Streetwise Professor

A while back–summer of 2010, if memory serves–I predicted that any CFTC position limit rule would be the subject of legal challenge.  My prediction was that someone would argue that the CFTC did not have the statutory authority to promulgate position limits because it had not made a finding that there was indeed excessive speculation that made it necessary to impose limits.  Subsequently, a DC Appeals Court decision that overturned an SEC regulation due to a failure to carry out an adequate cost-benefit analysis, made it clear that  this would be a major vulnerability for a variety of CFTC rulemakings, position limits among them. The day after the post-Dodd-Frank position limit rule was passed, speaking at a JP Morgan commodity conference, I said a suit challenging the rule would be “coming soon to a courthouse near you.”

Well, soon means about 6 weeks.  Today ISDA and SIFMA filed suit in DC contesting the position limit rule.   These organizations allege that the CFTC:

— Erred in concluding that the Dodd-Frank Act required it to establish position limits without first determining whether they were even necessary;

— Failed to present a reasoned analysis or consider all evidence in setting position limits;

— Failed to conduct an adequate cost-benefit analysis as required by law;

— Conducted a flawed rulemaking process that prevented commenters from meaningfully participating.

I imagine that others–such as the CME and maybe ICE–will follow suit, as it were.  I also expect that other rules will also wind up in court.  The position limit rule is probably the most vulnerable because of the statutory language about excessive speculation, but all of the rules the CFTC has passed are on extremely shaky on cost-benefit analysis grounds.

Frankendodd is under some pressure in Congress, but given the Democratic control of the Senate and the White House, nothing is going to happen on that front.  Instead, pieces of it will be chipped away in court.  Position limits could well be the first chip off the block.  Which is as it should be.

Showing its deep, deep concern for the environment, Gazprom is warning about the hazards of natural gas fracking:

But in a sign the phenomenon is in fact being taken seriously, the board of directors at the world’s biggest gas producer, state-owned OAO Gazprom, this week highlighted environmental risks and the high costs of production in Europe.

“The production of shale gas is associated with significant environmental risks, in particular the hazard of surface and underground water contamination with chemicals applied in the production process,” Gazprom said in the statement following the board meeting.

Now surely, this has absolutely nothing to do with the fact that expanded gas production, especially in Europe, would be devastating for Gazprom.  The experience in the US shows how quickly the gas market can turn.  In 2006, the consensus prediction was that the US was facing a low supply-high price gas future, and that the country would be a gas importer.  Gas prices were well north of $10/mmbtu.  A few short years later, the US supply situation was turned on its head.  Gas prices are now in the mid-$3/mmbtu range, and the play of the day is to figure out how to export gas to Europe and Asia.

LNG sourced from the Middle East or the US is already a near-to-medium term threat to Gazprom, as the ongoing disconnect between gas prices and oil prices (which determine the price of Gazprom gas under its long term contracts) indicated.   Even a modest increase in production in Europe would put even more pressure on the company.  And as the US experience shows, that increase can take place extremely rapidly (though for a variety of reasons such speed is unlikely in Europe).

Hence, it is doing what comes naturally to Sovoks: propaganda.  It is pulling out all the stops to discredit shale and fracking, not just in Europe, but elsewhere.  The next time you hear anti-fracking flacking, it’s fair to ask who’s paying for it.  No, not all the opposition is from Gazprom: some is from the well-intentioned, some from those who reflexively oppose any kind of energy production.  But knowing the way Gazprom works, no doubt some Gazprom money is funding anti-fracking lobbying, politicking, and information campaigns

But the enviro angle is really just too much.  Sorry, but lectures on environmentalism from the direct descendent of the Soviet Ministry of Gas (the USSR being history’s largest environmental catastrophe), and a company with a pretty poor environmental record to boot (witness the huge problems with leakage from Gazprom pipelines), are enough to challenge the strongest gag reflex.

But the fact that the company feels compelled to engage in such risible hypocrisy is actually encouraging news.  The more Gazprom execs squeal about shale, the more you know that it is a threat to them.

