Banking Crisis - again ...

Commodities down on banking stress

Here at C@W we pride ourselves on having spotted the "2008" banking crisis in the summer of 2007, when two German banks went down, followed by Northern Rock - all three being canaries in the dank, dirty coalmine of culpably fatuous and irresponsible banking strategies being practised deep underground, that turned out to be systemic.

So what's happening now?  It doesn't look good.

• Silicon Valley and Signature
• Deutsche Bank (again) and Credit Suisse
• risk to economic recovery due to reduced bank lending
• likely response of the authorities: back to QE! (interest rates coming off already ...)

Thus far, the current banking woes have been accompanied by a pronounced downtick in commodity prices.  If, on the basis of economic contraction, that persists then maybe inflation doesn't just take off again with QE ... and people are forever pronouncing on the Chinese property market ... but I'm no good at predicting these macro phenomena.  (What's more, I don't know who is.)  Are you out there, CU?!

ND

Decline and Fall of Exxon

What a story.  Exxon, once the greatest corporation in the world, now struck out of the Dow Jones Industrial Average and eclipsed in market cap by a wind-farmer!  OK, every traditional energy stock has received a smacking this year - some reckon that 2019 will prove to have been 'peak oil' - but Exxon stands out from the Shells, BPs, Chevrons and Totals as having been in slow and steady decline for years before that. 

This is the firm that was the triumphant main survivor of the anti-trust purges against the Rockefeller / Standard Oil empire; that for decades managed its stock price carefully through a strategic buyback scheme, so that every pension fund in the USA had more Exxon in it than anything else.  That was AAA rated long after that became a distant memory for industrials.  That was totally self-confident in its own strength and abilities; that would blithely flout US sanctions if it chose**; that had every bank in the world at its beck and call; that remained magisterially above the hurly-burly of politics, domestic and foreign (until Russia expropiated some of its stake in Sakhalin, to the company's utter amazement: that's the kind of thing that happens to the others, but not us!).

What happened?  

It certainly wan't a single bad decision.  I know Exxon well, having dealt with them at length in several different manifestations.   On the one hand, they were (let's start in the past tense) totally confident in their own abilities.  They never recruited from outside: everyone started at the bottom of the Exxon pyramid, and at each successive layer a few more would drop off.  Management were trained to be generalists in a laudable programme of assignments to widely varying divisions.  If you'd never worked in the corporate treasury, that was a very good reason for being given a role there for your next job.    For this to be feasible, numeracy was the primary requirement; and training needed to be superb.  In technical subjects, it was.  There was an Exxon way of doing things, in almost every sphere.  By dint of the 'no external recruiting' principle, nobody knew any different anyhow.   By its own lights (share price, credit rating, ability to take on global mega-projects only Shell could match), this all clearly worked superbly well.  If you liked being in a competent, well-resourced, confident, and hence relaxed environment, you could have a very happy career.    

The downside?  Well, arrogance, natch.  And total insularity.  Exxon had no idea what it didn't know.  Like, absolutely none whatsoever.  This even included what else was going on in the oil industry, if Exxon didn't participate in a particular corner of it.  This extended to what were the lastest technical breakthroughs, if Exxon hadn't been involved.  (I was once set on, as an outsider, to conduct a formal enquiry into a vexed distortion in the UK oil taxation regime and the various ways most companies were finding to dodge around it: HMG wanted to straighten it all out.  I was invited to interview any executive in any company I chose and - on the strict basis of 'no names mentioned' - demand full candour from them.  This was forthcoming, and we bottomed out the loophole issue quite easily.  Exxon, naturally, insisted on being one of the interviewees (fair enough): they sat me down and earnestly assured me, with transparent good faith, that nobody in the industry was dodging anything at all, and the whole thing was a big misunderstanding.  Well, they certainly weren't dodging; they showed me their books.  They had absolutely no idea what the rest of the oil patch was up to.)

A subsidiary failing was their total lack of interest in entrepreneurial activity.  They made their money by being (as they saw it) the best engineers with the biggest balance-sheet, who could thereby command a monopoly on the biggest and most lucrative challenges / opportunities in energy.  Anyone piping up with a smart idea for making a few extra bucks was told to get back to their desks: too small to be of interest.  That's an attitude that corrodes the spirit of many of the brightest and best.   

