In joining private equity firm Carlyle Group to help rescue Sunoco Inc‘s Philadelphia plant from likely closure, the Wall Street titan cast its multibillion-dollar physical commodity business as an essential client service, financing inventory and trading on behalf of the new owners.
This was about helping conclude a deal that would preserve jobs and avert a potential fuel price spike during the heat of an election year summer — not another risky trading venture after the more than $2 billion ‘London Whale’ loss.
But the deal also highlights a largely overlooked clause in the Volcker rule that threatens to squeeze banks out of physical markets if applied strictly by regulators, one that JPMorgan and rivals like Morgan Stanley have been quietly fighting for months.
While it has long been known the Volcker rule will ban banks’ proprietary trading in securities, futures, and other financial tools like swaps, a draft rule released in October cast a net over commercial physical contracts known as ‘commodity forwards’, which had previously been all but exempt from financial oversight.
The banks say that physical commodity forwards are a world away from the exotic derivatives blamed for exacerbating the financial crisis. A forward contract in commodities exists somewhere in the gray area between a derivative like a swap – which involves the exchange of money but not any physical assets – and the spot market, where short-term cash deals are cut.
Banks say they are also essential to conclude the kind of deal that JPMorgan lauded on Monday.
“JPMorgan’s comprehensive solution, which leverages our physical commodities capabilities… demonstrates how financial institutions with physical capabilities can prudently, yet more effectively, meet our clients’ capital needs,” the bank said in a press release.
But regulators say they are keen to avoid leaving a loophole in their brand new rule, named after former Federal Reserve Chairman Paul Volcker, that could allow banks to shift high-stakes trades from financial to physical markets.
“We intended the Volcker Rule to prohibit a broad swath of risky bets, including bets on the prices of commodities,” said Democratic Senator Carl Levin, who helped draft the part of the 2010 Dodd-Frank financial reform law that mandates the proprietary trading ban.
“The proposed Volcker Rule should cover commodity forwards because those instruments often constitute a bet on the future prices of commodities.”
In the latest example of a refining company outsourcing its trading operations to Wall Street, JPMorgan will not only provide working capital for the joint venture between Carlyle Group and Sunoco Inc, but will also operate a ‘supply and offtake’ agreement that has the bank’s traders shipping crude oil from around the world to the plant, then marketing the gasoline and diesel it makes.
If the rule is finalized as it stands the question will turn on whether banks can convince regulators that their physical deals are only done on behalf of clients, making them eligible for an exemption from the crackdown.
BANKS GET PHYSICAL
Over the last decade Wall Street banks quietly grew from financial commodity traders into major players in the physical market of crude oil cargoes, copper stockpiles and natural gas wells, often owning and operating vast assets too.
Bankers argue that forward contracts are necessary if they are to help refineries like Philadelphia curb costs and free up capital, to help power plants to hedge prices, or to let metals producers and grain farmers finance storage.
Forwards are essentially contracts to buy or sell a certain amount of a physical commodity at an agreed price in the future. Their duration can range from a few days to a number of years.
“To pull forwards into the Volcker rule just because someone has a fear that they could, in some instances, be used to evade the swap rules is just ridiculous,” one Wall Street commodities executive said.
“We move oil all over the world. We have barrels in storage. They are real, not just things on paper. They go on ships and they go to refineries. It is basically equating forwards with intent for physical delivery as swaps – and they’re not.”
She added: “You can’t burn a swap in a power plant.”
Unlike a swap, which will be settled between counterparties on the basis of an underlying financial price, a forward will usually turn into a real asset after time. Unlike hard assets, however, the forward contract can be bought or sold months or years before the commodity is produced or stored.
Historically the physical commodity markets have remained beyond financial regulatory supervision and forwards are not mentioned specifically in the part of the 2010 Dodd-Frank law that mandates the drafting of the Volcker rule.
But the drafters of Dodd-Frank say it was always their aim to prevent banks that receive government backstops like deposit insurance from trading for their own gain. They worry that banks could quickly boost trading for their own book in forward markets rather than purely for the benefit of clients.
“The issue is the potential for evasion,” said one official at the Commodity Futures Trading Commission (CFTC) who was not authorized to speak on the matter. He said traders could easily buy and sell the same commodity forward contract, profiting on the price difference, without the goods ever changing hands.
