Thursday, December 29, 2011

Get Ready: $5 Gasoline on the Horizon

Iran's (probably) hollow threat to close the Strait of Hormuz is a danger that has long faced the oil-consuming world. The 34-mile wide strait offers a strategic chokehold on the Persian Gulf, and Iran appears to have the upper hand in controlling it. In my (as yet unpublished) book Trust Me, I painted a picture of what would happen if Hormuz were closed after an Iranian missile strike on Israel:
Almost 40% of the world's seaborne oil supply goes through the Strait of Hormuz, around 15 million barrels per day. The loss of this oil on the open market, even for a day or so, would send prices even further through the roof. The traders were ready. If the Strait was closed, they would hold and profit. If it didn't they would sell tomorrow morning - and still profit. There was bound to be a bit of a panic in the Asian and European markets when they opened. Oh, life was sweet! Oil markets love a good disaster.
Although Trust Me is fiction, I have drawn a fairly accurate portrait of the oil trading community. Oil is a scarce, highly desired commodity, making it a magnet for traders.

Even at today's prices oil is an extremely cheap source of energy. The reason that prices have been rising gradually but doggedly for the past 30 years is because developing nations need more and more oil to power their cars and factories. But because it comes from countries where democracy is a pipe dream and despots and dictators treat oil reserves as their personal 401K's, it will not remain cheap. From the smallest coup to the most outrageous missile strike against a neighboring country, many of the producing countries' instability is palpable, Every ripple reflects in the price of oil, making the market easy to hype and to spook.

Add to this general uncertainty the snail's pace of refinery development in the western world, and we will see refined products such as gasoline and diesel become increasingly more expensive as demand rises. In fact, the refinery count is decreasing in certain countries. In the US, few permits to build new refineries make it past the environmental lobbyists or local residents. One old, but still productive, 145,000 b/d East Coast refinery owned by Sunoco is slated for dis-assembly to be taken lock, stock and smokestack to India.

Conoco Phillips shut its 185,000 b/d Trainer, PA refinery in September, and Sunoco closed the 175,000 b/d Marcus Hook, PA refinery recently. That effectively removes over 500,000 barrels of refined product per day from the US East Coast market - nearly 3% of daily US consumption.

In Europe the largest independent refiner, Petroplus, has had such terrible margins that its $1bn line of credit has been cut off. It will be tough for it to buy crude to refine if it survives, and even tougher for it to find buyers for its five refineries in this climate if it doesn't.

If there is anyone out there who does not believe that oil prices will stay over $100 a barrel, and probably rise to nearer $200, then they are delusional. And gasoline, jet, diesel and heating oil will rise disproportionately more. Get ready for $5.00 gasoline.

Wednesday, December 21, 2011

Deja Vu All Over Again for JP Morgan

  Twitter is alight with MF Global customers asking for the boycotting of JP Morgan. The bank may have received "stolen goods" when MF Global settled a debt allegedly using $200m of customer money. Dealbook said:
One e-mail chain refers to the transfer of roughly $200 million that MF Global owed JPMorgan Chase on Oct. 28 — the firm’s last business day before it filed for bankruptcy. In that chain, a senior official in the firm’s Chicago office was told to make the transfer, said the people close to the investigation who requested anonymity because the inquiry was still open... The roughly $200 million that JPMorgan Chase received is said to be entirely customer money.
 This must seem like deja vu for JP Morgan, which also pulled a snatch-and-grab before Lehman Brothers hit the dust. JPM asked for two lots of $5bn each in collateral just days before Lehman collapsed, prompting speculation that it and Citi (which did a similar thing) may have caused the lack of liquidity that brought Lehman down. (The case is still in court.)
  I'm no fan of JP Morgan, it comes off as greedy and callous, but from where I sit it looks like it has some bloody good risk management people and processes. Maybe if Lehman and MF Global had had the same, they would still be around.

Monday, December 19, 2011

The Culture of Corruption

  I spent 20 years working on the fringes of the oil industry - mostly writing about trading and oil prices and OPEC, but also broking a bit and doing some (dreaded) marketing of oil price services. Once I left Platts, the oil industry bible owned by McGraw-Hill's Standard & Poors, people within the industry opened up to me a little and I got a taste for just how corrupt the oil industry is. From blatant bribery of government officials to inspectors and, yes, reporters the corruption in that business was (and still is to an extent) all in a day's work.
  The corruption I see today in the financial services arena makes oil traders look like amateurs: Rogue traders such as Kweku Adoboli at UBS, with his $2.3 billion worth of hidden trading losses; MF Global with $1.2 billion of customer money seemingly vanishing into the maw of a bad trade on European debt; Ponzi schemes such as Bernie Madoff's. 
  Few oil traders would steal money from their firms to pay a bribe or for a client's night with an 'escort'. Also, few of them would hide trading losses until they escalated into disaster. It is difficult to hide losses on a cargo that got delivered and paid for. Most of their activities, while under the radar of much of the world, were above board and known by management (if slightly less than legal).
  There is a culture of greed infiltrating the financial markets and it isn't pretty. It leads to the kinds of major corruption we saw in 2011 and all sorts of minor, though still significant, acts of creative accounting which we may never see. But shareholders and customers of these firms are paying the price. Occupy Wall Street may have had a point, even if they weren't quite sure what it was.
  Happy Christmas!

Monday, December 5, 2011

MF Global Story Goes from Bad to Personal

  The MF Global story gets worse and worse; the firm had been dipping into client funds for weeks and the customer shortfall may be as high as $1.2 billion. Therefore I was thrilled to hear that the Board resigned last week, and that Jon Corzine will be forced to testify in front of Congress. Meanwhile regulators moved quickly for a change. Bloomberg reported:  
U.S. derivatives regulators voted today to restrict how brokers can invest customer funds, acting on a delayed rule after as much as $1.2 billion went missing before MF Global Holdings Ltd. sought bankruptcy protection. The Commodity Futures Trading Commission voted 5-0 at a Washington meeting to limit how brokers invest clients’ margin in money market funds, and ban investments in foreign sovereign debt and in-house transactions such as repurchase agreements.
  This is a good start, but it doesn't address the client money segregation bit of the problem. In today's FT, two professors had some suggestions though. Darrell Duffie, Professor of Finance at Stanford University’s Graduate School of Business, and Joe Grundfest, Professor of Law and Business at Stanford Law School and a former Commissioner of the SEC, penned a comment suggesting that the rules be more stringent. 
  They offered two possibilities: 1.) Segregate customer funds with an independent custodian, and 2.) Form an information-technology firewall at the broker, creating a “virtual custodian”. Both of these are valuable and realizable solutions. So why did the comments to the article say things like this is "old news" and one wondered why such a big deal is being made of "tiny MF?"
  I'll tell you why it is a big deal. A good friend of my husband's, his boss, and some colleagues of his are missing hundreds of thousands of dollars of their investments. MF Global has made good only a tiny percentage of their money thus far, and they are very concerned that they may not get any more back. And I know people who are MF Global employees, they are also receiving a good rogering by the firm; part of their compensation was tied up in MF Global shares which are now as good as worthless.
  The fallout is large, it is personal and it tells a story of what happens when transparency is not mandated. And although investors are getting more savvy, as purported by the FT's Gillian Tett's column on November 24th, it should not be incumbent upon them to inspect every crevice and cranny of their broker's books before they turn over their money to be invested.