So yet again: Gazprom gripes–music to my ears.

The President of South Korea goes Jimmy “Sweater” Carter one better on dealing with energy shortages (h/t Renee):

President Lee Myung-bak on Monday stressed the need for public participation in the government’s drive to curb electricity use as it steps up a battle against power shortages this winter.

He urged Koreans to lower thermostat settings, switch off unneeded lights and install energy-efficient appliances in their homes and offices.

“Although the government has drawn up measures to cope with the looming electricity crunch, I’d like to make an urgent request for your participation,” Lee said during his biweekly radio address.

“There are various ways to save electricity in daily life. Recently, I started wearing underwear myself after lowering the room temperature. Though it felt a bit bulky at first, now I feel very warm and comfortable.”

Yeah, I’m sure it’s a translation issue, but I couldn’t resist.

Update.  Renee asks whether President Lee was formerly referred to as “Commando in Chief”.

Gazprom’s oil-linked pricing mechanism is under further pressure, as GDF Suez is also trying to renegotiate gas contracts with the Russian company:

France’s GDF Suez has joined other major European utilities in entering talks with Russia’s Gazprom to renegotiate the price of oil-indexed gas supply contracts, the head of economic research at its trading arm said.

“We are negotiating like the other major utilities in Europe,” said Evariste Nyouki at an energy trading conference.

He added the utility had not started an arbitration process, unlike Germany’s E.ON, which kick started legal procedures to resolve the dispute in August.

One picture (courtesy Mark Perry at the excellent Carpe Diem blog) tells it all:

The gap between US gas prices and world oil prices is approximately 75 percent of the oil price.  Differentials between oil equivalent and European spot gas prices are far narrower, but they are wide enough.  As US gas export infrastructure–which depend crucially on US government approvals (a scary thought given this administration’s energy policies)–comes on-line, however, European and world gas prices will come under heavy pressure, and the already obsolete oil-linked pricing mechanism will become completely untenable.

So expect even more ludicrous Gazprom attempts to rationalize the irrational in the months and years to come.  These will be entertaining, in a perverse sort of way, but ultimately futile.  Economics will out.

The last 10 days have seen events that illustrate the idiotic alpha and omega of the Obama administration’s energy policy.  These tell you everything you need to know about its complete inversion of priorities, and its utter incomprehension of how energy, markets, and government work–or don’t.

On the one hand, there is the Congressional testimony of Energy Secretary Steven Chu defending the $500 million plus Solyndra debacle, news about a Kennedy company with equally illusory prospects receiving a federal loan guarantee almost three times as large, and reports that 80 percent of Department of Energy “green energy” loans went to Obama donors.

On the other, there is the administration’s delay in approving the Keystone XL pipeline, and yesterday’s announcement that the USDA was imposing a six month delay on auctioning shale gas properties in the Wayne National Forest in Ohio to further “study” the surface impacts of hydraulic fracking.

Note the contrast.

On the one hand: An unshakable commitment to throw vast sums of money extracted by coercion from American citizens at delusional, patently uneconomic projects that will produce little energy, and which just oh-so-coincidentally (It is a coincidence!  Really! Chu says so!) happen to be owned by Obama donors.

On the other hand: Using every regulatory power available to stymie the investment of private capital freely provided in economically viable projects that will produce large amounts of energy now and into the future, pursuant to highly speculative–and dubious–theories about the environmental impact of these projects.

The mental vacuum in which these environmental impacts are conceived is beyond belief.  Are trade-offs considered?  Surely you jest.  In the case of Keystone, for instance, the administration did not give the slightest inkling that it had considered the George Bailey question: What would happen if Keystone was not born?  Would there be a greater reliance on the use of seaborne oil transportation, which is far more environmentally risky than pipeline transport?  Would it result in greater off-shore oil production in the Gulf?  (You’d think that the Mocondo experience would make that a particularly salient issue to an allegedly environmentalist administration.  You’d be wrong.)  Would it result in the building of a pipeline in other environmentally sensitive areas (e.g., the Canadian Rockies), over which the oil would be transported and then put on environmentally riskier tankers?