It would be a useful tool “if you want to hide activities or evade margin requirements,” he added.
RISKY BET OR HARMLESS HEDGE?
Kurt Barrow, vice president at IHS Purvin & Gertz in Houston and lead author of a Morgan Stanley-commissioned report on the impact of the Volcker rule on banks’ commodity businesses said deals like JPMorgan’s with Carlyle and Sunoco could be in jeopardy.
“One of the problems with Volcker is the way it is written assumes that every trade the banks make is in violation of it, and then they have to go through a series of steps to prove that it’s not,” Barrow said.
“If the banks have physical obligations they need to hedge, like in supply and off-take agreements with refineries, there are already concerns that they could be seen to be in violation of the Volcker rule. The rules are geared toward equity trading and don’t take account of how commodity markets really work.”
Goldman Sachs and Morgan Stanley, which alongside JPMorgan dominate physical commodity trading on Wall Street, also take part in supply and offtake agreements with independent refiners.
Without leeway to trade forward contracts, banks would have little reason to retain the metal warehouses, power plants, pipelines, and oil storage tanks that are the crown jewels of their commodity empires.
The future of those assets is already in question as the Federal Reserve must soon decide if banks backstopped by the government will be allowed to retain those assets indefinitely.
In the years preceding the financial crisis, major banks were at times booking as much as a fifth of their total profits from their commodity trading expertise, but drew criticism they could combine their physical market knowledge with huge balance sheets to try and push prices in their favor.
That criticism has resurfaced this year.
“Americans are already paying heavily at the pump for excessive speculation in the oil markets,” Senator Jeff Merkley, who co-authored the Volcker provision with Senator Levin, told Reuters.
“The last thing they need is more of that speculation and risk-taking, especially when it would not only drive gas prices even higher but could also contribute to another 2008-style meltdown.”
NO FORWARDS, NO PHYSICAL, NO SERVICE
The inclusion of forwards in the proposed Volcker rule has created concern beyond Wall Street. Some industry groups argue banks have become so embedded in the structure of both financial and physical commodity markets that they are now key trading partners for a wide range of firms.
“We were surprised,” said Russell Wasson at the National Rural Electric Cooperative Association (NRESCA). “To us they are straightforward business contracts because they’re associated with physical delivery. They’re being treated as derivatives when they never have been before.”
The concerns are the same as with other aspects of the Dodd-Frank reforms, the biggest overhaul of financial regulation since the Great Depression: tough new limits will reduce liquidity, thereby increasing market volatility and hedging costs.
The Volcker rule does include key exemptions to allow banks to hedge risk and make markets for clients.
But some commodities experts say proving that forwards fit into these categories may be too onerous to be helpful.
University of Houston professor Craig Pirrong, an expert in finance and energy markets who has generally argued against the proposed regulation, said he was skeptical of the hedging exemption’s utility, and was sure regulators would take a tough line in the wake of JPMorgan’s recent losses.
“They will have to provide justification that these (commodity forwards) are hedges or entered into as part of their “flow” business with customers,” he said.
“In the post-Whale world, banks are on the defensive and I would not bet on them prevailing on an issue like this.”
Banking executives say they are now desperate to convince skeptical regulators that their physical arms have been transformed into purely market making and client facing businesses.
“Banks have been working to reposition their commodities business… under the assumption that physical markets would be covered by Volcker,” one senior Wall Street commodities executive said.
“Several banks shut down their proprietary trading about two years ago in anticipation of this. The argument that physical commodity markets will present some kind of Volcker loophole for banks is false.”
(Reporting By David Sheppard; Editing by Bob Burgdorfer)
- Wall Street Supporters in Congress Unmoved by Libor Probe – Bloomberg (bloomberg.com)
- Reexamining The Volcker Rule After JPMorgan’s Derivatives Loss (seekingalpha.com)
- After Loss, JPMorgan Regulators in Spotlight (dealbook.nytimes.com)
- Oil rises above $84 amid tighter Iran sanctions (news.yahoo.com)
All of this noise out of Greece has taken attention away from the fastly approaching U.S. fiscal cliff: the end-of-year deadline that threatens to lop off an estimated 3 to 5 percentage points off of GDP growth in 2013.
