Saudi Investment Fireworks

In my most recent blog entry I focused on the pressure being exerted on the Kingdom of Saudi Arabia by credit default swap (CDS) investors.  No surprise that the Saudi CDS rates continue to rise, as the probability of Saudi Arabia not meeting sovereign debt obligations continues to rise.

As the screws turn tighter on Saudi leaders to come up with solutions in the midst of soft petroleum markets, the Kingdom is tapping into old fashioned Western style financial instruments and manipulative strategies to help maximize Saudi crude assets.

In the past Saudi Arabia was able and was comfortable controlling crude market pricing by either increasing or decreasing production.  The US shale producers are making that simple tool much more difficult to administer as futures markets over react driving price points well beyond Saudi targets.

Meanwhile civilian strife or potential thereof is adding flames to the budget heat.

As reported by CNBC reporter, David Johnson:

"Saudi Arabia is somewhere in between: a stable nation with a sizable backup of reserve assets, somewhere around $624 billion as of December.  But much of that stability is bought with government jobs and generous public spending and with falling oil prices, the country has had to dip into its reserve assets to make up the difference.

Of course, the analysis depends on no major economic changes or events affecting Saudi Arabia. It also assumes oil prices remain low, which experts consider likely for the time being.

Looking at the country's finances in August, when oil swung between $48 and $41 a barrel. It had fallen a long way from its highs of $65 a barrel a few months before, but our lower estimate for its direction was way off. At the time, CNBC estimated the Saudis would be broke in August 2018, yet that was based on oil at $40 a barrel and before the Saudis cut public spending. 

The 2016 Saudi budget includes a spending cut of 13.8 percent from 2015 levels, though projections from Barclays puts that cut closer to 5 percent. Even so, the country is expected to reach a budget deficit of 12.9 percent of GDP in 2016, according to the investment bank."

That’s why the Kingdom may be considering to use an unconventional weapon in the oil war, which is to break the riyal ‘s peg against the US dollar. In other words, let the riyal fall.
That will make Saudi oil less expensive in global markets, help the country regain its market share in the US, and finish up the war against American frackers.

A weaker riyal will further help Saudi Arabia execute on its new strategy of producing and exporting refined products.
The problem is that this weapon may backfire and hurt Saudi Arabia’s economy. The prospect of a lower riyal, for instance, could cause a capital flight. And it could fuel inflation soon after it takes place, widening the Kingdom’s social budget deficit.

Saudi Arabia will be pulling out all the stops with its newly announced emphasis on sovereign equity fund investments, going public with a 5% equity of Saudi Aramco and currency manipulation tactics. 

Risky stuff.   Keep on your toes as the Saudi financial fireworks begin lighting up the volatile energy markets.

Will Saudi Arabian CDS Spreads Pressure the Kingdom to Cry Uncle Again

   
November 28, 2014 was the day that rocked the energy complex off its moorings. Tremors and aftershocks continue into 2016 as energy market participants struggle to understand the future of an unhinged market.

The hinge came off when Saudi Arabia announced it was no longer willing to be the price stabilizer for crude, rejecting cries from OPEC member countries to lower crude oil production.

Saudi Arabia blocked calls from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to  four-year lows.

Brent oil fell more than $6 to $71.25 a barrel after OPEC ministers meeting in Vienna left the group's output ceiling unchanged despite huge global oversupply, marking a major shift away from its long-standing policy of defending prices.

This outcome set the stage for a battle for market share between OPEC and non-OPEC countries, as a boom in U.S. shale oil production and weaker economic growth in China and Europe have sent crude prices tumbling.

"It was a great decision," Saudi Oil Minister Ali al-Naimi said as he emerged smiling after around five hours of talks.  

The jury is still out on whether this was a great decision for Saudi Arabia.  They are rapidly losing desperately needed oil revenues. Increased domestic expenses along with the war with neighboring Yemen is posing increased budgeting stress. “This war is draining the Saudis militarily, politically, strategically,” said Farea al-Muslimi, a Yemen analyst at the Beirut-based Carnegie Middle East Center.
“The problem is, they’re stuck there.” 

Saudis have been busy cutting domestic spending and raising taxes to cope with the lower oil revenues. Not a good recipe for a country whose people have never been good at 
accepting austerity measures.

