Wednesday, December 17, 2014

America, democracy and torture

Did you know that in a recent Poll (yesterday) 78% 59% (if you exclude -- sometime justified) of Americans thought that torture was A-O-K! Jack Bower proved that torture is a righteous tool!  That it works and it should be used.  That its OK for ordinary people to be killed by drones (even though their only crime is to be live in country that are not America).

Across gender, race and income levels Americans are pro-torture!

Right now its foreigners (mostly) that get tortured, but how long will that last, when will it become ok to torture an guy so that he tells you who were his accomplices in a bank robbery (still no problem).  How about we torture a couple of bankers to tell us how the made sure their deals would fall apart... how about then.

How about when Americans protest about their civil rights... a OK turns out they don't care about that either.

Rouble is back... for now, and other news

(1)  Less than 24 hours after the Russian Rouble became unconvertible its back.  Again, this could be temporary, this could be permanent, but its clear that the world's central banks decided that the impact of having the Rouble out of the equation was not acceptable.  

Will it last, don't know

(2)  Yesterday Greece (a non-consequential country) continues to play its political games, the opposition announced that if elected they will repudiate parts of its foreign debt (that's more like it).

(3)  This morning inflation numbers came in (USA) and they are -0.3% for the month; that a 3.4% deflation rate on an annual basis -- fuel cost have half, and fuel is core to the inflation calculator

Where we go from here?  Don't know

(4) Christmas is around the corner, trading (for real accounts and not algo) is about to collapse -- cause the punters are full of turkey.

(5) Heavy oil (Canada) is in the low $40 -- we are close to variable cost of extraction in Canada for the Tar sands.

My gut feeling -- stay away from the trading desk, square your positions the Gremlins have the upper hand here there is no glory in guessing.

Tuesday, December 16, 2014

Could this be it?

I've often said (in this blog) that when the end comes it will come from an unexpected direction.  First off, those who are losing in the oil price "war" are producers - they are many, but they are still far fewer than consumers.  So this correction left a lot of very big losers and many many small winners. This morning the Russian Rouble ceased to be convertible, and "trades" will be unwound.

Russia was always on the edge, its been playing political hard ball for some months/years now. Russia has been funding its world stage presence with oil at $105/bbl.  As the saying goes: "being elegant is expensive", but being a bully even more so!  Especially when a oligopolistic business system is driven by high borrowings -- driven by a desire to limit dilution, but also driven by a junk bond market primed for risk and yield -- in a world of very low yields junk bond financing is attractive.  Russia borrowings were not cheap before -- the prime rate was around 6% a few weeks ago, it jumped to 10% about 6 weeks ago, when the run on their currency started, yesterday they went to 17% in a "shock and awe" exercise -- that failed (it was a good try).  Now short term loans are priced at 19% -- impossibly expensive for a very leveraged economy.

This morning, the Russian rouble ceased to be convertible -- this may be temporary, but it complicates things immensely; lenders have made loans in Euro or US dollars (they didn't want to take any currency risks), with conversion out of the door, these loans/bonds are in technical default -- as the borrowers cannot repay their loans in foreign currency.

My guess is that some "Megabanks" have taken on some massive swap exposure (between the bond holders and issuers) taking-on that Rouble risk (as a nice little earner).  Don't know how this will work out for them?  The biggest derivatives players are: Citibank, JP Morgan, and Deutsch Bank (no position).  Others will also have played -- and lost, but it will take a while for the dust to settle -- trust me it took months for my gang to figure out the "hurt" when Lehman went bust.  The easy part is the banks' mark to market reaction (try to delay).  I have no idea how these exposure will play out -- the real issue is that I am convinced that the senior management in each of these three institutions are equally clueless -- its just too complicated  -- also we are going to witness some massive imbalances in the derivatives books.  The Chinese proverb "may you live in interesting times" would seem to apply here.

It is amusing that Congress passed a new law last week to make derivatives trading even easier and less regulated, timing sometimes is everything.

So, what happens next, don't know (anyone who says otherwise a $#@&% liar), but we can make some broad assumptions:
  1. De-risking is on the cards 
  2. Yields (see one above) are certain to rise -- even for the best credits
  3. You sell what you can, not what you want
  4. Everyone is going to slow down its credit approval process
  5. The banks are going to be looking at where from the bad debt could emerge 
  6. This could slow down economic activity
Again, this could be very local (I doubt it) it could be a short term shock (I hope so) , but it could be something else.  So far the North American markets have been taking this whole thing as "not about us", but I doubt that this will continue, I could be wrong, but this is a massive change, Russia has zero good will in the West, and has even worked hard at making the west look like aggressors.

December 2014 could be a very interesting month -- stay tuned! 

Wednesday, December 10, 2014

First comes the reassurance, then the penny drops


GS says that the extraction costs for Bakken fields (fracking oil) are in the low $40s.... at most.  Well that sounds not right.  First off, this stuff is deep, so deep that at times radioactive waters are extracted at the same time -- the oil has to be heated out of the rock, and then cleaned from all the chemicals used to extract and make it more viscous.  All together this is not a simple process, or inexpensive.