Reinhart’s note discusses the timetable regarding the fiscal cliff:
Unfortunately, there is no clear timetable for action. Congress will deal with the situation when it is good and ready to do so. And, the lessons from similar experiences in recent years suggests that such action will occur at the last minute.
But as an economist who’s getting paid to make forecasts and opinions, he shares with us the key dates that he’ll be watching. Here’s his assesment:
[T]here is a strong likelihood that there will be a lame duck session of Congress following the November election. Ideally, legislators will reach agreement on a plan which avoids the 2013 fiscal cliff and, at the same time, addresses the unsustainable longer-term course of US fiscal policy. However, given the elevated degree of gridlock in DC and the likelihood that some degree of gridlock will remain no matter what the election outcome (it is mathematically impossible for either party to achieve a filibuster proof majority in the Senate), this is an awful lot to expect during a post-election session of Congress that may last six weeks or so at most. A more likely scenario might involve a short-term extension of the major budget provisions or delayed action until debt ceiling constraints help to force a compromise agreement in early 2013. Of course, the longer the delay, the greater the likelihood that policy uncertainty will negatively impact the real economy.
- Morgan Stanley Just Slashed Its US GDP Forecast And Warned Things Could Get A Lot Worse (businessinsider.com)
- CBO Warning: Recession Will Follow 2013 ‘Fiscal Cliff’ (theatlanticwire.com)
- Fiscal cliffs, multipliers, and the myth of central bank independence (economist.com)
Cheniere Energy Partners said today that it has engaged eight financial institutions to act as Joint Lead Arrangers to assist in the structuring and arranging of up to $4 billion of debt facilities.
The proceeds will be used to pay for costs of development and construction of the liquefaction project at the Sabine Pass LNG terminal, to fund the acquisition of the Creole Trail Pipeline from Cheniere Energy, and for general business purposes. As previously disclosed, estimated capital costs before financing for the first two trains of the liquefaction project of $4.5 billion to $5.0 billion are expected to be funded from a combination of debt and equity financings.
The eight Arrangers are The Bank of Tokyo-Mitsubishi UFJ, Ltd., Credit Agricole Corporate and Investment Bank, Credit Suisse Securities (USA) LLC, HSBC, J.P. Morgan Securities LLC, Morgan Stanley, RBC Capital Markets, and SG Americas Securities, LLC.
“Obtaining financing is one of the last steps to complete before proceeding with the construction of the first two liquefaction trains being developed at the Sabine Pass LNG terminal,” said Charif Souki, Chairman and CEO. “We have engaged an experienced group of financial institutions as our core banking group and look forward to completing the financing for the project in due course.”
- USA: Cheniere CEO Sees Domestic Gas Prices at USD 2/MMBtu (mb50.wordpress.com)
- Cheniere: Sabine 1,2 Train Construction Start in H1 2012 (USA) (mb50.wordpress.com)
- USA: Cheniere, KOGAS Ink Sabine Pass LNG Deal (mb50.wordpress.com)
- USA (Sabine Pass): BG Ups Sabine Pass LNG Volumes to 5.5 MTPA (mb50.wordpress.com)
- Why America’s Missing Out on the Billion-Dollar Global LNG Game (mb50.wordpress.com)
- USA: ETE Units File with FERC for Proposed Lake Charles Liquefaction Project (mb50.wordpress.com)
By Brian Winter SAO PAULO | Thu Jan 12, 2012 9:20am EST
(Reuters) – Here’s an economic riddle of sorts: Which economy grew faster over the last seven years? A) President Hugo Chavez‘s Venezuela, famous for its forced nationalizations and “21st century socialism,” or B) Chile, long renowned as a capitalist paradise for investors.
It might surprise some outsiders to learn that the answer is actually A. In recent years, commodities prices have dictated growth in Latin America more than any other factor, meaning that countries could trample on businesses but still grow briskly as long as they exported plenty of raw materials such as oil and iron ore to China and elsewhere.