The ratings agencies are starting to take notice. Standard Poor's Ratings Services in October lowered Saudi Arabia's long-term foreign currency sovereign credit rating to A+ from AA-, citing a widening budget deficit resulting from weaker oil prices. The ratings agency projected the country's fiscal shortfall will jump to 16% of gross domestic product in 2015  from 1.5% in 2014. S&P said it expects Saudi Arabia to draw down its fiscal assets and issue debt to finance its deficit, though the country does not have much monetary-policy flexibility given the riyal's peg to the U.S. dollar. "The outlook remains negative, reflecting the challenge of reversing the marked deterioration in Saudi Arabia's fiscal balance," said S&P.

Deja vu may soon be coming for the kingdom of Saudi Arabia. In January of 1999 Saudi Arabia could no longer idly watch the continued descent of crude prices causing the kingdom's five year credit default swap (CDS) spreads to skyrocket. They cut crude production resulting in a prolific fifteen year crude bull market. 

There is nothing like good old fashioned market pressure that will soon be applied by Saudi CDS spreads that may lead to a repeat of 1999 crude production reductions.

How Petroleum Barrels Got the Blues

We often go about our daily tasks in the petroleum business working with strange measurements and symbols without giving a thought as to how they originated. For instance, how did 42 gallons become the standard for a barrel? And to go a strange step further, how did BBL become the symbol for a barrel of crude oil when a simple BL should have sufficed?

Many years ago after the first oil discovery in 1859, America's earliest oil and gas producers in Pennsylvania decided that a barrel of oil should be set at 42 gallons. Forty-two gallons seemed like the most reasonable size for transportation and for floating down the Allegheny
river. Titusville, Pennsylvania led the entire world in oil production at the time.

A 42-gallon barrel weighed 300 pounds when filled with oil. At that time, men, wagons, horses and boats and barrels moved the area’s oil. Pipelines wouldn’t come into play until later. Three-hundred pounds was about as much weight as a man would handle. Twenty would fit on a typical barge or railroad flatcar. Anything bigger was unmanageable, anything smaller was less profitable.

In that day, watertight tierce was a standard container for shipping fish, soap, butter, molasses, wine and whale oil. The 42-gallon barrels were quite familiar for commodity traders before the oil guys claimed it.

Just as a side note, a normal wine cask back in the day held 84 gallons. Today, wine cask capacity depends on the varietal.

Before the oil guys deemed a 42-gallon barrel their vessel of standard choice, they used wooden tierces, whiskey barrels, casks and barrels of all sizes.

In 1872, the 42-gallon standard was officially adopted by the Petroleum Producers Association, and by the U.S. Geological Survey and the U.S. Bureau of Mines in 1882.

The industry soon struggled with finding 42 gallon barrels after the decision was made, so Standard Oil Company began making the 42 gallon oil barrels, which they painted blue. 

It wasn’t long before people in the oil and gas industry started referring to the barrels as blue barrels, and thus the abbreviation BBLS came into play.

Today, the oil and gas industry refers to a 42-gallon barrel of any color as a “BBL.”

So now when you are crunching your spreadsheet analytic modeling metrics converting gallons to BBLs, BBLs to metric tons and so on, you will have a greater appreciation for our industry's arcane symbols and measurements.

QE Infinity Coming to an End

Seven years ago, Wall Street came closer to imploding than at any other time since the Great Depression.

That was when the venerable investment bank Lehman Brothers filed for bankruptcy on Sept. 15, 2008, amid the global mortgage meltdown, triggering a cascade effect across Wall Street. Within days, the insurer AIG had to be bailed out by the federal government while other investment banks, including Morgan Stanley and Merrill Lynch, were pushed to the brink. Merrill, in fact, was eventually sold amid panic to Bank of America.

Seven years later, the nation’s financial system seems to have largely healed. Banks are back to posting record profits. Over the past several years, financial stocks have been among the hottest areas of the market.

The recovery came mostly on quantative easing policies initiated by the US Federal Open Market Committee.

The US Federal Reserve held between $700 billion and $800 billion of Treasury notes on its balance sheet before the recession. In late November 2008, the Federal Reserve started buying $600 billion in mortgage-backed securities.  By March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes; this amount reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy started to improve, but resumed in August 2010 when the Fed decided the economy was not growing robustly. After the halt in June, holdings started falling naturally as debt matured and were projected to fall to $1.7 trillion by 2012. The Fed's revised goal became to keep holdings at $2.054 trillion. To maintain that level, the Fed bought $30 billion in two- to ten-year Treasury notes every month.

In November 2010, the Fed announced a second round of quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011. The expression "QE2" became a ubiquitous nickname in 2010, used to refer to this second round of quantitative easing by US central banks. Retrospectively, the round of quantitative easing preceding QE2 was called "QE1".