In other words, lavishing billions on unicorn fantasies flogged by political and ideological allies, and throwing regulatory roadblock after regulatory roadblock at real, viable projects.  And both the lavishing and the blocking based on literally incredible environmental theories.

In Federalist #70, Alexander Hamilton extolled “energy in the executive.”  In the past days we have seen an executive devoting all its energies, positive and negative, to pushing some projects that will produce no energy, and to thwarting others that will.   An energetic twofer: they will make us poorer, by making energy more expensive, and they will not help the environment–and will quite plausibly make the environment worse.

That kind of energy we can very much do without.

Free money will not stay on the table for long.  Earlier this year I wrote about the value that was available for the taking by reversing the flow of the Seaway Pipeline connecting Cushing, OK and the Gulf.  ConocoPhillips (COP) owned half of the pipeline, and its refinery operations benefited from the low price of crude in the Midcon due to the backup of Canadian and Bakken crude in Cushing. Hence it balked at reversal. But the differential between the Cushing price and the price in the Gulf meant that it was possible to make COP a deal that more than compensated for any loss in refining profits resulting from a reversal of Seaway and the resulting increase in Midcon crude prices.

Well, that deal has just been done.  Enbridge has bought COP’s 50 percent share of Seaway, and immediately after that announcement Enbridge and Enterprise, the owner of the other 50 percent, announced that they will reverse the pipeline.  150K bbl will flow by the 2Q 2012, and 400K by 2013.

The result?: an immediate compression of the Brent-WTI spread.  WTI nearby is up $2.40/bbl, Brent down about $1.60..

Or you’ve been working to devise US energy policy over the last couple of decades.  But I repeat myself: the latter group is a proper subset of the former.

I am referring to articles running in the official house organs of the conventional liberal wisdom, the WaPo and the NYT, which confirm the obvious: government subsidies for energy, and particularly “alternative” energy and renewables, have proved to be a dreary litany of failure after expensive failure.

These failures were predictable–and in fact predicted.  But the predictions have been ignored.  For decades, as the WaPo article points out in excruciating detail.  Good money has been thrown after bad which had been thrown after worse.  These decisions have been driven by political economy rather than economic calculation.  If something needs a subsidy, that means it costs too much for the value it produces.  Yes, there can be circumstances in which there is some value that is not internalized by the producer, in which a subsidy may theoretically be justified.  But as the historical record makes abundantly clear, that’s not what drives how subsidies are allocated: they come out of the political sausage grinder, and it is politics and political connections that turn the crank.

Whatever you think about ExxonMobil, they deserve credit for not buying into the “beyond petroleum” moonshinery of BP and some other supermajors in the last decade.  During the Bush years, XOM CEOs Lee Raymond and Rex Tillerson steadfastly refused to commit capital into renewables and alternative energy, and resisted playing the subsidy game: they were unabashedly an oil company, and didn’t pretend otherwise.  They had seen the boondoggles of the 1970s–remember Synfuels?–and didn’t want to squander valuable capital on similar boondoggles in the new millennium.  Unfortunately, Congress and two administrations–particularly the current one–haven’t been quite so perceptive.   As a result tens of billions of dollars have been wasted, and wasted predictably.

German energy giant RWE has been hurt badly by the yawning gap between spot gas prices and the prices it pays some of its suppliers, which are based on a formula tied to oil prices.  The firm has made some progress modifying those contracts with its suppliers, notably Norway’s Statoil:

RWE has managed with three of its suppliers to either end some long-term contracts – which in total account for half of the RWE’s gas purchases and run as long as 2036 – or to index them to the price of freely traded gas on European exchanges, it said on Thursday.

But one big supplier holds out.  No points for figuring out which one:

Negotiations with Russian state-owned gas monopoly Gazprom, the world’s largest natural gas producer, are continuing, RWE Finance Chief Rolf Pohlig indicated.