Well, they've had a good run: but for years now it's become obvious this introspective giant was going to stumble really badly if the world moved on.  They'd never realise what was happening outside their frosted windows, for one thing.  And when the need came for nimbleness?  Forget it.  (There was once an Exxon CEO who said he was going to "teach the elephant to dance".  No chance.)  Two years ago they announced they were going to get seriously into trading - as had, for very many years past been Shell, BP, Chevron, Total ... et al, ad infinitum.  What: a massive oil company, not in trading?!  Yup.  Trading was evil.  If you give the toys to the boys, the boys will play with the toys; and then where would we be?  Nope, we'll be self-sufficient, thank you very much.  Well: try changing course in a volatile, fast-evolving commodity market without a good trading division.  Can't be done.  Needless to say, their new efforts have made no impact.

If the world moved on ... and so it has proved.  Exxon is now pretty paralysed, with most discretionary expenditure frozen while they figure out what the Hell to do next, as the rest of the western world heads along different paths towards Net Zero 2050.  (You can see them thinking:  the world will still need oil ... maybe there's a niche for just one unreconstructed old dinosaur ...) Their credit rating is still AA - albeit having been downgraded this year by both S&P and Moody's, and with negative outlook - so there's never any problem raising $$$.  They might still lash out on something left-field (like in the 1980s when they decided to beat IBM at office systems - sic ++).  

Chances of success?  Pretty low.  Still, it's a big corpse for many a vulture to feed off (see footnote) over the coming years.  My name is Ozymandias ...

ND

Update:  I found the "elephant dance" story online

_____________

**  yet again, a story for another day (perhaps when the corpse has been interred)

++ from wiki, the story of a highly instructive $1bn Exxon cockup of old: 

Under the guidance of its paid consultants at Boston Consulting Group, Exxon announced in the 1970s, that it would compete against IBM and Xerox. The mantra was ‘Information Is the Oil of the 21st Century’. It launched Exxon Office Systems, which predictably failed, since "the giant oil company failed to fully realize the subtleties of managing small high-tech companies." In the early 1980s, Exxon retailed its fax machines and software through Sears. Exxon announced the closure of the venture at the end of 1984.

Oil ain't free

Really despair at the media approach to the world currently, everything is shock and awe and it shows up how few of the journalists really understand much about anything.

Yesterday was the last day to complete on storage contracts for May in the USA. With a huge fall in demand, production is way ahead of needs. As you would expect the price of oil has been falling, but it has to go somewhere. One little understood aspect of oil production is that once a well is drilled you more or less have to keep it swtiched on - if you cap and stop the flow it might never work again - or only at huge cost to re-start. So you can throttle back production but the rule is don't stop the flow completely. Over-supply is hard to contain.

Also, as a business generally you need cashflow, in Oil and Gas the expensive bit is the exploration and production set-up. Literally a sunk cost. So, to pay your loans back you produce - the price don't matter so much. All the calculations of around cost of production are of course a projection across the lifetime of the project - there is little real-time cost. The daily production cost is very small, it is the financing and set-up that swallowed the investment.

Anyway, in the US some less than smart people decided that going long physical oil whilst the price was low would be a smart thing to do. Those who trade a lot, just laughed; they bought the storage contracts as they felt the physical price was being held up given the demand shock. Try taking physical delivery with no storage. This is what happened yesterday, dumb money getting eaten by smart money to buy storage and get rid of the oil. A good lesson in not to interfer in things you don't understand.

Addtionally, whilst we are on oil prices, China bought a year's worth of physical supply from the US last week at $7 per barrel. Saudi was trying with Russia to sell at $10 to kill the US Shale producers. Now who is laughing. The shale producers may not make it, but neither will the Saudi or Russian budgets.

Plus of course, this demand shock is very deep. Anyone fancy a long-haul holiday this year? Thought not. How about a cruise? Drive to Milan? The only thing even close to this was the 1974 oil shock which was a Government led demand reduction. The idea, also floated today in the media, that there will be some big re-bound to $80 in a year is hilarious. The world is literally full of ships with unused crude  - it has been around for hundreds of millions of years, it is not a perishable good. Months of normality to burn off this surplus and as I just said, normailty is for 2021 people. Yes, no new exploration will be done, but with such massive over-capacity in USA, Russia and Saudi we are looking at a few years of low prices, not a few months.

So, no the real price of oil is not zero but may get close, but it won't get there for us petrol-station using people (tax will end up as near 90% of the price we pay!). Nor there will not be some easy spring back and yes Oil dependent nations will feel a fiscal shock - but who isn't today? Not the big deal many may think it when put into the context of the global recession facing us all.

How Long the Dollar as World Currency?

