Some housekeeping: It’s the Easter holidays so posting will be intermittent and light for the next two weeks. But not totally absent!
Finance, markets etc…
- Pippa Malmgren on the off-balance sheet world.
A really interesting piece that essentially makes explicit what has been implicit for a long time. That globalism and open source practice has encouraged the government to increasingly spin out its operations in ways that makes a lot of government activity much less accountable democratically. I also wonder if it emulates the sort of corporatism that favoured in Mussolini’s Italy?
- Zoltan Pozsar of Credit Suisse is back with a follow up.
The theme is the same: the end of the petrodollar and the rise of Bretton Woods III. This time, however, Zoltan’s chief concern is why did the ECB turn down commodity traders’ plea for funding support? He equates this to a call for emergency liquidity assistance, which I think is fair. There’s some talk about the futility of central bank intervention in commodity markets in that context, because commodities can’t be printed etc etc. Agree with that too. Even so, there’s also an assertion that central banks might yet be convinced to intervene to help fund the expanded balance sheets needed to trade commodities at this point. But Zoltan’s argument is that it will likely come at a cost, and that cost could be nationalisation. As Zoltan notes: “We are not talking about Russia nationalizing the assets of BP. We are thinking about parallels to AIG, where liquidity assistance came in exchange for a steep equity interest, and AIG having to sell its stake in AIA. Maybe it’s a good omen that the SNB is an experienced investor in equities – a good omen for the New York core, but not for the equity investors of commodity trading houses.”
I predicted a while ago that all ESG roads would eventually lead to international confrontation, nationalisation or protectionism one way or the other (and I’m sticking to the argument that the current debacle is ultimately the result of ESG and net zero policy). So I’m going to agree with that too.
But two additional thoughts struck me while reading Zoltan’s latest. The first was that central bank intervention in commodity markets is not without precedent. It’s just that in the past it’s come in the shape of the Joseph and the Pharaoh model, i.e. creating a buyer of last resort in over abundant times (counter-cyclical times) to ensure supply and demand can be smoothed over into times of shortages, in a way that allows inflation expectations to remain lifted in what would otherwise be deflationary periods.
Most of the stuff I previously wrote about the topic in FT Alphaville was during the deflationary period of 2010-2011. The arguments were focused on having the Fed intervene in commodity futures to flatten energy curves so as to dampen speculator effects, which at the time were incentivising contango hoarding and over-investment relative to current demand.
To support the view I cited a 2010 article by Hilda Ochoa-Brillembourg, a former World Bank official who helped to set up investment manager Strategic Investment Group, in which she argued that the Fed could sell futures on the curve to better sterilise QE. I thought this was an interesting idea. Obviously it wouldn’t work today. We are in exactly the opposite situation: we are suffering from under-investment and underhoarding in commodity markets. But it did make me wonder if the Fed buying futures on the curve to drive up a mega contango, could be a neat (and arms-length) way to incentivise the market to accelerate energy investment and commodity purchases.
While it’s true that neither the cbank or the government can print commodities, the most powerful thing they can do is guarantee future market demand for any commodities produced from investments undertaken today. And this, ultimately, is what the market needs to correct imbalances as quickly as possible and what banks need to de-risk lending to commodity traders so that trade does not seize up today.
If in five years time, global political stability is back, mutual assured nuclear destruction is off the table and we’re all mates who can focus on fighting climate change again — then those future government commodity purchases can simply be put back into the ground or into an SPR that is never burned. But they won’t be entirely worthless “stranded assets” either. They will be valued in the same way that nukes are on any sovereign balance sheet: as a national security asset which the country hopes it will never use, but which can be simultaneously used to dissuade enemies or aggressors from taking advantage of energy insecurity.
This by the way is exactly what the US did with the Bioshield Act in the name of biodefense. In the wake of the anthrax attacks in Washington in 2001, the Bush administration passed legislation that committed the US government to purchasing billions of dollars worth of anti-anthrax vaccines from private sector pharmaceutical companies for the purpose of forming a strategic stockpile of vaccines to dissaude potential attackers. The idea behind the legislation was centred on the fact that without government support, pharma companies would have no incentive to research, develop or manufacture such vaccines. Whether the vaccines were used or not did not matter. What mattered was the defensive role the stockpiles would play in the national security situation.
Of course, the downside of such intervention is the growing government influence over the affairs of private sector companies. To what degree are such government contractors just extended government departments? And to what degree is the work they do, just outsourced government work which escapes direct democratic scrutiny? Which reverts to Pippa’s off-balance sheet world point.