“It’s about a lot of money in an area where we have different opinions. That’s certainly more confrontational,” he said.

Russia is playing “hardball” said Frank Umbach, writing for the Geopolitical Information Service.

“Norway has shown a lot of flexibility so as not to lose important market share in Europe. But Russia considered itself to be in a stronger position and insisted on its long-term contracts,” he said.

The Norwegians are being more reasonable and flexible than the Russians.  Go figure.

But the 25 percent ($100/mcm) price gap between the oil-linked price and current spot prices is putting pressure on Gazprom.  It has made noises about adjusting contract prices:

A $100 gap between the forward price of gas in Europe and the current price of some Russian contract gas points to a possible deal with German consumers, who are seeking relief from high contract prices, Russia’s gas export chief said on Tuesday, Interfax reported.

Gazprom Export Chief Executive Alexander Medvedev, speaking in Lubmin, Germany, following the launch of the first phase of the new Nord Stream pipeline, which will ultimately carry 55 billion cubic metres per year to Germany from Russia along the floor of the Baltic Sea, said gas cost $500 per thousand cubic metres under some contracts this quarter.

Forward prices are now at around $400, he said. “This is a good basis for finding a good resolution with our German friends,” Medvedev was quoted as saying.

It is becoming increasingly clear that the oil-linked mechanism is becoming obsolete.  Gazprom’s arguments about the necessity of the mechanism are risible, especially in light of increasing liquidity in spot markets at European hubs.  Indeed, there is a positive feedback mechanism here.  Wider use of spot pricing mechanisms by Statoil and other suppliers increases the liquidity of trading at European hubs, which makes spot prices from these markets even more reliable as the basis for supply contract prices.  This process occurred after deregulation of gas markets in the US, and soon resulted in the evolution of liquid, deep, and transparent spot and forward markets at a variety of points.  Utilities now routinely buy gas at prices indexed to spot gas prices at these points.

And it is not just gas.  This process is also proceeding rapidly in iron ore, another commodity that historically has been bought and sold under annual negotiated contract prices.  But the development of some modest spot trading soon revealed substantial disconnects between contract and spot prices during the financial crisis of 2008-2009, which drove more activity to the spot market, which undermined the forward pricing system.  As a consequence, the industry moved to quarterly pricing, but that system is now under stress as well:

But this system is now under pressure as spot iron ore prices, at 15-month lows of $128 a tonne, are well below the quarterly price of $175, providing an incentive to steel mills to default on their contracts and buy instead on the spot market.

“This quarterly system, which has been in since late 2009, now looks to be failing,” says Rob Clifford, mining analyst at Deutsche Bank in London.

Another industry figure quoted in the article says that the movement to spot pricing is “accelerating.”  This is an illustration of the positive feedback effect at work.  The more spot trading there is, the less viable negotiated pricing becomes: the process feeds on itself with tremendous speed.

The Chinese were a big force pushing the iron ore industry towards shorter-term pricing mechanisms, and they are evidently taking this lesson to the gas market:

Russian energy giant Gazprom expects to rely heavily on liquefied natural gas (LNG) exports to Asia as talks with China on pipeline gas supply have stalled, the company’s head said on Sunday.

Gazprom has been mired in painstaking discussions with China about Russian pipeline gas supply since 2006 but the talks appeared to hit a dead-end over pricing terms.

Gazprom has insisted on the oil-linked mechanism for sales to China, but the Chinese have said no dice.  Hence the “stalled” contract talks.  Keep this in mind every time Putin or Sechin or anybody from Gazprom say that a deal with China is all but final: that is so much bull.  I know: shocking, isn’t it?  I bet you are so disillusioned.