BTL in a recent post, Anon asked for views on how much of the present ME unpleasantness is explained by US desire to maintain the dollar as the currency in which the world buys oil?   Anon went on to mention that Gaddafi head been mooting a barter scheme to circumvent dealing in dollars before his demise.

This is quite a long post so I'll summarise here: not really plausible, IMHO. 

It's not an academic response, nor does it contain any quantified macro-economics (my being in neither profession): but after a career in pragmatic multinational micro-economics - the energy business - I do have a number of practical observations.

*   *   *   *   *   *

1.  Liquidity / critical mass is vital in every sector.  Nothing stymies business worse than non-fungibility and non-convertability.   Needless to say, if anything that has "currency" today is doing a halfway satisfactory job in the market, that militates strongly against the adoption of anything else.  The intertia / barriers to entry & exit are great.

2.  There have long been plenty of national-pride-based attempts to drag the commercial world away from Anglo-US dominance of the instruments of liquidity.  In my own sphere: many countries hate having their oil priced against Brent (which almost all crude oil is, except US production), let alone in dollars; and there have been attempts to establish marker-prices for other blends, and to have them traded in other financial centres.  Kuwait Blend; Urals Blend, Dubai ... they come along, they get reduced to a basis-differential against Brent, and the world carries on.  And this despite apparently formidable technical difficulties in maintaining "Brent" as a marker (due to terminally declining North Sea production).  But the clever chaps in London cunningly keep extending the definition of the blend and - thus far - they've had total success.

Likewise, and to Anon's question, lots of folks have dreamed of having oil - even just their own local production grades - priced in their own currencies.  You might justly argue that provided there is full FX convertability between those currencies and USD, what's to stop them?  Answer: nothing - except it would be entirely empty.  The whole business world speaks English (and reads the FT), not Russian or Mandarin.  Arbitrage ensures "their" price would always be (Brent USD +/- basis)*FX.

As regards barter schemes ... well, money was invented, partly because there are distinct, nay fatal limitations as to what barter can achieve.  So I don't think Gaddafi represented any kind of threat to dollar oil trade.   BTW, the Russians have tried to sell gas to China in complex packages with industrial equipment - but the Chinese are having none of it!  Cash on the nail, so far as they are concerned.

3.  Some things do change & evolve: but typically only for very good reasons (which do not include national pride).  Example: the first natural gas trading hub in Europe was the UK's "NBP", and European gas prices for many years were given as NBP (+/- basis).  How logical was this, when the UK isn't remotely the centre of gravity of European gas movements, and the Eu deals mostly in EUR?  Very logical indeed - when only the UK's gas market was truly liquid.  However, over time, unsurprisingly several other hubs emerged as the rest of the EU belatedly caught up on gas trading (well, sort-of), one of which - the Dutch TTF -  was very much closer to the continental centre of gravity than our peripheral island market.  A German hub would have been just as likely a candidate: but the Germans genuinely don't understand how markets work, and screwed up their market design.  The Dutch are much better at it: and so today the TTF is more usually given as reference point for "the gas price in Europe".  (By the way, NBP and TTF trade at incredibly high correlations and the basis differential is always easily rationalised - as you'd expect, because they are both liquid, and generally inter-connected physically.)

4.  So: given that things can change over time and with good fundamental reasons, who's to rule out everything coming under Chinese hegemony in the long run, when their economy becomes dominant?  Well, in the very long run, maybe.  But right now they don't really understand markets either, nor indeed quite How The World Works.  Case in point: they'd spent years cultivating Gaddafi (for his oil), and were gobsmacked when "the West" just did away with him one day.   WTF?, you could hear them saying.   And, to their disgust, right now large & mainstream Chinese firms are obliged to, errrr, kowtow to US sanctions on Iran, much as they'd like to exploit the situation commercially. 

Of course, they hate this stuff and have every intention of supplanting it.  One day.  And who knows, maybe Trump will so overplay his hand, he'll help them accelerate the process.

Then again, the French have long hated the use of the English language everywhere - and most specifically in the organs and councils of the EU.  Tough titty, mes braves; not even Brexit is going to change that. 

No lengthy post is complete without an army anecdote.  All army vehicles come with a comprehensive toolkit.  But as I quickly discovered when becoming responsible for a troop of 30 vehicles, there's only one item out of a dozen or so that's ever taken out of the box, and which is permanently going missing - the Spanner Adjustable.  

Yes: some things turn out to be Really Useful.  The English language, the Brent oil contract, and the Almighty USD are excellent examples.  The clever Chinese will need to come up with something even better if they want any of them to be superceded.

