The Great Debate

Making oil and mining dollars transparent

By Raymond C. Offenheiser
The opinions expressed are his own.

For most of us, this July 15th will be the start of just another hot summer weekend. But for many, the day marks the one-year anniversary of Congressional approval of a landmark law that will lift the veil of secrecy on billions of dollars that flow every year from oil and mining companies to governments around the world.

Tucked into the massive Dodd-Frank Wall Street Reform and Consumer Protection Act is a provision requiring oil, gas and mining companies reporting to the US Securities and Exchange Commission (SEC) to disclose the payments they make to host governments.

From rural villagers in Africa to investors on Wall Street, the groundbreaking law casts the transparency net far and wide, arming the public with information it can use to track the amount of money governments receive from oil and mining companies. The provision, backed by a bipartisan group including Senators Lugar and Cardin, among others, requires annual reporting of taxes, royalties and other payments, and covers a broad range of US, European, Chinese, Brazilian and other companies. By law, the final regulation from the SEC — the regulatory agency responsible for implementing the law — should have been issued in April. However, no final rule has been issued.

One of the reasons for the financial crisis was a lack of public information about the real risks of investments. In the case of the oil and mining industries, investors need to know how and whether companies are exposed to political and expropriation risks in volatile resource-rich countries. In some places, companies can make up front payments of over a billion dollars before a drop of oil is produced and this information is not disclosed to investors. This disclosure provision — in addition to providing useful information to citizens in resource-rich countries — also provides valuable information to investors on how to assess risk. This is part of the SEC’s core mandate. As a display of investor interest, investors representing more than $1.2 trillion in assets under management, including TIAA-CREF and others, have called on the SEC to implement strong rules for this provision.

We at Oxfam America joined NGOs in the Publish What You Pay coalition, faith groups and investors representing over $1.2 trillion in assets to commend the SEC for drafting a regulation in December that followed Congressional intent. Industry and other stakeholders have had plenty of time to comment on the draft — the SEC even extended the comment period.

Let them eat oil


By Erik Mielke, who is a partner at Namir Capital Management LLC, a New York-based investment management firm that invests in emerging markets. The opinions expressed are his own.

The winds of change are forcing fundamental political and economic shifts across the Arab world. But one area of economic reform is likely to be brought to a stop as regimes respond to popular protests with populist measures. These initiatives include extending and expanding the region’s massive energy-price subsidies. For the rest of the world, this matters tremendously. One additional barrel consumed in Tehran or Riyadh is effectively one less barrel for the export market, and that means higher global oil prices.

Fueled by petrodollars and subsidized oil, energy consumption has been rising rapidly throughout the region. In the 10-year period to 2009, oil consumption in Middle East and North Africa rose by 50%, or 2.7 million barrels per day, second only to China’s rate of growth. In the same period, the region’s oil production only rose by 2.5 million barrels per day. The net result was a decline in oil exports from the world’s key producers.

Will oil prices stabilize around $80?

Most commentators and oil analysts are convinced a further rise in prices is inevitable in the next few years as emerging market consumption grows and supplies increasingly come from more costly and technically challenging sources such as ultra-deepwater.

While there are disagreements about the extent and the timing of price changes, there is a remarkable degree of consensus about the direction: up. But the roller-coaster experience of the last five years should have taught forecasters to be much more cautious about extrapolating trends and assuming the future direction is obvious.

Price forecasts are notoriously unreliable. There are simply too many variables and too much uncertainty about the current state of the market let alone how supply and demand will evolve in future. The crucial role of expectations in price formation adds an element to “reflexivity” which is hard for forecasters to anticipate or model accurately.

Forecasting and its discontents

“Prediction is very difficult, especially if it’s about the future,” is attributed to a long list of people. Even with that in mind, however, the first eight months of 2010 have been especially unkind to professional forecasters and investors as markets have lurched between extremes of pessimism and optimism.

Normally forecasters can benefit from diversification — publishing lots of forecasts ensures at least some prove correct. But heightened correlation between and within asset classes has denied forecasters and investors even that consolation.

Federal Reserve Chairman Ben Bernanke has complained about the “unusual uncertainty” clouding the outlook. And macro hedge funds have run into trouble, several prominent ones closing down and returning money to investors, as the big trends on which they thrive have disappeared amid volatility and sharp switchbacks.

Speculators abandon oil for the moment

Bullishness about the short-term prospects for crude is evaporating among banks and hedge funds, as the market fails to sustain rallies above $80 and girds for widespread refinery shutdowns to work off bulging gasoline stocks.

The urge to buy on the dips, trade the range and hope for a breakout seems to be fading. Banks and other swap dealers boosted their net long position in WTI-linked futures and options by a meagre 7,000 contracts to just 22,000 in the week to Aug. 17, even as prices tumbled from over $80 to around $75.

The last time the market pulled back this far, swap dealers were carrying a net long position of 65-75,000 contracts, according to data published by the Commodity Futures Trading Commission (CFTC).

Micro and macro volatility in the oil market

- John Kemp is a Reuters market analyst. The views expressed are his own –

“Most probably we will continue to have reasonably high short-term volatility but in a narrower price range between $60-95 per barrel”.
That was the (accurate) forecast for crude oil prices given by Mercuria’s head of trading Daniel Jaeggi to the UN Commodities Forum in Geneva back in March [ID:nLDE62M0MT].
In fact front-month futures <CLc1> have been trapped in an even narrower range of $60-86 for the past 12 months, shrinking to $64-86 so far in 2010. Spot prices have barely budged since July last year, despite a substantial improvement in demand, as one puzzled investment bank noted recently.
Yet many traders complain high volatility is making either directional or technical strategies difficult to implement.
The apparent contradiction (high levels of very short-term price movement in a market trending sideways) highlights the different levels of volatility prevailing at different time horizons.

