television program.

“In other words, Gazprom gas moves into Europe and immediately turns back and goes to Ukraine,” Miller said. “It doesn’t just get pumped across,” he said, claiming that Ukraine would transmit gas provided by Gazprom to the border, where a measuring station would show that a certain amount of gas had gone to Europe, but then the gas would return to Ukraine.

“These schemes smack of fraudulent schemes of some kind,” Miller said.

On matters of fraudulent gas schemes, I defer to Gazprom.  Indeed, since Ukraine is as Sovok as Gazprom, on matters of fraud, it’s hard to choose between either on a priori grounds.

In other news, the Russian government is hardly trusting of Russian energy firms, and natural resource firms generally.  Case in point.  The Finance Ministry is opposing replacement of extraction taxes and export taxes on energy with a profits (income) tax:

Industry experts say profits-based taxation would allow companies to cut their tax base by artificially reducing their profits.

The tax authorities calculate MET based on Reuters pricing, and export duties from the Argus agency’s average price for Russian Urals blend.

“The Finance Ministry does not trust oil companies; it would not believe them should the tax be based on their profits. Mineral extraction tax based on a certain oil price, which is impossible to change,” said one industry expert.

Quantities and revenues are harder to manipulate than profits.  This is a testament to the limitations of the Russian tax system, especially  when the energy/oil industry is involved.

This story also speaks to the fiscal stresses on Russia, especially in light of the many promises that he made to get reelected:

The Finance Ministry cited guidelines set by Russian President Vladimir Putin, who before his return to the Kremlin last year promised to increase state salaries and other social spending.

“Our task is to increase the tax burden on the commodity sector,” Trunin said.

Brent and Urals Blend are currently hovering at the levels at which the Russian budget balances.  Putin cannot afford any slippage in tax collection on oil sales.

Finally, if you need further convincing that the prospects for making Russia a major financial center are delusional, consider how Rosneft is totally hosing the minority shareholders in TNK-BP.  Why? Because they can:

Prosperity Capital Management is looking to team up with fellow investors in the TNK’s traded unit, OAO TNK-BP Holding (TNBP), and seek redress after Rosneft’s plan to borrow money from the company rather than paying dividends sent the shares to a record low this week. Rosneft said its move was standard practice.

The biggest takeover in Russian history strengthens the state’s hold over oil and gas production, the source of half its budget revenue. The government is trying to turn Moscow into a global financial hub to attract investors and shift the economy away from resource dependence.

“The whole country’s reputation will suffer if a big company like Rosneft can behave like this,” Prosperity CEO Mattias Westman, who helps oversee about $4 billion in Russian assets, said by phone from Texas. “We will be talking to other investors and communicating directly with Rosneft on this.”

TNK-BP Holding fell the most since trading began on the Micex, retreating 26 percent to a record low on March 26. The biggest previous one-day decline came in October when Igor Sechin, Rosneft’s chief executive officer, warned that the company may end TNK-BP’s dividend policy and had no plans to buy them out.

This is classic short-termism.  Although legally permissible, the refusal to buy out the minority interests in TNK-BP, and the draining of its cash makes it abundantly clear to foreign investors that they can expect the worst.  Hardly calculated to make Russia a serious contender as an international financial center, even if its climate were indistinguishable from Cyprus’s or the BVI.

This also illustrates Rosneft’s limitations.  It is the biggest publicly traded oil company in the world by production, but is straining every nerve to finance its acquisition of TNK-BP.  A real supermajor would not face such difficulties, or find it necessary to engage in prepay transactions with oil trading firms or China to raise the funds for the acquisition.  Which is why the long-term consequences of hammering minority shareholders are rather irrelevant to Rosneft, and to Russia.  The financial pressures of the present are all important.  The future will just have to take care of itself.  Whether it will is highly uncertain, and outside of Russia’s control.  It depends on many contingencies, which likely accounts for the obvious nervousness at Gazprom, Rosneft, and the MiFi.

Rosneft closed the TNK-BP deal today, and is crowing that it is now the world’s largest publicly traded oil company.  Measured by production and reserves that’s true.  By market capitalization-not even close.  And that disparity between size measured by production and size measured by market cap is very, very telling.

Per its press release announcing the original deal, Rosneft compares itself to ExxonMobil (XOM).  It notes that Rosneft’s production will be nearly double XOM’s, which is in turn substantially larger than the production of Chevron, Shell, Total, etc.  Its reserves will also outstrip XOM’s and all the other non-NOCs.