ND

Saudi: Feels Like a Classic Scenario

Did We Say 'Gas and Power Prices Up' ?  Oh yes we did.

But it looks as though we ain't seen nothing yet.  Live by the drone, die by the drone: and bombing Saudi oil facilities, whether by Yeminis or Iranian proxies, is the stuff of classic scenarios for it All Kicking Off.

Several major economies on the brink of recession ... China widely felt to be a lot less robust than they'd be keen to have you know ... Europe thoroughly distracted ... Hong Kong in turmoil ... wars and rumours of wars ...

Yes, a classic scenario.  Hold onto your hats. 

ND

Oil price:  instant reaction

OPEC price restrictions still works but for how long?

The oil price, which goes in and out of fashion, has had in interesting 2018 so far. Last year, OPEC finally managed to get Russia and Saudi to agree price cuts, which together with falling exports from Nigeria and Venezuela (due to incompetence and corruption) had offset the rapid rise on Iran and Iraq as producers.


The next impact was to see oil prices recover last year from the multi-decade lows to around the $40-$50 per barrel. Indeed by the year end the trend had take the price over $60, way above where any predictions are.


However, there is still a big variable. The USA has become a bigger supplier of crude than Saudi Arabia, second only to Russia. The shale oil that the US has is ready for export and the US refineries don't rely on Saud anymore with imports down heavily to less than 10% of the US market.


Shale is now profitable at the $60 mark quite easily and rig counts are rising slowly in the US. So this may well put a cap on the price rises, even as Russia has agreed to extend production cuts (incidentally and anecdotally, supplies of processed oil from Russia are being pushed away from Europe to China, which long-term the Kremlin sees as a more stable political ally - good luck with that!).


So to date in 2018 we have seen a drop off in the price of crude, perhaps marking the top of this recent boom and seeing a more stable pricing for the rest of the year. A benefit of this to the little UK play in oil and gas is that $60 also works, just, for the remaining North Sea oil so there should be a small recovery in Scotland that is more sustainable.


All of this has big impacts on geopolitics, it is not coincidence that Saudi is throwing its financial muscle around whilst it still can.

Oil Price Forecast? 'Up' or 'Down' Would be Nice

Writing as someone whose willingness to be tempted to say stuff about future oil prices has (rightly) been mocked, I had to smile at these two adjacent headlines:

Oil Price: Hurricane Harvey Is A Disaster For OPEC ... refinery outages could eat into crude oil demand for quite some time: Goldman says that the supply outages could be outweighed by the destruction of demand.

Reuters: Harvey may succeed where OPEC has struggled by boosting oil prices ... according to a report from S&P Global Platts, onshore shale oil output was in the storm’s path ... and producers in the region have idled production.

See - nobody knows!  And that's before Fat Boy exploded his H-bomb: stew that one in!  The Beeb is in on it, too:

Why economic forecasting has always been a flawed science: Radio 4 examines why experts often get predictions wrong – and meets the people who get them right 

More like they met a handful of stopped clocks who presumably told the time correctly on a couple of occasions.  Nope: 'experts' can't even agree on up or down (and when they do, it's probably time to go contrarian).  There are many, many reasons to agree with Keynes, Galbraith and Drucker that price-forecasting based on 'fundamental analysis' or similar is not intellectually respectable.  That's quite apart from its track record being diabolical.

Still, people believing in forecasts are what makes the world go round.  The bookie always has a deal for you ... and all those spec assets become sunk costs.   Well - someone had to build the railways.

ND 

Not Looking Great for OPEC & Co

The complexities of the internal politics of OPEC leave me reeling, but they won't get any less fraught with this as the backdrop.

Yes, the great effort to sustain $55 looks to have failed comprehensively, and US shale production storms ahead anyway. 

$45 it is, then, which looks like serious trouble ahead, from Nigeria to Saudi to Moscow.  Economic migrants?  We ain't seen nothing yet.  One that saddens me is the hard times that have befallen Oman, my favourite Gulf state, a country I keep up-to-date with in an occasional way.   It's a benign little regime, and used to be able to afford all manner of nice civilities: but all that largesse had to come from somewhere.

Yes, casualties aplenty and worse to come, no doubt.  As noted before, perhaps $100 oil was the 'tax' we paid to keep everyone happy.

