Streetwise Professor

I was incorrect to blame the leak of confidential CFTC trade information on the agency itself.  I jumped to a conclusion, and that was wrong.

The malfeasor has been revealed.  It is US Senator Bernie Sanders (Socialist–really–VT):

Oil trading data that exposed the extensive positions speculators held in the run-up to record high prices in 2008 were intentionally leaked by a U.S. senator, sparking broader concern about industry confidentiality as Congress moves on Wall Street reform.

Senator Bernie Sanders, a staunch critic of oil speculators, leaked the information to a major newspaper in a move that has unsettled both regulators and Wall Street alike.

In a June 16 e-mail reviewed by Reuters, a senior policy adviser to Sanders discusses how his office received private data with the names and positions of traders and forwarded it exclusively to a Wall Street Journal reporter.

The e-mail, which also attaches two files with the data, was sent to Public Citizen’s Tyson Slocum asking him to review it and speak with the newspaper about his observations.

In a statement from Sanders provided to Reuters, Sanders said he felt the data needed to be publicly aired.

“The CFTC has kept this information hidden from the American public for nearly three years,” he said. “This is an outrage. The American people have a right to know exactly who caused gas prices to skyrocket in 2008 and who is causing them to spike today.”

No, Senator, the outrage is that you violated confidentiality to engage in political grandstanding.  Moreover, you provide no evidence to support your assertion that the firms and individuals whose identity you revealed “caused gas prices to skyrocket.”  None.

There you have it, ladies and gentlemen.  The Senator from Vermont, providing additional proof, as if any was needed of Mark Twain’s dictum that “America is a nation without a distinct criminal class…with the possible exception of Congress.”

Today’s WSJ has an article that lists the positions of several market participants in the oil futures market on 30 June, 2008, shortly before prices hit their all-time high  This information was leaked by somebody in the CFTC.  A CFTC spokesman “said the agency couldn’t comment because the list contains confidential information.”

You don’t say.  [I cleaned that up.]  Apparently somebody in CFTC didn’t get the memo.

This is egregious.  Truly egregious.  This is highly confidential information.  Its disclosure was clearly intended to advance some political agenda.

Let me hazard a guess what is driving that agenda: next month the CFTC is likely to move on its energy position limits proposal.  The disclosures about the positions held by financial players will no doubt help shape the battlefield for that fight.

I cannot emphasize enough what an abuse this is.

And it will hinder the CFTC going forward.  The agency often relies on voluntary cooperation by market participants to supply data that helps it understand what is going on in the market, or to help develop policies.  Is there any doubt that companies receiving such requests will now think twice about cooperating?

And don’t you feel so much better that under Frank-n-Dodd that the CFTC will have access to far more data from far more markets?

I just shake my head.   And speaking of heads, somebody’s should roll over this.  Maybe several somebody’s heads.

Michael Giberson at Knowledge Problem has an excellent post that illustrates perfectly three fundamental problems with the metastasizing regulatory state.   EPA rules on air toxins and mercury are going to force–or at least accelerate–the closure of large numbers of coal-fired power plants especially in the East and Midwest.

Problem One: making uncoordinated policy decisions that have myriad impacts in tightly connected systems.  The EPA decision focuses on one thing: air quality.  But its chosen remedy has the potential to cause major disruptions in areas outside of EPA jurisdiction, considerations that EPA did not take sufficiently into consideration.  Specifically, the loss of such large quantities of baseload generation threatens electricity supply, and electricity reliability.  The stability of the grid depends crucially on the spatial configuration of load and generation; those have to be balanced tightly in order to ensure reliability.  Shutting down just one plant can upset that delicate balance in a way that greatly increases the system’s vulnerability.  So in its zeal to do good, EPA has created a huge potential for bad.

Problems Two and Three have their roots in EPA’s response to Problem One.  EPA says: “Don’t worry!  We’ll use our discretion to try to mitigate these bad effects!  We might give waivers!”

As Richard Epstein pointed out, Government by Waiver has at least two serious defects.  First, it is an invitation to rent seeking, lobbying, and politicking–all just different flavors of corruption.  Resources are wasted in competing for favors.  And favors are allocated to those who have a comparative advantage in politicking, not those who have a comparative advantage in producing or consuming efficiently.