Market cap? Totally different story:

Rosneft market cap: $82 billion.

XOM Market cap: $397 billion.

Chevron Market cap: $233 billion.

Shell Market cap: $210 billion.

BP Market cap: $129 billion.

Total Market cap: $112 billion.

So Rosneft produces more than XOM, and has more reserves, and has about 1/5th of the market cap.  It has a smaller capitalization than other firms that it dwarfs in terms of production and reserves.

And that’s Russia in a nutshell.  It is grossly inefficient at creating value.  Think of what ExxonMobil or Chevron or ConocoPhillips could do with access to Rosneft’s reserves-in a world where property rights and the rule of law were respected.  Think of what their market caps would be if Rosneft’s reserves were in North America, rather than Russia.

In other words, the yawning gap between Rosneft’s standing in the production table, and its placement in the market cap table is a damning indictment of Russia.

And, believe it or not, as bad as Rosneft is, it’s not the worst Russian energy behemoth.  That dubious distinction goes to my fave, Gazprom.  Check out this article from the Economist that provides the gory details.  But this shouldn’t be news if you’ve been hanging out here at all over the past 7 years.

One Cyprus scenario that has received considerable hype is that Gazprom will bail out the country in exchange for rights to develop its offshore gas resources.  IMO, this reflects a fundamental misunderstanding of Gazprom’s interests.  If anything, Gazprom has an incentive to pay to ensure that Cyprus’s gas reserves are not developed.

That is, Gazprom has every reason to want the gas to remain under the sea.  Eastern Med gas would compete with Gazprom’s Russian production: if Gazprom controlled Cyprus’s gas, sales from these fields would cannibalize sales of Russian gas.  Meaning that Gazprom has no real interest in developing Cypriot gas-to the contrary.

Obtaining exclusive development rights would give Gazprom the right to not develop, and to prevent anyone else from doing so.  This would suit it quite well, and it might be willing to pay something for that right.  But as desperate as Cyprus is, it has to realize that giving Gazprom control over its gas destiny would deprive it of the future revenue its resources could generate.  It is highly doubtful that Cyprus could negotiate a deal that would effectively compel Gazprom to develop the country’s gas.  Therefore, by dealing with Gazprom it would essentially be writing off any prospect of enjoying the benefits of future gas production.

This means that Gazprom’s interests and Cyprus’s are not aligned: the latter wants to maximize the commercial development of its gas fields, the former has no such interest.  Cyprus’s horizon might be very short, given its pressing financial needs, but it would have to discount the future extremely heavily to make a deal with Gazprom remotely rational.  I consequently deem it very unlikely that Cyprus and Gazprom could reach a mutually beneficial deal.

Development rights to Cyprus’s gas might be valuable collateral for loans that ease the country’s current financial straits.  But Cyprus should look energy firms whose interest is to maximize the commercial prospects of its gas resources, rather than Gazprom, which would like nothing better than to sabotage their development.

John Kemp pixeled a rather lame response to my criticism of his earlier piece on “Broken Brent.”  I say lame because he did not even attempt to address any of the analysis I laid out.  Specifically, Kemp originally pointed to the dramatic drop in correlations between spot and forward prices and the different behavior of the curve in 2008 vs. 2012-2013 as evidence that fundamentals were somehow no longer driving oil prices.  I pointed out that that a fundamentals-based model would predict exactly such a pattern due to the pronounced backwardation in Brent and the substantial decline in macro volatility; I further pointed out that I had presented theoretical models that made this prediction and empirical evidence supporting it going back to the early-to-mid-1990s.  That’s what we call science.

Kemp’s response?  <Crickets.>

The most plausible explanation for his failure to rebut my analysis is that he can’t.  So instead he doubles down on “the hedge funds done it.”  Although he does it in a much more circumspect, passive way the second time around:

In a recent column, I suggested most of the short-term movements in Brent (and WTI) prices since mid-2010 could be traced to changes in money managers’ positions rather than fundamentals.

Read his original piece, and you’ll see that he did more than “suggest.” Accuse is more like it.

Kemp’s evidence consists of a few graphs depicting managed money futures positions and prices.  Point 1: eyeballs are not reliable evidence. Point 2: reliable evidence would involve some rigorous statistical analysis, which Kemp does not provide.  Point 3: said statistical analysis should attempt to control for other relevant factors, notably fundamentals.