ND

Fracking Across The Globe

Been a bit busy of late but a couple of Grauniad headlines still caught the attention over the weekend, starting with the latest update from the increasingly active northern shale gas drilling scene:

Shale gas firm Cuadrilla brands anti-fracking activists 'irresponsible'  -  CEO Francis Egan complains about protesters ‘harassing’ contractors supplying Preston New Road site in Lancashire

Yes, after a very long hiatus the North of England Shale Show is back on the road!  Or being hindered by a roadblock, as it would seem, because there's plenty of pesky opposition - the usual combination of genuinely local nimbys, misinformed 'ordinary people' with too much time on their hands, and itinerant swampies now trading as Reclaim The Power.  (You'd imagine the hyperventilating hoards of Momentum wouldn't be far behind, except that they are fully occupied with fratricide just now.  And I'm guessing t'unions may have told Corbyn to keep out of it, based on how they made him support nuclear in Copeland.)   An enjoyable line in outdoor relief for all concerned (plus overtime for Old Bill) - except for the local contractors.

But shale in the UK never looked to be a near-term phenomenon (we've discussed this all before).  Even if the reserves are as big as Cuadrilla believe, in broad-spectrum practical terms they just ain't particularly accessible.  A far cry from the USA, where the recent OPEC-driven rise in oil price is, though rather modest by the standards of 2010-2014 prices, more than enough to re-ignite the mighty shale-drilling activity there, oil and gas.  This comes as a big shock to legions of idiots who consoled themselves with the thought that shale needed a price of $100 - or was it $80? - or $60? - to be viable.  Sorry, but technology doesn't work like that: it gets better and better, cheaper and cheaper, and always surprises idiots.  If in doubt, go short - because there's always more stuff out there than anyone thinks. 

This leads to another mighty quandry for all the antis who thought they could put moral / financial pressure on big companies and pension funds etc, to effect some kind of investment boycott of the fossil fuel industries, and force the authorities to mark down oil company oil reserves as stranded and worthless.  Why, the Grauniad itself even tried to run a campaign along these lines. Which brings us to the second headline:

Environmentalists urge French bank not to finance Texas fracking project Activist points to ‘hypocrisy’ in BNP Paribas’s involvement in south Texas export terminal, given bank’s claimed commitment to the environment

Well, sorry guys but shale in the USA is 100% mainstream now and you won't actually find a major bank or indeed any other financial institution that isn't already 'in'.  Because, as we know, shale is going to make the USA self-sufficient in energy as far forward as anyone can see, with momentous geo-political implications.  And that's before Venezuela lets rip, because they have more accessible shale oil reserves than Saudi has 'conventional' oil.  And (when they need the extra reserves) Russia has more gas than the world will ever need.

And the IEA - which is seriously schizophrenic on this issue, BTW - thinks we need much, much more oil ... (well, that's what it thinks this month).

Anyhow, Swampy and Cuadrilla will no doubt continue to slug it out in Lancashire.  But they are a sideshow of such small proportions, it'll make Paul Mason's head explode one day.

ND

OPEC's Oil Price Fix - Is That All You've Got?

So - OPEC finally came up with its production-cutting deal last November, and sure enough, up went the price of crude.  Members' discipline has been OK (Iraq and Venezuela excepted) but, needless to say, it's been heavy going for the Saudis, who have needed to hold back rather more than agreed to achieve even this ...

Pretty feeble for a price-hike, huh?  And US oil stocks are high right now: and the hedge funds are holding record long positions in oil (nearly 900 million barrels) - whatever you think that means.  But $55 is quite enough to get the great shale-oil venture back on the road, and the US 'rig count' has been climbing since its low of May last year.  A bit of a cyclical upswing, to be followed by a cyclical production response ...

In case anyone doesn't know, as this new(ish) development in fracking technology really gets into its stride the Middle East is living on borrowed time because (a) the USA now knows it has all the oil it will probably ever need; and (b) should there be the slightest error in that calculation, it now transpires that the world's largest reserves belong to ... Venezuela.  As for gas, if Russia can ever get to grips with the fracking technology (shouldn't be beyond them), they have so much more gas than everyone used to think, it's quite off the scale.  Enough of all these hydrocarbons to make a Green weep.

Venezuela, eh?  The politics of the western hemisphere may get quite interesting down the road.  A good job for them President Trump doesn't need to go looking abroad for US supplies.

What price that slice of Aramco then?  The 'risks' section of the prospectus should make interesting reading.  Remember, anyone caught lying in a prospectus for a Wall Street flotation goes straight to gaol, do not pass Go.  It's taken very seriously there.

ND