Second, it creates substantial uncertainty.  Investments in generation and transmission (which can be both a complement to or a substitute for generation) have very long lives.  The return on any investment can depend decisively on regulatory decisions.  Yeah, EPA can say it is striving “to provide a rational basis for utility planning,” but anyone out of diapers knows how the game is really played.  The outcome of the regulatory process is very difficult to predict because it depends on the uncertain outcome of the rent seeking process, fluke events (e.g., one utility is the subject of a damaging revelation, perhaps untrue, which makes it a political pariah), and other unfathomable possibilities.  “Regulatory discretion” is a recipe for radical uncertainty.  Anyone contemplating making a huge investment that can turn into a long-lived white elephant at a regulator’s whim will often decide to wait until that uncertainty is resolved.  Thus, this policy uncertainty tends to retard investment, leading to higher prices and lower reliability.

Markets rely primarily on the price system to coordinate the actions of millions of dispersed decision makers acting on little pieces of information.  Prices tell people about the consequences of their actions, give them an incentive to act efficiently and take these consequences into account even if they could not possibly articulate what those consequences are.

There is no analogous mechanism to coordinate the actions of regulators.  Regulators routinely take actions that are perfectly sensible within their narrow, legally circumscribed spheres, but which impose huge costs elsewhere.  There is a feedback mechanism of sorts, but the ways that regulators respond to the feedback creates its own problems.  In this instance, EPA did something in pursuit of its legislative mandate which will have severe adverse consequences outside of it.  The affected industry howled, providing feedback, so EPA is extemporizing a response.  But that extemporization brings on its own bad effects, in the form of corruption and investment-killing uncertainty.

Like Reagan said: The nine most terrifying words in the English language: “‘I’m from the government and I’m here to help.”

The respite from TNK-BP-Rosneft-related news was broken the other day, with news that the AAR consortium is restarting legal action.  The Gang of Four is demanding $10 billion to compensate for business opportunities allegedly lost as a result of the abortive BP-Rosneft tie-up.  The theory as to how these opportunities are lost and gone forever now that the deal is, well, aborted, is rather difficult to discern from news accounts.

Moreover, minority shareholders of TNK-BP Holdings are suing TNK-BP Holdings, TNK-BP Management and BP Exploration Operations Company, and two BP employees who serve on the Holdings board for preventing TNK-BP from participating in the BP-Rosneft tie up.

AAR denies being a party to the suit, but acknowledges that it had been informed about it, and that the issues raised in the lawsuit are the same as those in the Gang of Four’s actions in the Stockholm Arbitration Tribunal.

Perhaps this is a coincidence, but the private lawsuit is being filed in the same court in Tyumen where a straw plaintiff (a shadowy off-shore investment fund called Fairmex) sued Telenor over Vimpelcom.  The beneficiary of this lawsuit was Alfa Group–the first A in AAR.  Ultimately Telenor capitulated and came to terms with Alfa.

So maybe it isn’t a coincidence: an ostensibly independent group of minority shareholders files a suit in the Tyumen court that benefits AAR.  Telenor’s torturous experience in Siberia shows that the court can exert substantial pressure, enough to compel a capitulation.

In other words, we are seeing a legal pincer movement.  Or perhaps more accurately, extortion by law.  It seems pretty clear that AAR is attempting to compel BP into buying their half of TNK-BP at a very high price.

As I’ve said before, there is a wicked irony here.  BP is being tormented legally for its strategy that relied upon its belief that Russian lawlessness would allow it to flout the TNK-BP shareholder agreement–as long as it had the protection of Igor Sechin.  I still do not understand exactly why BP’s bet failed: whether they got played, or murky backroom politics in the lead-up to the Russian presidential election undercut Sechin, or something else.  But it is crystal clear that its bet failed spectacularly, and now it will pay.  And pay dearly.