The threat to move to LNG sales to Asia is just another Gazprom/Russian vaporcontract threat intended to put pressure on the Chinese–just as they use threats to sell to China to put pressure on the Europeans.  LNG is costlier, and definitely not Gazprom’s comparative advantage.  The gas that Gazprom would sell to China is much more efficiently sent to them via pipeline than to other Asian locations via LNG: and don’t think that the Chinese don’t know this.   Moreover, Gazprom would face much more intense competition in the LNG market from not just Qatar (mentioned in the article), but the US and soon Canada which has some geographic advantages in serving Pacific markets and which is facing declining demand for its gas in the US due to the shale boom.  This is a transparent bluff.  It will be called.

So who is Gazprom going to use as its next bogeyman buyer if it can’t use the Chinese to frighten the Europeans and other Asian markets to scare the Chinese?  Martians?

Probably not, given what just happened with Russia’s Mars mission.

In sum, cracks in Gazprom’s pricing structure are becoming more apparent by the day.  It continues its frenzied attempts to paper over these cracks, but these attempts are quite clearly futile and rather pathetic if you think about the economics.  The increase in world gas supplies and the integration of the world gas market with LNG are fundamentally undermining Gazprom’s competitive position, and rendering its pricing mechanism obsolete.  The positive feedback mechanism, in which the improvement of spot market liquidity drives more activity to the spot market and spot-based pricing mechanisms, improving spot liquidity even further, means that all of Gazprom’s frenzy will be for nought.

Which all means that last week’s much ballyhooed opening of the Nordstream pipeline does not represent the harbinger of increasing Gazprom–and Russian–power in the European energy market.  Instead, it is a day-late-and-several-billion-dollar-short (about $9 billion, to be exact) monument to the past.  Yes, Gazprom will likely sell gas through that pipeline for years to come, but it will have to do so at prices determined in increasingly liquid and competitive spot markets

Sucks to be Gazprom.  But it will be fun to watch!

One of the most underreported stories of the last week is the non-demotion demotion of Bill Daley as Obama’s Chief of Staff.  The prevailing narrative is that Daley was ineffective in working with Congress.  This view from lefty Jonathan Chait seems closer to the mark:

Daley, pursuing his theory, heavily courted business leaders. He made long-term deficit reduction a top priority, and spent hours with Republican leaders, meeting them three-quarters of the way in hopes of securing a deal that would demonstrate his centrism and bipartisanship. The effort failed completely.

. . . .

The effort failed because Daley’s analysis — which is also the analysis of David Brooks and Michael Bloomberg — was fatally incorrect. Americans were not itching for Obama to make peace with corporate America. Americans are in an angry, populist mood — distrustful of government, but even more distrustful of business.

. . . .

The effort failed because Daley’s analysis — which is also the analysis of David Brooks and Michael Bloomberg — was fatally incorrect. Americans were not itching for Obama to make peace with corporate America. Americans are in an angry, populist mood — distrustful of government, but even more distrustful of business.

. . . .

Since that debacle, Obama issued a course correction and started pursuing a strategy that’s in line with the realities of public opinion and the Congress, as opposed to Daley’s fantasy version thereof.

There is a core of truth here.  Daley was seen by many in corporate America as someone who would serve as a counterweight to Obama’s leftist instincts.  That’s obviously not going to happen.  And that’s why this story deserves more attention than it has gotten.  It is an indication of where Obama is going. (And just to make clear: I am no fan of Daleyesque corporatism.)

I also surmise that there’s another thing going on here, a Chicago game.  Although Chicago is a One Party State, that party is rent into factions that barely coexist at the best of times, and battle viciously at others.  Obama’s alter ego (or is it Svengali?), Valerie Jarrett, and Daley are from opposing, hostile, factions.  Jarrett was not pleased by Daley’s presence.  Jarrett is a hardcore progressive.  Daley’s goal–as described by Chait–was to soften the progressivism.

Daley’s departure likely marks Jarrett’s victory.  It also signals, as Chait suggests, a turn to a more hardcore progressive policy and strategy: if Jarrett has the wheel, there ain’t going to be any right turns.  It is a move towards the Occupy types and a move away from the corporatist, Democratic party establishment personified by Daley.