The second thought I had related to whether commodity traders could be granted their own banking licenses and/or direct access to the central bank balance sheet? We did it for investment banks. And we did it for money market funds. So why not do it for commodity traders, who themselves already operate as credit recyclers and intermediators? This, or a walk down of Basel III, seems inevitable to my mind.
- Elon Musk trashes ESG and buys a big chunk of Twitter.
The two together hint to me that Elon is about to use the principles of ESG investing to fight the principle of ESG investing — in the first instance by furthering his own “social” political agenda, which is focused on free speech. It may also prove an interesting exercise in figuring out whether activism trumps divestment.
- My first piece for Bloomberg in which I argue that Russia is moving toward a tiered financial system, using rubles for enemies and bitcoin for friends. But also that it’s tried – and failed – with this strategy before.
One after thought is that I hope this encourages the West to actively differentiate itself by using financial technology to further freedom, liberty, privacy and personal empowerment.
On the subject of “off balance-sheet” my thesis is that Enron’s tripartite prepay funding (70% of their income never existed) was broadly adopted from 2001 onwards and that ICE was founded by Gary Cohn (GS) & John Shapiro (Morgan Stanley) over dinner as a vehicle for systematic financialisation of energy markets generally and oil specifically.
The only market which was not financialised in this way was base metals, because China/HK outbid ICE. But LME was nearly killed off anyway because the “for profit” operators failed to regulate rampant speculative participation cf nickel.
In my view, there has been a realisation at inter-state/global corporate level that the current market paradigm of allowing passive “inflation hedger” participants to financialise markets and price formation is no longer sustainable. It seems to me that one of the aims of the US Energy Dominance strategy (announced the day before Saudi ceased to use the ICE BWAVE benchmark) is for the US to dominate oil price formation (via the new WTI Midland AGC contract) and moreover to thereby peg the US Dollar to Us shale oil via macro tripartite prepay shale oil funding as follows: 1/ Big 4 bank PropCo/OpCo shale oil production sharing LLC (announced late 2019 or so); 2/ WTI Midland AGC futures sales (initially China, but potentially Japan, EU or other state sponsored long term buyers/refiners) with futures margin collateralised by Treasuries 3/NotQE liquidity privided by the Fed as the third party in a macro Enronisation.
Izabella, you note, “I predicted a while ago that all ESG roads would eventually lead to international confrontation, nationalisation or protectionism one way or the other (and I’m sticking to the argument that the current debacle is ultimately the result of ESG and net zero policy). So I’m going to agree with that to.” Could you put in a few links to that writing?
“In the long run, depriving national energy assets of formal funding only opens the door to a transfer of ownership away from responsible investors to irresponsible ones. Worse still, it opens the door to ownership by foreign governments or bodies more keen on accumulating power than beating climate change.
It’s true domestic governments could block foreign buyouts of ESG-boycotted domestic energy assets. But what would that really achieve in the short term other than increased dependency on energy sourced from potentially less scrupulous foreign actors? Autarky takes time to achieve. And access to cheap energy is essential to achieve that transition quickly.”
Thanks for this.
It’s another case though of me not being bold enough in terms of communicating what I really thought at the time. The conversations I had in the office leading up to that piece basically centred on the idea that ESG would inevitably create an asset grab for the defunded assets, and that the west would be stupid to think that BP or whoever could just decommission assets (especially abroad) and not see them be bought up on the cheap by potentially hostile states. Domestically they would have to basically block foreign purchases. Either way it would transfer cheap energy to those states that don’t care about climate change or political stability because they have more pressing issues like hungry populations. So seeing the west just luxuriously defund energy assets was always going to be politically destabilizing and the only way to really stop those assets being burned was to sabotage or destroy them Saddam style first.
And the second part of that conversation was simply about energy security during the transition period which could be leveraged by hostile energy rich states for self empowerment purposes. Didn’t write about that specifically until 2021 however. But by Q3 it was obvious to me that Russia would take advantage of the gas situation, and I said as much in my hybrid warfare piece. At the time it was still taboo to talk about hybrid warfare.
I recall very specifically when the gas crisis first struck speaking to other reporters about whether Russia’s supposed domestic shortfalls were naturally occurring or just a ploy. And there was a tendency to give Russia the benefit of the doubt at that time. Though this was based on what industry was saying. Commodity trading companies essentially were telling reporters that they believed Russia’s shortages were genuine. I now seriously doubt that.
I also discussed a lot of these issues in the Michael Shellenberger podcast that was recorded at the FT but which never aired – as alphachat was scrapped just before it could be produced.
Some of the bits of the interview made it into this https://twitter.com/edielush/status/1237308079278116864?s=21&t=Wn1LzcSkskYa9Otx0ZAC6w