A third round of quantitative easing, "QE3", was announced on 13 September 2012. In an 11–1 vote, the Federal Reserve decided to launch a new $40 billion per month, open-ended bond purchasing program of agency mortgage-backed securities. Additionally, the Federal Open Market Committee (FOMC) announced that it would likely maintain the federal funds rate near zero "at least through 2015." According to NASDAQ.com, this is effectively a stimulus program that allows the Federal Reserve to relieve $40 billion per month of commercial housing market debt risk. Because of its open-ended nature, QE3 has earned the popular nickname of "QE-Infinity." On 12 December 2012, the FOMC announced an increase in the amount of open-ended purchases from $40 billion to $85 billion per month.

On 19 June 2013, Ben Bernanke announced a "tapering" of some of the Fed's QE policies contingent upon continued positive economic data. Specifically, he said that the Fed could scale back its bond purchases from $85 billion to $65 billion a month during the upcoming September 2013 policy meeting. He also suggested that the bond-buying program could wrap up by mid-2014.While Bernanke did not announce an interest rate hike, he suggested that if inflation followed a 2% target rate and unemployment decreased to 6.5%, the Fed would likely start raising rates. The stock markets dropped by approximately 4.3% over the three trading days following Bernanke's announcement, with the Dow Jones dropping 659 points between 19 and 24 June, closing at 14,660 at the end of the day on 24 June. On 18 September 2013, the Fed decided to hold off on scaling back its bond-buying program,] and later began tapering purchases the next year—February 2014. Purchases were halted on 29 October 2014 after accumulating $4.5 trillion in assets.

The interest rate raising baton is now in the hands of Federal Reserve Chief, Janet Yellen, She likes the unemployment rate of 5.1%, she hates the inflation rate of only .2%. With all of the effort thrown at the economy Janet Yellen  is well aware that a rate hike may send the economy into a deflationary spiral.

 QE infinity will eventually come to an end.  We likely will not see a rate hike until December or sometime in Q1 2016. The energy complex will likely feed  off this support as traders rely on the Yellen put as a hedge.

"Don't Fight the Fed"

     The old adage used by Wall Streeters from time immemorial, "Don't fight the Fed", proved itself quite succinctly today with RBOB October futures finishing up .0625.  The highly anticipated speech by Fed Chairman Bernanke appeared to leave the door open for another round of quantitative easing to help counter higher US unemployment. This added more support to risk-appetites and fueled more gains in the crude oil market.

     Ben Bernanke has been on a mission to keep asset prices from falling since the fall of Lehman Brothers in September of 2008.  Being a life long student of the cause and persistence of asset depreciation during the "Great Depression", Mr Bernanke is willing, more than willing, to pump up commodity prices through quantative easing policies, to keep the US economy from sliding back into a deep recession.  Traders will do well to not fight the power that the Federal Reserve wields.

    Speaking at the Fed’s annual gathering in Jackson Hole, Wyoming, Mr Bernanke offered no direct promise of further intervention. But by spelling out the feeble state of the economy, the Fed’s intention to be forceful and its range of policy tools, he raised expectations of action in September.
“Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions,” said the Fed chairman on Friday.

     The clearest hint that Mr Bernanke is ready to do more came from his disappointment with the economy’s progress. He noted some recovery over the past few years but said that improvement in the labour market has been “painfully slow”. He said “unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time”.

     By midday, the S&P had rebounded from a drop after Mr Bernanke's comments, and closed up 0.5 per cent. The 10-year Treasury note rose, pushing its yield 5 basis points lower to 1.58 per cent, as markets decided Mr Bernanke’s comments did signal further easing. Mr Bernanke argued that the Fed’s forecasts of future interest rates – it anticipates rates staying low at least until late 2014 – illustrated its resolve in supporting a recovery.

     In one possible hint of future policy, he said that the current late-2014 date “is broadly consistent with prescriptions coming from a range of standard benchmarks”, but that “a number of considerations also argue for planning to keep rates low for a longer time than implied by policy rules developed during more normal periods”. That could imply a Fed policy of extending the forecast date into 2015 while making clear that it reflects a change in the central bank’s intentions rather than any downgrade to the economic outlook.

     The old adage is to be ignored at the risk of your own trading profitability, "Don't fight the Fed".

Drought Driving Ethanol and Gas Prices Higher

The worst U.S. drought in half a century has fueled a 50 percent surge in corn prices to a record of more than $8 a bushel, heightening fears of a food crisis. Even as the crop wilts, the farm economy has rarely looked healthier thanks to high property prices, widespread accessibility to insurance and a four-year commodity boom.