But Kemp breezily dismisses the possibility that fundamentals could explain price movements in recent months.  After all, his original post is titled “static fundamentals”, and in that article and his response to me he asserts-and merely asserts-that fundamentals cannot explain price movements.  Since he does not even attempt to control for any fundamentals-related variable, Kemp’s analysis is plagued by omitted variables bias.  And that’s being charitable, because that phrase is usually employed to criticize statistical/econometric analyses, rather than gazes at graphs.

Sorry, John, but that doesn’t cut it.  In a commodity characterized by extremely inelastic supply and demand, such as oil, small fluctuations in supply and demand fundamentals can cause appreciable price movements.  Indeed, in a low macro volatility environment, fundamentals-based models imply that price movements are driven by highly technical, transient supply and demand shocks, and that moreover, these shocks cause substantial volatility in the shape of the forward curve.  That is, they cause low correlations between spot and futures prices.

In such an environment, seemingly minor factors such as the shut down of a refinery or regulatory perversities (such as the impact of RIN credits) drive movements in prices and the slope of the curve.  People who understand the fine structure of energy markets-people like Phil Verleger-realize this. Phil’s 18 February “Notes at the Margin” (which he kindly sent to me) provides a very detailed analysis of how low gasoline stocks and the closure of a Hess refinery are combining to increase gasoline cracks, which in turn are causing European refineries to buy and process Brent crude for sale to the US gasoline markets, which is in turn supporting Brent prices and backs.  As Phil characterizes it, the tight US East Coast gasoline market tail is wagging the Brent crude dog.  Fundamentals 101.

Phil analyzes these things carefully.  John couldn’t be bothered.  Instead, he squints at a few charts of COT data and prices, and declares fundamentals don’t matter.  If he could show that after correcting for the kinds of factors Phil Verleger analyzes carefully week after week that managed money position movements were associated with price changes, he would have established that a necessary condition for speculative price impact would hold: merely a necessary condition, but not a sufficient condition, because it could well be the case that the fundamentals were driving the managed money trades.  (To his credit, Kemp recognizes this possibility in his original article, though he dismisses it too readily.)

In brief, John Kemp’s attempt to show that hedge fund trading is causing movements in Brent crude prices and that fundamentals do not is plagued by numerous flaws.  Methodologically, graph gazing is the start of an analysis, not the culmination.  Furthermore, fundamentals-based models explain many of the phenomena Kemp finds anomalous.  What’s more, a micro-level analysis of supply and demand factors in the oil and product markets can account for many of the price movements that mystify Kemp.  When he confronts these issues head on, I’ll take him more seriously.

Climateer Investing weighs in on Kemp-Pirrong, and wonders why I felt obliged to go into smack down mode.  The answer is simple.  There are too many regulators and legislators and rabble-rousers (e.g., Oxfam)  who are more than willing to seize upon any claim that evil speculators are distorting markets in order to justify interference, in the form of position limits or transaction taxes or just general harassment of those engaged in legitimate and beneficial activities: yes, speculation is a legitimate and beneficial activity.  I have written and lectured extensively on the subject, and understand that speculation can, in exceptional circumstances, distort markets, but that such distortions leave distinctive tracks in quantities (e.g., inventories).  If you believe speculation has distorted markets, provide evidence that those tracks indeed exist.  Superficial examinations not grounded in well-established theoretical and empirical work don’t cut it, but feed prejudices that in turn too often lead to wrongheaded and destructive interventions into markets that cause real distortions (e.g., the rather cowardly decision of some European banks to exit the ag markets because of the propaganda campaigns waged by Oxfam and others).  When people writing for reputable sources like Reuters lazily encourage these prejudices, I will respond.  And being a Chicago guy, from a school where econ seminars are the academic equivalent of the MMA or UFC, my responses tend to be rather blunt and uncompromising.  If you can’t take it, don’t get in the ring.

And as to Climateer’s claim that the fall in oil prices from the $140s in July 08 to the $30s in early ’09 is some sort of “gotcha!” QED of the impact of speculation.  Please.  If you want me to take you seriously, you have to do a lot better than that.  A major adverse macro shock that causes the most severe, protracted economic contraction in decades following a period of robust demand (and again I commend Phil Verleger’s analysis of the summer of 2008 as the go-to source to understand what drove prices in that period) will cause a precipitous drop in the price of an inelastically supplied commodity.  Every time.  It would be anomalous if they didn’t.