ConocoPhillips’s announcement of a restructuring plan that would create separate upstream and downstream companies got me thinking again about the Seaway Pipeline, of which CP is a 50 percent owner.  Recall that the company has refused to reverse the flow of Seaway to go from Cushing to the Gulf despite the fact that Midcon prices are far below Gulf prices.

Indeed, since my earlier post, the divergence has increased. At the time, LLS-WTI spreads were about $12-$14, depending on the delivery month: now they are about $16-$18.  (Here’s a link to price quotes on LLS-WTI spread swaps.)  Since the gain to reversal is proportional to the square of the price difference, a 20 percent widening of the spread (which is conservative) corresponds to a 44 percent increase in the social gain to reversing the pipeline.  That translates roughly to about $3 million per day–at a minimum, under the assumption that reversal would completely close the LLS-WTI gap (except for transport cost).  The figure is larger if–as is plausible–the capacity on Seaway (plus Keystone, when that gets on line) is not enough to close the gap.  As I said before, from the perspective of market participants collectively, it is a no brainer as the reversal would pay for itself within days.  Days.

CP’s restructuring announcement therefore raises a very interesting question: where will Seaway go?  Will it go with the upstream operator?  If so, that firm may have an incentive to reverse, though that’s not crystal clear.  Reversal will cause Gulf prices to fall relative to Midcon and Canada: that would reduce the value of CP production in the Gulf and Texas.  If it goes with the downstream entity, that entity will still have no incentive to reverse–unless it is, uhm, persuaded through some Coasean bargain to let the oil flow free.  A third option is that Seaway could be spun off as part of the restructuring.

What will happen?  I don’t know.  The pipeline is a midstream asset, so it’s not obvious whether it sits more comfortably upstream or downstream.  I can say that the economic gains to reversal are even greater now than earlier in the year when I did my original analysis.  The restructuring provides a perfect opportunity for CP to monetize that value, through some kind of deal with producers tributary to the Midcontinent, or Gulf refiners.

The German Quadriga Foundation has cancelled this year’s ceremony during which Vladimir Putin was to receive the foundation’s reward “standing for freedom and democratic change.”  Apparently many German politicians, members of the German human rights community, and former recipients of the reward had somehow gotten into their silly heads the idea that Putin didn’t deserve a reward for “commitment to innovation, renewal, and a pioneering spirit through political, economic, and cultural activities,” and for those “whose courage tears down walls and whose commitment builds bridges” and who serve as “role models for Germany” and are “role models for enlightenment, dedication, and the public good.”

Yeah.  You say all that stuff and I assure you that the first name that pops into my head is “Vladimir Putin.”

Former recipient Olafur Eliasson (a Danish-Icelandic artist) handed in his prize in protest yesterday.  Vaclev Havel said he would return his if the foundation indeed gave Putin the reward.

As for the political backlash in Germany, it was intense:

Government human rights commissioner Markus Löning said the choice undermined the Quadriga award, which will be handed out on the Oct. 3 national holiday celebrating German unification in 1990, and others questioned Putin’s democratic credentials.

“It is downright cynical to award Putin the Quadriga prize and put him in the same group with Mikhail Gorbachev and Vaclav Havel,” Löning, a member of the Free Democrats who rule with Chancellor Angela Merkel‘s conservatives, told Der Spiegel magazine’s online edition. “It devalues the prize.”

Former Soviet leader Gorbachev and former Czech President Havel are among previous winners of the award.

Löning’s objections were echoed by a senior lawmaker in Merkel’s conservatives. Merkel herself has criticized Putin over human rights in the past.

Erika Steinbach, chair of the parliamentary committee on human rights, said she worried about lasting damage to the award first presented in 2003. It was inspired in part by former U.S. President Bill Clinton during a visit to Berlin.

“If the award’s committee doesn’t send a strong signal for human rights and revoke its decision, the Quadriga prize will be permanently devalued,” Steinbach said of the award that is popular in Germany but little-known abroad.