And a renaissance in domestic oil output in North Dakota and Texas is eating into dependence on foreign crude. Supporters of motor fuel made from U.S. grain have long used the foreign oil addiction as an argument for the Bush-era mandate, known as the Renewable Fuels Standard, or RFS.


Poultry, beef and pork producers complain the RFS, which requires petroleum blenders to use 13.2 billion gallons of corn ethanol this year or face fines, is also behind the rise in corn prices.

The higher corn prices go the more it boosts prices for one of their top expesnses: animal feed. So the industries are pushing the Environmental Protection Agency to waive the mandate this year.


But even with growing numbers of Midwestern counties declared disaster areas by the government, no ethanol opponent can yet make the case the EPA has said is necessary to grant a waiver: that implementing the mandate itself is causing "severe harm" to the economy of a state, region, or the country.


"Severe economic damage is a very high bar," said Mark McMinimy, a senior policy analyst at Guggenheim Washington Research Group, part of a financial services company.


Texas Governor Rick Perry discovered that for himself in 2008 when drought boosted grain prices and the meat industries pushed him to petition the EPA to waive the mandate. The agency turned him down, emphasizing that future petitions would have to demonstrate implementation of the mandate itself was causing the economic harm, not just contributing to it.


"I really don't see at this point what basis the administration would use to issue a waiver," McMinimy said.


U.S. Agriculture Secretary Tom Vilsack told a press conference at the White House on Wednesday the drought will spike crop prices. He also said beef and pork prices might rise late this year after rising in the short-term as ranchers and poultry farmers shrink herds and cull flocks.


But he also reiterated his agency's prediction last week that the corn crop could still be the third largest on record due to wider than normal plantings across the country this year.


In 2007 George W. Bush signed the RFS into law. It required 9 billion gallons of ethanol from corn in 2008, when Perry asked for the waiver. In 2015, the mandate peaks at 15 billion gallons requiring that level through 2022.


The mandate -- run by the EPA under the Clean Air Act -- was also embraced by President Barack Obama even before he hit the campaign trail for re-election and pushed an "all of the above" strategy on energy. Obama's blueprint lays out a future for oil, natural gas and wind and solar, but also for biofuels including ethanol made from corn.


Three of the swing states in the election, Ohio, Michigan, and Iowa, are top corn growing states, where voters might be dismayed by a move to take an important market for the grain off the table.


It is highly unlikely the mandate will be removed with these crucial swing states in play.


There is no doubt the severity of the drought has driven corn prices higher. This in turn lifts ethanol producers cost higher, resulting in higher ethanol prices and ulitmately higher ethanol blended gas prices higher.

The right thing to do is to relax the ethanol mandate immediately. However, it is doubtful any reduction in the mandate will come before the November Presidential elections.

Congratulations to all ethanol blenders who locked in large negative ethanol differentials to RBOB on their contracts earlier in the year!

German Chancellor Angela Merkel to the Rescue

What a day in the energy markets! RBOB rocketed up .15. HO even higher at .1577.  Brent crude and West Texas Intermediate bettered them all rising 7.5%. The catalyst for today's momentum was German Chancellor Angela Merkel reversing her stance on euro rescue funds being used to funnel  monies directly into euro zone banks.

So have all the world's problems been solved?  Are we to expect global growth to kick into high gear?

In my opinion, there are four glaring holes in the Summit’s announcements. First, it’s clear that given the language contained within the statement, any bank recapitalization plan by the European Stability Mechanism (ESM, which replaces the EFSF, the European Financial Stability Facility) is not a guarantee; it is a possibility if strict conditions are met. Secondly, and staying on the ESM, these changes now must be ratified by all 17 Euro-zone members; and Germany still needs to ratify the first agreement. So the ESM is far from being activated. Third, the idea of direct bank recapitalization will not sit well with tax payers in the European core. And finally, fourth, the bailout mechanisms, in my opinion, are doomed to fail once Italy and Spain tap them. Once these countries tap the funds, the burden falls onto the healthier countries, and we’ve already seen that Germany will be hard to convince to contribute more funds.

If there’s a positive to this Summit, it would be that seniority was removed from the ESM. This means that private bondholders, who were forced to take a haircut on Greek loans, won’t experience the same pain; this should help Spanish yields recover. They have thus far, with the Spanish 2-year note yield falling to 4.267% and the 10-year note yield falling to 6.393%.

All that being said, with peak hurricane season just one month away, I believe the bottom is in and hedgers are now able to ease up a little on seeking down side protection on crude and refined products.