Helluva choice, eh?

But it means that the next 12 months will be even more confrontational and contentious, and the next election will be among the most divisive in recent history.  I’m thinking ’68, or something in the 19th century divisive.

Today saw another indication of Obama’s choice.  He has delayed consideration of the Keystone Pipeline from Canada to the US.  This represents another genuflection to Obama’s environmentalist, leftist base.

Substantively, the decision is weak.  Obama said the environmental issues needed further study.  But never have the opponents of the pipeline recognized that there are environmental trade-offs.  Less oil from Canada means no probability of a pipeline spill: it is unlikely to affect the amount of oil produced as Canada can look to other markets.  But less oil from Canada means more oil imports via ship and more offshore drilling, both of which pose their own environmental hazards–hazards that are almost certainly far more acute than those posed by Keystone.  Not to mention the benefits of reducing reliance on oil from places like Venezuela.

The administration also cannot get its story straight.  Today, the State Department said this was purely a department decision, with no White House interference or politics involved:

Election-year politics played no role in the decision, a State Department official said today.

“The White House did not have anything to do with this decision,” Kerri-Ann Jones, assistant secretary of state for oceans and international environmental and scientific affairs, told reporters on a conference call. “They did not direct us to make this decision.”

Funny.  Obama and his Press Secretary Jay Carney apparently weren’t aware of this:

Obama has indicated he will make the final call. In a television interview on Tuesday, he outlined the economic and health criteria he would consider when the State Department’s recommendations come his way.

Activists viewed that as a departure from White House assertions that State was running the process.

White House spokesman Jay Carney played down the president’s comments, saying State was taking the lead but the final decision would clearly represent Obama’s opinions.

“The State Department is part of the Obama administration, and you can expect that the ultimate outcome of this process will reflect the president’s views,” Carney said.

So which is it?

For those of you a little slow on the uptake, discount what the State Department person says.  This was all politics, and all Obama.

This, and the Daley demotion, are clear indications of where Obama is going.  And where he is going is left, and likely hard left.

Well, not real hoppy marsupials, actually.  But kangaroo courts are definitely native to Russia.  Case in point, a story that is bizarre even by Russian standards:

A Russian judge decided to adjourn hearings on a $2.8 billion lawsuit against BP Plc executives on Thursday for one day, saying there were not enough chairs in the courtroom to accommodate the public.

. . . .

Both cases are now due to be heard on Friday, when the judge said the hearings should resume in a bigger room, according to law firm Liniya Prava, which represents the plaintiff.

A spokesman for a law firm which represents BP’s legal interests confirmed the development, calling the decision “a strange twist of the Russian judiciary”.

So somebody wanted a delay in the hearing, and the judge had to come up with some lame excuse.

In another legal story of a company that like BP is ensnared in Russia’s Kafkaesque legal system, Telenor is trying to get an arbitration panel to prevent Alfa Group from engaging in a legal subterfuge in their battle over governance of mobile operator Vimpelcom:

Telenor has asked an arbitration panel to uphold a key shareholder agreement in mobile phone operator Vimpelcom and thereby effectively block the appointment of a new board, the Norwegian firm said on Tuesday.

Telenor’s power struggle with Russia’s Alfa Group intensified in June when Alfa’s Altimo unit said it had cut its stake in Vimpelcom to less than 25 percent, thereby voiding the shareholder deal and allowing a board reshuffle from Dec. 10.

Telenor said in a statement that it believes Altimo sold the stake to a company ultimately controlled by the owners of Alfa Group and that the shareholder pact should therefore be upheld.

“We’re asking the arbitration panel for a temporary injunction to uphold today’s shareholder agreement,” Telenor spokeswoman Marianne Moe said.

And what a coincidence!  Mikhail Fridman’s Alfa Group is at the center of both the TNK-BP and Vimpelcom disputes.  Beware to investors who get involved in anything with Fridman/Alfa.  For you are likely to see kangaroo justice in its native habitat.