Venezuela, the region’s No. 1 oil exporter, has averaged about 4.6 percent economic growth since 2005, compared to 4 percent in Chile, the world’s leader in copper. An even clearer example of commodities’ almighty reign was Argentina, which averaged 7 percent growth during the same period as record soy and other farm exports helped offset the government’s hostile stance toward energy companies and some other investors.
Now, it looks as if the trend is shifting. In Latin America, 2012 seems set to be the year in which business climate clearly reestablishes its supremacy as the main driver of growth.
The countries expected to grow the fastest in 2012 are also generally the ones that are perceived by the World Bank and others as treating investors the best. That means Chile, Peru and Colombia should lead the pack, while Venezuela and even Brazil will lag a step behind – just as they did last year.
Graphic on region’s economies: r.reuters.com/bed95s
What has changed? The global economy.
Demand for many commodities is expected to slacken in 2012 due to economic problems in buyer markets such as China and Europe. That means it will be up to Latin American countries to generate more of their own growth – and the ones that fare best will be those who have made their labor laws more flexible, cut red tape, and taken other steps to stimulate business.
“There’s no question we’re seeing a change,” said David Rees, Latin America economist for Capital Economics in London. “The external drivers of growth are drying up and these countries will have to look to other sources like investment in order to keep up the pace.”
A DOGFIGHT FOR FIRST PLACE AMONG INVESTORS
One way to measure the trend is by looking at the World Bank’s annual “Doing Business” study, which ranks the business climate in 183 countries around the world based on how well they protect investors; the ease of starting a business; the simplicity of paying taxes; and other factors.
The cluster of Latin American countries that rank a clear step above their other regional peers in the survey are Chile (39), Peru (41) and Colombia (42).
All three of those economies are forecast to grow 4.5 percent or more this year, according to the International Monetary Fund‘s latest forecasts, made in October. Countries that rank lower in the Doing Business survey, such as Guatemala (97), Brazil (126) and Venezuela (177) are all forecast to grow in the 3.5 percent range or lower.
The divergent trend is even more pronounced in more recent 2012 forecasts by Wall Street firms such as Morgan Stanley.
The region’s other two big economies also appear to be headed in opposite directions.
Growth in Argentina (113) is expected by the IMF to be around 4.5 percent this year – but that’s just about half of last year’s pace. Meanwhile, Mexico’s (53) relatively open, low-tax economy should show resilience, with growth of 3.6 percent – well above its roughly 2 percent trend level since 2005.
Most of the countries at the top of the economic league table have vigorously implemented pro-business reforms in recent years, often with the explicit goal of improving their standing in the Doing Business rankings.
Peru, Chile and Colombia have been battling each other for supremacy within Latin America for years, said Luis Plata, a former Colombian trade minister. “We fought hard to be first,” he said in an interview. “It became a competition.”
“The rankings improve your standing with investors, but … the real reason to do it is to help you identify deep changes in the system, things that will help your economy grow better,” Plata said.
For this year’s “champion,” the dividends are clear. Chile saw foreign investment of $13.79 billion in 2011, a historic high that contributed to the country’s fastest economic growth in years. A top Chilean official told Reuters last month that the government expects a new record in foreign investment this year.
STALLED REFORMS IN BRAZIL
In countries closer to the bottom of the table, attitudes are notably different.
Argentine President Cristina Fernandez has shown few signs of softening an antagonistic stance toward some investors that in recent years has seen her government nationalize private pension funds and face widespread suspicions of manipulating basic economic data such as inflation.
Venezuela’s economy remained buoyant for years thanks largely to its status as South America’s biggest oil exporter, but Chavez’s frequent confrontations with business have hollowed out much of the private sector and left the economy dependent on state spending.
In Brazil, Latin America’s largest economy, the picture is slightly more complex. While successive governments have catered to private enterprise to a much greater extent than Argentina and Venezuela, Brazil has also failed to push any major pro-business reforms through Congress in a decade.
As a result, investors have become frustrated with the country’s high costs and red tape. Brazil dropped six spots in the latest Doing Business survey – more than any other big economy in Latin America – and ranks in the world’s bottom third in categories such as trading across borders, dealing with construction permits, and ease of paying taxes.
Partly as a result of the business climate, some economists believe that Brazil may be downshifting into a new era of 3 percent to 4 percent economic growth, which would be a letdown after the faster pace of previous years.