The initial decision represented Germany at its at-your-feet worst, which, sadly, is all to characteristic of its relationship with Russia, as this long RFE/RL piece makes abundantly clear.  The explanation has to be largely psychological, rather than economic.  Yes, there is energy, but a rational response to that dependence would be to take steps to mitigate it, but Germany–even under Merkel–have time and again done the exact opposite.  The irrationality of this actually reinforces the psychological interpretation.  And insofar as economics is concerned, Germany is a colossus, and Russia a dysfunctional dwarf.  If you think the latter statement is an exaggeration, consider this:

Germany sells more to the Czech Republic alone than to Russia, while imports from the Czech Republic, Poland, Slovakia, and Hungary amount to 40 billion euros ($56 billion) a year, compared to only 15 billion euros from Russia, including its energy [emphasis added].

French dealings with Russia are largely venal.  German dealings are far different–and far more cringe-inducing–than that, but apparently giving an award to Putin was going too far.  It’s a start, anyways.

Free Exchange, one of the blogs at the Economist writes up one of my takedowns of the SPR release.

Bloomberg reports that much of the oil being sold out of the Strategic Petroleum Reserve is being put right into private storage. Which is exactly what the figures in this post showed would happen.  Indeed, the only thing that is preventing more oil from moving into private storage is the fact that market participants now anticipate that it is more likely that oil will be released in the SPR in the future, thereby reducing the returns to private storage.

I can’t believe those that made the decision to release the oil from the reserve didn’t anticipate this would happen.  Perhaps they didn’t estimate the magnitude properly, but that wouldn’t be surprising given that this depends in large part on how market participants expect the SPR will be used in the future.  If they actually thought all of the oil would be consumed over the next month, thereby causing prices to crater, they have no business making such decisions.

The best part of the article is the bonus description of the inane consequences of the Jones Act, which prevents the use foreign-flag vessels to ship oil between US ports.

A few dots.  Maybe they connect.  Maybe they don’t.  But they are very interesting.

Dot 1.  The AAR partners–including Alfa Group–of TNK-BP blow up the Rosneft-BP deal that Sechin engineers.

Dot 2.  Oil pipeline monopoly Transneft excludes TNK-BP from the pipeline to Poland and slashes its shipments to Belarus:

TNK-BP clawed back some volumes but the allocations it got for the third quarter remain below previous levels, said Jonathan Kollek, senior vice president for sales, trading and logistics.

“After 10 years of working with one of our most profitable destinations we are thrown out. Can you say why?” Kollek said in a forthright two-hour interview at TNK-BP’s new headquarters.

The British-Russian venture saw its volumes slashed in pipeline operator Transneft’s second-quarter export schedule to Poland amid a shareholders dispute over co-owner BP’s bid to partner with Rosneft.

Kollek’s boss, TNK-BP shareholder German Khan, fired off a series of letters to top officials demanding explanations over why TNK-BP’s allocations had been cut in the quarterly “graphic” of exports to Poland compiled by Transneft.

The company was told, Kollek said, that priority would be given to companies that sign direct contracts with end users.

Reluctantly, TNK-BP last Friday signed a term contract for the third quarter with Polish refiner PKN Orlen despite having a long-standing relationship with trading house Mercuria to cover its Polish shipments.

. . . .

“On Poland an absurd, non-transparent action forces us to be in a position where we cannot fulfill a commitment to an internationally reputable company,” said Kollek, an Israeli who previously worked for trading house Marc Rich. “We lose money. Russia loses money. We lose face.”

Transneft non-transparent?  Say it ain’t so!  Does Alexei Navalny know?

Dot 3.  Executives of Avianova–majority owned by the Alfa Group that is also in the AAR consortium that owns 50 percent of TNK-BP–are evicted from their Moscow offices:

Guy Maclean, director of safety and quality at Avianova, said he rushed to work last Friday morning after receiving a garbled call from a colleague claiming he had been physically pushed out of the building.

When Maclean arrived, he found “a group of employees around the entrance in a state of agitation. Our lawyer was in tears, and she told us, ‘We’ve all been fired,'” Maclean said by telephone Wednesday night. “I said, ‘Well, who fired you?'”

Maclean noticed two “well-dressed” men in the parking lot who appeared to be watching the commotion. When he approached them for an explanation, one said that “unfortunately the foreigners no longer work at Avianova” because one of the shareholders has “restructured the company.”