John Kemp of Reuters-accompanied by cheerleading by Izabella Kaminska at FT Alphaville–is going on about the “disconnect” between nearby and deferred Brent.  He blames-wait for it-hedge funds.  Natch.

The Brent market is currently in a steep backwardation.  I demonstrated empirically almost 20 years ago that backwardation is associated with low correlations between spot and futures prices for oil and a variety of other commodities.  Indeed, my 1994 criticism of the Metallgesellschaft 1992-1993 “hedging” strategy-which led to several confrontations with Merton Miller-was based on the fact that MG’s “hedge” of long the nearby against distant deferred short positions was in fact risk increasing due to the fact that MG implemented this strategy during a backwardation, and this reduced substantially correlations thereby making the MG position very risky.  My 2011 book provides a robust model that predicts exactly this result.

The intuition is quite straightforward-as I’ve been teaching for about 20 years too.  Inventory is what connects spot and futures prices.  When inventories are large, the market is in contango, and spot and futures prices move together: cash-and-carry arbitrage connects these prices.  In contrast, when inventories are low, the market is in backwardation, cash-and-carry arbitrage doesn’t link the spot and the futures, and the correlation between these prices can go very low.  Hence the association between contango and high correlations.

Note: hedge funds, speculation, yadda yadda yadda have nothing to do with this.

Kemp does note that there is physical tightness that does explain the backwardation:

Overlaying all these broader factors are continuing problems with production of the four North Sea crude streams (Brent, Forties, Oseberg and Ekofisk) that physically underpin the Brent futures prices. BFOE crudes remain in short supply, keeping the market in a steep backwardation, with futures prices tending to rise sharply in the run up to contract expiry.

But then he discards this fundamental fact, and mounts his favorite hobby horse of bashing hedge funds and speculation.

Note even in this paragraph there is a telling piece of information that contradicts his view: “with futures prices tending to rise sharply in the run up to contract expiry.”  Uhm, that’s exactly when hedgies and other speculators are liquidating-selling-their nearby contracts and rolling them into the deferred months.  This should put downward pressure on nearby prices, if the speculators were really  in command. Completely inconsistent with his assertion that hedge funds are driving the disconnect between spot and futures.

Kemp also makes a comparison to spot price and curve movements in 2008 to more recent movements.  But as I also show in my book, to explain commodity price dynamics you need multiple shocks of differing persistence.  Curve shape is driven mainly by transitory shocks: that’s what inventory is used to smooth out.  The level of the curve is largely driven by persistent, business-cycle type shocks.  This means that conditioning on price levels alone is insufficient to make an apples-to-apples comparison.  The 2007-2008 boom was driven more by long run, secular factors-namely the Asian/Chinese growth boom.  This resulted in a rise in the price level and only a modest increase in backwardation.  That is completely different from current conditions-hence the different behavior.

Similarly, the differences between high correlations pre-2010 and low correlations now are readily explicable.  The market was much more abundantly supplied in 2009-2010 due to the severe economic contraction following the financial crisis, and as a result, the market was in contango most of that time-at times in a “supercontango”.  Again, one would expect this to be associated with high spot-futures correlations.

Moreover, there is a big difference in the composition of shocks, and the magnitude of these shocks that also explains the observed declines in correlations.  The 2009-2011 period was dominated by macro uncertainty driven by the financial crisis and then the Eurozone crisis.  These shocks tend to be persistent, affecting both current and expected future economic conditions in the same way, thereby contributing to high correlations between points on the curve; moreover, they tend to affect all commodities and asset classes similarly, leading to high correlations across commodities and asset classes.

At that time, macro volatility-as measured by the VIX-was high.   In early ’09, VIX was in the 30-50 percent range, and remained above 20 percent for most of 2010-2011, with spikes up to 35-40 percent.  Now VIX is tame, with levels in the low-teens, just like during the period of the “Great Moderation.”  High macro volatility tends to lead to high correlations along the curve and across commodities and between commodities and equities: common shocks dominate, especially when they are big.  The decline in macro volatility means that commodity-specific, relatively transient shocks tend to dominate: this tends to depress correlations along curves and across commodities, and between commodities and equities.  These are exactly the patterns observed in the past months.