“Brazil hasn’t kept pace with some other (Latin American) countries on some of the really important long-term questions, and they may pay the price for that,” said Gray Newman, chief Latin America economist for Morgan Stanley.
“People focus on things like inflation, and that’s good, but what about – How long does it take to open a business? How easy is it to hire and fire?” Newman said. “The economies that are moving forward are the ones that have looked at those metrics, and have put them at the heart of government policy.”
(Editing by Todd Benson and Kieran Murray)
- Iranian president to tour Latin America (mb50.wordpress.com)
- Here’s What Lies Ahead For Latin America This Year (businessinsider.com)
- Ahmadinejad in Latin America: What’s Iran’s Agenda in the Western Hemisphere? (globalspin.blogs.time.com)
- Why Your Business Needs Latin America (greatfinds.icrossing.com)
- 2011 Tech Rewind: This year in Latin America (thenextweb.com)
- Iran’s president looks to Latin America as global sanctions grow (news.blogs.cnn.com)
- Is there a threat to the U.S. behind meetings of Latin American, Iranian leaders? – Alaska Dispatch (alaskadispatch.com)
by Eric Platt
The dark clouds in the Federal Reserve’s 2012 annual stress test are keeping bankers up at night, as banks are being asked to imagine their balance sheet situation under some horrible economic scenarios.
Here are some of the key metrics, complete with headline numbers, for what would happen in the Fed’s worst scenario:
U.S. Real GDP:
- 4Q11: -4.84%
- 1Q12: -7.98%
- 2Q12: -4.23%
- 3Q12: -3.51%
- 4Q12: +0.00%
- 1Q13: +0.72%
- 2Q13: +2.21%
- 3Q13: +2.32%
- 4Q13: +3.45%
- 4Q11: 9.68%
- 1Q12: 10.58%
- 2Q12: 11.40%
- 3Q12: 12.16%
- 4Q12: 12.76%
- 1Q13: 13.00%
- 2Q13: 13.05%
- 3Q13: 12.96%
- 4Q13: 12.76%
U.S. 10-Year Treasury Yield:
- 4Q11: 2.07%
- 1Q12: 1.94%
- 2Q12: 1.76%
- 3Q12: 1.67%
- 4Q12: 1.76%
- 1Q13: 1.74%
- 2Q13: 1.84%
- 3Q13: 1.98%
- 4Q13: 1.97%
Dow Jones Industrial Average Price:
- 4Q11: 9,504.48
- 1Q12: 7,576.38
- 2Q12: 7,089.87
- 3Q12: 5,705.55
- 4Q12: 5,668.34
- 1Q13: 6,082.47
- 2Q13: 6,384.32
- 3Q13: 7,084.65
- 4Q13: 7,618.89
EU Real GDP:
- 4Q11: -1.03%
- 1Q12: -3.49%
- 2Q12: -5.40%
- 3Q12: -6.91%
- 4Q12: -4.92%
- 1Q13: -0.88%
- 2Q13: +0.35%
- 3Q13: +1.11%
- 4Q13: +1.50%
Remember, banks have less than two months to stress test their portfolios against these, and 21 other metrics. For a full list of scenario inputs visit the Federal Reserve’s site.
- The doomsday scenarios the Fed wants banks to test (business.financialpost.com)
- Fed Sets Jan 9 for New Round of Fin Inst Stress Tests (forexlive.com)
- The Fed’s Stress Tests: Too Little, Too Late (247wallst.com)
- Federal Reserve Board issues final rule on annual capital plans, launches 2012 review (bespacific.com)
- Top U.S. banks told to stress test against severe recession (business.financialpost.com)
- Federal Reserve Will Force 31 Banks To Stress Test Portfolios (GS, BAC, JPM, MS, WFC, MET, AXP) (businessinsider.com)
- Fed FAQ Re Fin Institution Stress Tests (forexlive.com)
- Fed Tells Top U.S. Banks to Submit Capital Plans (businessweek.com)
A super-cool chart from Morgan Stanley, which basically examines different kinds out potential outcomes in Europe (with the top-right quadrant being the best, and the bottom-left quadrant being the worst), with some ideas about what kinds of policies get you to where.