“Then he told me that ‘the power vertical has been changed,'” Maclean said. “It just stuck in my head, such a stupid phrase. The whole thing was very intimidating and very unpleasant.”

The man later identified himself as Konstantin Teterin and said he had been “invited by the shareholders to take part in the project,” Maclean said.

Avianova named Teterin, a former deputy director of Red Wings airline who has also worked at Aeroflot and Transaero, as its new first deputy general director in a statement Monday.

The statement said Teterin had been hired to “increase the financial efficiency of the company in line with its strategic goals and development plans.” No mention was made of the dismissal of staff or any restructuring of the airline.

Teterin was also one of the candidates being considered for a board seat at Aeroflot’s annual shareholders meeting Wednesday, Interfax reported. The results of the meeting were not immediately available late Wednesday.

An attempt to locate Teterin for comment was unsuccessful.

In retrospect, Maclean said the only sign of possible change was the arrival of new security guards about a week earlier.

“They were bigger, muscular, in slightly different uniforms,” he said.

He said they had grabbed the British colleague who had called him earlier Friday morning, and when they blocked other employees as well, the purpose of their arrival became clear.

“All I know is my e-mail has been cut off, I’ve been kicked out of the office and I don’t know what’s going on,” Maclean said. “None of us want to walk away from the project.”

Maclean said five staff including a Russian lawyer were barred from the office on Friday, and since then “three or four” Russian staff have also been forced out.

New security guards.  Bigger.  More muscular.  I’ll bet.  Russian rent-a-cops are in a whole different galaxy from your typical suburban mall cop.

This all could be coincidence.  Three unconnected dots in the vast pointillist mural that depicts the ugly realities of doing business in Russia.

But maybe the dots, when connected, lead back to Igor Sechin, exacting retribution on AAR.

This bears watching.

In my weekend post on the IEA/US SPR release, I noted that this was likely to fuel speculation, as now market participants have to divine what the powers that be will do with SPR stocks going forward.  As if to prove my point, the deputy executive director of the IEA made a statement so oblique and open-ended that it would do Greenspan or Bernanke proud:

The International Energy Agency could decide by mid-July whether the release of strategic oil reserves needs to be extended for a month or two, an official said.

The 28-member IEA announced last week a plan to release 60 million barrels over an initial 30 days to fill the gap in supplies left by the disruption to Libya’s output.

Richard Jones, deputy executive director of the IEA, said he believed the release would be temporary since demand would likely drop in the fourth quarter.

“We do believe it could be temporary but we have to see how the market evolves. There could be other disruptions, for example, we are compensating for the losses in Libya,” Jones said at an event in Mexico City.

A decision on whether to extend the release could be made around the third week of July, he said.

“It will be up to our member countries, they could decide to continue it for a month or two. I don’t see that we’ll need to continue it for very long because we see demand declining in the fourth quarter, so we think it’s a temporary measure.”

It could be temporary.  But maybe not.  We could decide to continue.  But maybe not.  It will depend on conditions. Could be this.  Could be that.  Am I making myself clear?

As mud, Jonesy.

Way to inject certainty and transparency into the process there, Mr. Jones! How many traders in Geneva, New York, Houston, London, Singapore, etc., are parsing that statement and other Delphic pronouncements coming out of the IEA?  What mental models are they constructing that will use to try to predict what the IEA/US will do, and how the market will react, and how the Saudis will react, and how the IEA/US will react to their reactions, and on and on ad infinitum?   What data/information will they feed into their models?  How will wiggles and jiggles in that data affect oil prices?

Just what the world needs: more would-be Mandarins trying to engineer outcomes in vast, complex markets, and in the process, unleashing the creative energies and analytical skills of people whose knowledge and expertise should be put to far better uses than figuring out what said Mandarins are going to do and what effects it will have.

There may be a case for strategic commodity stockpiles: I’ve suggested one.  (Hint: it’s a way of offsetting the effects of governments’ inability to commit not to interfere stupidly in markets.)  I can state with metaphysical certainty that whatever that case may be, the IEA’s/US’s current action doesn’t meet its criteria.