There’s a new Zoltan Pozsar of Credit Suisse report out… and he starts off by saying:
…you can print money, but not oil to heat or wheat to eat.
I’m so glad because this rather obvious point seems to be completely missed by economists and analysts for unknown reasons.
Nor do they seem to get that just because the commodity market doesn’t match the scale of the bond or equity market that doesn’t mean it is not significantly more important for the world economy than anything else.
The way I explain it is that commodities are like the oxygen the body needs to stay alive. The lifeblood is all the other financial stuff.
You can give up a lot of blood and still keep living. But it doesn’t take a very large oxygen deficit to kill you.
Back to Zoltan (before Zerohedge and everyone else is over the report). Or should I say Z̶oltan and Z̶erohedge. (Though I’ve just noticed that striking through the Z makes it look like the Azov battalion symbol so that’s also no good. We are going to have to go with Soltan and Serohedge).
The key point is that Soltan is sticking to his guns about this being a paradigm shifting moment for finance.
And regarding that point that other economists don’t seem to understand (my emphasis):
Central banks are good at curbing demand, not at conjuring supply. Energy and commodities are needed for virtually everything, Russia exports everything, and unlike 1973, it’s not just the price of oil, but the price of everything that is surging. After laying dormant for decades, the fourth price of money is back with a vengeance – the par, basis, and FX-related prices of money are dormant at the moment, but the price level is about to become very volatile and the market is trying to price the price of future money (OIS), that is, the number of interest rate hikes and the FOMC adjusting the level of terminal rates (r*) in response to the new price level regime brought about by war and sanctions
When it comes to commodities Soltan has definitely done his homework. A really great point relates to the important role of shipping in the maintenance of global price equilibrium. If commodities are the oxygen, ships are the blood vessels that carry the oxygen through the system:
Shipping used to be about minimizing the time it takes to get commodities from producers to consumers. Time at sea is a function of sea routes, and different sea routes correspond to different types of vessels. In the case of oil, for example, the three main types of vessels are VLCC, Suezmax, and Aframax vessels. VLCCs (very large crude carriers) carry 2 million barrels and are used for long-haul voyages. There are about 800 VLCCs in the world. Suezmax refers to tankers that are capable of passing through the Suez Canal in a laden condition. Suezmax tankers carry 1 million barrels on long-haul voyages. There are 700 of them. Aframax vessels are “go-fast boats” in comparison, shuttling 600,000 barrels on short-haul trips. There are about 600 Aframax carriers in the world. All this detail is important to know when the flow of oil – and in particular, the flow of Russian oil – is disrupted. If you trade STIR and cared about money fund reform, you need to follow “oil flow reform” too (reform due to sanctions, not SEC rules).
VLCCs and banks’ LCLoR are interrelated. This is how:
Oil from Russia (Urals) gets loaded on Aframax carriers at the Port of Primorsk or the Port of Ust Luga to then be shipped on short shuttle runs to Hamburg and Rotterdam. But if Europe boycotts Russian oil, Russia will have to ship its oil to Asia through much less-efficient routes. Oil must be pumped, oil fields don’t like to be turned off and on, and there are no new pipelines to Asia. Storage capacity can accommodate excess production in Russia for a while, but when storage facilities fill up, oil will have to get moved. Without pipelines, the only way Russian oil can be moved over to China will be through vessels, and this is where things get complicated: it’s uneconomical to transport crude on long-haul voyages on Aframax carriers. If Europe no longer wants Russian oil and Russian oil needs an outlet, and that outlet is a buyer in China (see here), China will need more VLCC carriers to get oil from Primorsk and Ust Luga.
I will get back to the significance of the wider note after I do the school run. But the key observation Soltan makes on shipping is that the above is setting us up for the creation of a mighty blood clot in the system:
Worse, it’s not just the time to market that’s getting worse, but we also end up with a ship shortage and a corresponding surge in shipping freight rates: consider that we are still using the same number of Aframax ships as before but now as links in a longer intermediation chain (the STS crude transfer bit), and we now also need 80 VLCCs to get the oil to the final consumer in China. 80 VLCCs are basically the product of the new, longer shipping routes to China: the logic is that instead of taking a week or so to move the oil to consumers, oil will now take at least 120 days (two months plus two months = four months) to transport, and so 1.3 million barrels per day (which is 75% of a VLCC’s load) times 120 days over 2 million barrels ship size is 78 VLCCs in permanent use!
The 80 VLCCs the world will soon be short of represent about 10% of the world’s VLCC capacity, which includes 50 VLCCs that are Iranian flag vessels (NIOC) that are currently being used for floating storage, so the re-routing of Russian crude oil will encumber more than 10% of the global VLCC capacity.
And this feeds into funding because it means trade finance will have to cover 4 months instead of 60 days:
There are implications for funding markets and parallels with funding markets: as the above example shows, oil transports will take four months to finance instead of two weeks, and because oil prices are up, it will take more money to fill up VLCCs – which means more notional borrowings for much longer terms.
Our instinct says that as commodity price inflation and volatility drives the commodity world’s credit demand higher, banks’ LCLoRs will move higher too and banks’ willingness and ability to fulfill the commodity world’s credit needs will diminish. In 2019, o/n repo rates popped because banks got to LCLoR and they stopped lending reserves. In 2022, term credit to commodity traders may dry up because QT will soon begin in an environment where banks’ LCLoR needs are going up, not down. History never repeats itself, but it rhymes…
Which is a long way of saying that it’s not just that rates will go up, it’s that some trade routes won’t get funding at all. At least not in dollars.
I’ll be back with more comment about what he says about other markets in the next installment.