Click Here – Morgan Stanley
- A Closer Look At Leverage At MF Global And Jefferies (businessinsider.com)
- Banking time bomb – banks’ balance sheet risks are increasing (tradingfloor.com)
- Morgan Stanley Presents Everything You Need To Know About Europe (MS) (businessinsider.com)
- CHART OF THE DAY: The Decline And Fall Of Morgan Stanley (businessinsider.com)
- Mapping Out The European Crisis In One Gigantic Chart (businessinsider.com)
Real resources are always a true constraint for any economy. This has become an increasingly important point over the last 10 years as commodity prices have surged. But the debate over the cause of this surge and the lack and real resources is still very much up in the air. Some say it is due to an insatiable demand from China. Some blame the decline of the dollar due to irresponsible government action. Others say Wall Street is cornering the commodities markets and turning it into another profit making casino. The truth, in all likelihood, lies somewhere inbetween.
One of the more important themes I’ve discussed over the years here has been the financialization of our economy. Financialization has seeped into many facets of our economy in order to help the big banks maximize profits. This has led to massive deregulation, increasing reliance on the FIRE industry, a concentration of power in this industry and an economy that is increasingly volatile and dependent on this industry which produces little, but takes much. This financialization has been nowhere more apparent than it has been in the commodities markets.
A few weeks ago I wrote a piece about the continual imbalance in the commodities markets and a veteran of the energy market happened to be reading. Dan Dicker reached out through the comments section and offered to send me a free copy of his book, Oil’s Endless Bid (see here to buy a copy). I had heard of Dan’s book and had been meaning to read it for some time. Now, I get a lot of free books from financial people. A LOT. They all want me to promote their books on the site. 95% of the books never get mentioned on the site. As you’ve noticed, I don’t just crank out content for the sake of cranking out content and the “payment” of a free 300 page book is not really incentive enough for me to write about a book. So, a lot of books end up in my fireplace (I’m an energy conservationist obviously). This one is different because I think Dan is conquering an incredibly important subject and he does so from the position of an informed insider.
His perspective is very much in-line with the positions of Michael Masters who has been one of the more vocal proponents of this financialziation of the commodities markets. Dan Dicker is a 20+ year veteran of the oil markets and a long-time seat holder at the NYMEX. Dan’s book is a frighteningly eye opening perspective from someone who has been in the trenches and has witnessed the massive changes in real-time. Dan highlights the massive changes that occurred over the years as the industry has morphed from one that was dominated by big oil into an industry that is dominated by big banks (from the book):
“In the mid-1990′s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies. The list of NYMEX seat owners again shows just how deep the change was. Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products. But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.
That’s a total of 56 seats owned by investment banks! (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.)
Of course, the most important purpose for some of these firms to own seats was to execute orders for clients, some retail, but many commercial clients who were being sold on the importance of risk management of energy costs. And during the years from the mid-1990′s though 2005, this made for a legitimate increase in the volume of crude. But commercial growth of risk management programs was a happy appetizer for the quick rise of the investment banks in the trade of oil. Oil companies that tried to maintain a presence and dominance in trading began to be overshadowed by the volume and influence of trading from these banks and their clients.”
These firms aren’t dominating the trading pits at these exchanges because they want to buy and sell commodities for real economic purposes. They are dominating the exchanges because they know there is big money in financializing the asset class of commodities. And they’re succeeding. They’ve sold the asset class as an investment and the investing public has eaten it up hook, line and sinker. Dan goes into much more detail about this destructive trend and its impact on the economy and ultimately concludes that massive change is needed. We need to get control of our economy again and wrangle it back from these big banks who are looking out for the interest of their shareholders and not the US economy. Dan Dicker’s book is one of the most important ones I have read in a long time. It should be required reading for the US Congress.
- Oil, gold keep losses after manufacturing data (marketwatch.com)
- Review 145: Griftopia (thelablib.org)
- Yergin, D. “The Prize” Chapter 35 (iranrevolt.wordpress.com)
- How US Banks Are Lying About Their European Exposure; Or How Bilateral Netting Ends With A Bang, Not A Whimper (zerohedge.com)