GS is the same gang that says that oil extraction in Libya (where the stuff is almost lying on the ground) is very expensive, but the "North American deep and expensive wells costs are around $40" is their new song -- why?

The reason is that GS is well aware that lots of investors (in the junk bonds they issued over the past few years) are starting to either (a) read the prospectus they were given, and (b) are just starting to panic -- and are thinking the worse case scenario.  Now, I am certain that GS is not lying (hey they know how to be "economical with the truth", but that's not lying) so investors will think (or hope) that its not "their junk bond that's in trouble" maybe its even time to buy some more as "other investors" panic and sell at a discount.

Now, I'm not an E&P guy -- my interest is marginal but there are a number of truism that you must follow for valuations:

  1. Fracking is an expensive process
  2. The wells are deep and require lots of horizontal drilling
  3. Chemicals have to be used to "loosen" the oil from the rock
  4. The oil is considered "synthetic" and sells for less than "light and sweet" from the Gulf
  5. Frackers (not the best term) have used massive amounts of debt (leverage) so as to improve their returns
Dont' forget that GS are the guys who were confident that gold was on its way to sub $1,000 from $1,200 -- of course gold is still around $1,227, so that was not the best call in the world, but within the standard of investment banks absolutely within the standard of protecting their market.  They are probably right there are ways of calculating the extraction cost of Bakken fields at around $40 -- my guess is that you have to make some aggressive assumptions on production yields...

Anyway, this morning WTI went as low as $62.00 -- the ride continues!

Tuesday, December 2, 2014

Oil price, elasticity winners and losers!

Sunday night I began writing on the astounding drop in the oil sector, at the time (Tokyo time 9am Monday) the price of oil was on its way to $64/bbl down from $105 in January -- this is a 39% drop in price -- a singularly important component of the world economy, just became much cheaper. Since then oil prices have risen back to the $67/68 range, so crisis averted...

The retracement in the oil market is natural, a function of properly working financial market.  My guess was that at $64.55/bbl we were looking at a massive natural barrier to further drops, there's a futures market out there, and for the players there are "natural" inflection points.  Now these are usually technical (rules of thumb) issues, but it remains that they are real for the market.  What is happening is "consolidation", the market overshot and now its finding a new (maybe temporary) equilibrium.  Oil prices are not independent, they are a transfer of wealth between the user and the supplier.  Lower oil prices means that the users retain more of their wealth, and the supplier have less to spend.

The big losers:  Countries such as Saudi Arabia that have variable costs of maybe $10/bbl are still doing well, although I understand that to justify the country's "living expenses" $70/90 per barrel is really much more comfortable.  Watch this year -- Saudi Arabia's government will have a sizeable deficit.

The big winners are massive consumers:  China, most of South America, the US (they still import) and Europe.  the big losers:  Russia, Canada, Middle East -- Far East (Malaysia & Indonesia).  So there are winners and there are losers too.

Capital markets will probably not be very happy.  A substantial portion of the junk bond market has financed oil and gas project -- some of these are fine, others not so much.  The real problem is that with the hedge fund industry all bets are off, what in the past would have been a technical default with a covenant renegotiation can become a drawn-out battle for control.  Those who have a small position can easily be crushed by these big players -- logic has little to do with these instruments.

We have witnessed a major shift in the oil&gas segment.  At this stage it is unclear where all this is going; there is no doubt that at $105/bbl there was lots of money hunting new finds.  At $60/70 per bbl there will be less money hunting for new oil finds.  Already certain Canadian oil sands projects are hitting the wall -- at $55/bbl (heavy crude is discounted against the WTI) the economics are just not there anymore.  projects that are already up and running (when the heavy Capex has already occurred) continue to operate, at least as long as the variable covered.

Canada is one of the losers (well Alberta and Saskatchewan the big producers) are hurting, budgets will have to be revised, since the province (where there is no provincial income taxes) lives of the royalties from its oil and gas finds -- very little of Alberta's oil revenues have been saved for a rainy day, mainly because the size of the oil sands (a few hundred years).

So what's the big takeaway here:  First the 35% drop in oil price has transferred wealth from some parts of the world to others -- China, as a massive oil importer, just saw its production costs drop, Russia is not finding this very amusing -- although its production costs are low, but the size of the transfer just dropped.

Green energy solutions were kicked in the teeth, at $105 solar pannels are nearly competitive -- and once you take into account the fixe/variable cost analysis -- solar energy was basically on par with oil.  Now they are 40% more expensive.  This price drop is almost certain to reduce the attractiveness of all green energy projects.

The concern by economist is that everyone has been cooking the books -- just a little; the problem is not the rise in supply but the fall in demand (we now know that Europe's growth last summer was virtually inexistent) we are talking 0.1%.  Although the ECB has targeted inflation rates of 2% -- the numbers are far low (and now with a massive drop in the cost of energy) inflation numbers could go negative -- deflation could be here.

Japan is a mess, China may see some hope out of the lower oil price but as a massive exporter of goods and where its markets (Japan, Europe and the US) are either in recession, near a recession or suffering from low growth -- despite very stimulative policies it may be that its not only the supply side that is a problem, but more fundamentally the demand side of the equation...