Standard measures of volatility take price changes from the close of one business day to the next, averaged over the last 20 or 30 trading days, and then adjust them to an annualised rate.
On this basis, oil price volatility has been unusually low in H1 2010. Close-to-close volatility hit a 2.5 year trough of 19 percent in March.
Volatility increased as the rally broke down, peaking at almost 40.5 percent in late May and early June. But even that was low compared with peaks of more than 50 percent or 60 percent during previous periods of elevated volatility.
Close-to-close volatility is now back to just 28 percent, putting it in the 30th percentile of the distribution for all periods since the start of 2005.
But over other time horizons, volatility looks very different (http://graphics.thomsonreuters.com/ce/VOL-HRZN.pdf).
Intra-day volatility is higher compared with past periods. The real measure of intra-day volatility would take 5-minute or even 1-minute price changes over an hour or a day and annualise them. In practice that is too data-intensive for anyone not undertaking a full modelling exercise. But the daily trading range (high-low) is a reasonable if rough proxy.
Intra-day volatility (based on the high-low trading range) is currently running around 15 percent per year. While that is low compared with the close-to-close measure (28 percent) it is quite high compared with previous periods.
Intra-day volatility is currently in the 40th percentile (compared with the 30th for close-to-close volatility). Moreover, intra-day volatility peaked at the 90th percentile back in late May, compared with a peak in the 81st for daily volatility at the same time.
Traders who complain about large intra-day price swings are not imagining it; the market really is exhibiting unusually wide daily trading ranges at present.
Weekly volatility (measured from the close of business on one Friday to the next) is even more elevated compared with past periods. On a week-to-week basis, volatility is currently running at just over 41 percent, putting it in the 75th percentile of the distribution since the start of 2005.

The challenge is to find a “narrative” explaining high levels of volatility at intra-day and weekly levels, yet comparatively low levels of volatility at the daily and yearly ones.
As former Federal Reserve Governor Lawrence Meyer remarked “When I’m asked what my profession was prior to joining the Board of Governors, I do not say that I was an economic forecaster, but rather a storyteller. As a forecaster, I had learned that neither my students nor my clients wanted to be buried in reams of computer output. They wanted me to tell a story that brought together in a coherent way the implications of the large numbers of economic indicators they saw as otherwise unconnected and therefore confusing”.
So can we attempt a “story” to explain different oil market volatility at different time horizons over the past 12 months?
Overall the market appears to have found a balance between bullish and bearish forces in recent weeks and months — which might mark an equilibrium (my view), an “uneasy truce” (the International Energy Agency’s view, expressed in its Medium Term Oil and Gas Markets Outlook) or a “state of disequilibrium” (Barclays Capital Commodity Refiner, Autumn 2010, page 62).
However this state is defined, it accounts for the broad sideways trend in prices over the past 9-12 months in a fairly narrow range of $70-80 or $65-85 per barrel, and the relatively low level of volatility over longer horizons.
But as the market has fluctuated between extremes or poles of euphoria and despair, prices show large week-to-week variations within the band. The price has “cycled” between the high end of the range and the low one, accounting for the high level of volatility at intermediate horizons such as the weekly level.

The darkest period before dawn?


Abandon hope all ye who enter here was the inscription written above the gates of Hell in Dante’s Divine Comedy.

Investors who decided to take a long position in commodity futures at the start of 2010 anticipating a global recovery, tightening supply-demand balances, and rising prices, could be forgiven a sense of despair.

Their risk-taking has been rewarded with range-bound prices and a contango eating deeply into returns. Most longs lost money in H1 2010.

from The Great Debate UK:

Facebook group defends “harassed” BP


BP’s chief executive Tony Hayward branded “the most hated man in America” may be surprised to find himself cast in the role of victim by a growing clan of web-based supporters on Facebook.

One such group ‘Support BP’ calls itself the defender of an “undeservedly harassed institution” and seeks to show that the public opprobrium BP faces over its now 60-day-old Gulf of Mexico oil spill is not universal.

Members have been increasingly vocal since a succession of strong rebukes of BP by U.S. President Obama and lawmakers at Thursday’s congressional hearing, which they are calling a “lynch mob”.

Don’t bank on return of backwardation

Many energy analysts are predicting the crude market will move into backwardation before the end of the year.

Increasing demand and rising refinery runs will, in their view, reverse the unusual build up of inventories around the NYMEX delivery point at Cushing, and the market should revert to a more normal term structure.

The extreme contango visible at the front end of the NYMEX futures curve in the last seven weeks is certainly evidence of a “dislocation” caused by congestion around the delivery point. Front-month NYMEX futures have been trading at abnormally large discounts not only to second- and third-month NYMEX futures but also to Brent and other spot crudes such as Tapis.

Money illusion and “real backwardation” in oil

Forward commodity prices are not properly accounting for the impact of inflation.

“Money illusion” was the term coined by Cambridge economist John Maynard Keynes to describe the tendency of people to be fooled by thinking in nominal rather than real terms, ignoring the effect of inflation on the purchasing power of money.

It is usually associated with unsophisticated retail investors. But there is evidence it is misleading a much wider group in the commodity markets, and long-term commodity prices are being mis-valued as a result.