That said, there are reasons to suspect the backwardation and the decline in correlations might be overdone, but not because of the malign influence of hedge funds.  Specifically, given the declining Brent supply base, it is reasonable to ask whether the backwardation is excessive.  At present, Forties is cheapest-t0-deliver, and this represents only about 350kbd of production.  Overall BFOE production is only about 1mmbpd.  Given the immense open interest in Brent futures and OTC derivatives, it is more that possible that large players are exercising market power by taking delivery of too much physical oil, thereby exacerbating the backwardation (i.e., creating an artificial scarcity).

If you want to identify who might be doing that, look at who is taking the physical cargoes.  Those parties would be the squeezers.  If hedge funds are the culprits, they should be taking a lot of physical supply.  Kemp certainly doesn’t provide any evidence of this, and his piece suggests these players are just playing with paper barrels, not wet ones: that’s my understanding too.  Historically, the Brent market has been the scene of many squeezes, but the squeezers have tended to be trading companies (e.g., Arcadia) or perhaps supermajors.

Brent was a squeezers paradise in the 1990s due to declining physical volumes and growing paper volumes.  Platts’s addition of Forties, Ekofisk and Oseberg to the delivery slate increased supply sufficiently to mitigate the manipulation problems.  But the decline in production has continued inexorably, and Brent is increasingly vulnerable to squeezes.  Which is why Platts and Shell have competing plans to tweak the pricing mechanism, namely by providing premiums for OE (Platts) or BOE (Shell), thereby reducing the delivery pressure on the cheapest-to-deliver Forties.

Squeeze-driven backwardation also tends to reduce spot-forward correlations.  The spot price is driven by squeeze-related technicals, the forward price by longer run fundamentals.  Squeezes also distort the inventory holding decision, and cause a breakdown in the cash-and-carry arb mechanism.  As I show in another book (and many articles).

So Brent may indeed be broken, but hedge funds haven’t broken it.  It is a classic problem in derivatives markets: a burgeoning derivatives market balancing on top of a declining deliverable supply.  I often analogize this to an inverted pyramid: and in Brent, the base of the pyramid (the paper market) is growing while its point (the physical market) is getting sharper.

Fixing Brent requires enhancing deliverable supply.  Not an easy thing to do.

Again contrast Brent and WTI.  Brent boosters have constantly bashed the WTI disconnect.  But this can be fixed by investments in infrastructure, which are being made, though not as fast as expected or as needed.  But building infrastructure is a helluva lot easier than building  a new Buzzard. Trust me on this.

So in the medium term, I expect Brent will get broker, and WTI will get better, leading to a shift of much futures and index trading activity (including hedge fund trades) back to WTI, which will no doubt lead John Kemp to saddle up his hobby horse and ride west into the Oklahoma sunset.

Rosneft CEO and Putin henchman Igor Sechin will be in Houston for CERA Week.  While there, he will preview Rosneft’s future strategy: he choose to do so in the US (on only his second visit to the country) to emphasize Rosneft’s new international horizons.  It’s not just for Russia anymore, apparently.

I’m so stoked.  I think I’ll head over to CERA Week to see if I can get a glimpse of him. I’d better remind myself of what he looks like:

No. No. Sorry. Wrong Igor.

Here we go:

Darn it. Wrong one again. Here we go:

I ask you: which one is the most campily horrifying?

I laughed out loud when I read this paragraph from a Risk Magazine article about futurisation in the energy markets:

Top CFTC officials [GiGi? Is that you?] as well as members of Congress who supported Dodd-Frank [that’s Frankendodd around here, buddy] have repeatedly said the law was not aimed at physical end users of derivatives.  But if the the flight towards futures causes liquidity elsewhere in the market to dry up, end-users might have no choice but to fall in line.

Look: Elvis Costello’s “My aim is true” is definitely not the theme song of regulators and legislators in the US, or anywhere for that matter.  A 16 year old, hopped up, Afghan jihadi sprayin’ and prayin’ with his AK on full auto is more discriminating in his targeting than most regulators, and regulations.  Unintended consequences-AKA collateral damage-are the rule, rather than the exception with regulations.  This goes N-fold for monstrosities like Frankendodd.

Frankendodd is just starting its rampage.  The energy derivatives markets-and end-users in them-are only the first victims.

So when a regulator or legislator says that a particular reg or law isn’t aimed at you, don’t take comfort: take cover; there will be incoming.   We’re not talking Sergeant York or Annie Oakley behind the trigger here. More like Blind Lemon Jefferson.