Wednesday, August 13, 2014 - Oil, At Least in Theory

Oil, At Least in Theory
by Sinclair Noe

DOW + 91 = 16,651
SPX + 12 = 1946
NAS + 44 = 4434
10 YR YLD - .03 = 2.41%
OIL - .04 = 97.33
GOLD + 3.70 = 1313.20
SILV - .11 = 19.91

The economic news today did not point to a positive session for Wall Street. Retail sales for July were flat compared to June. Excluding autos and gas, retail sales were up just 0.1%. Clothing sales increased 0.4% but that was primarily due to extreme discounting. That report was confirmed by an earnings report from Macy’s, which missed expectations on earnings and revenue, and then lowered guidance. In after-hours trade, Cisco reported better than expected earnings and revenue.

The US has deployed 130 Marines and Special Operations forces to northern Iraq to help assess ways to rescue thousands of members of the Yazidi religious group taking refuge on Mount Sinjar. Those military advisers will not have a combat role, but the Defense Department left open the possibility that US troops could help create a safe passage for the Yazidi off Mount Sinjar. That might put US troops in direct combat with the ISIS militants trying to kill the Yazidi, a proposition President Obama has not signed off on, but one the military advisers are exploring.

The US and Iran don't agree on much, but it appears the two countries are backing Iraqi Prime Minister Nouri al-Maliki's replacement, Haider al-Abadi. Iran's endorsement on Tuesday means that Maliki, who has indicated he won't go quietly, will have an even harder time holding onto his position. The United States and its allies hope that replacing Maliki, who alienated the Sunnis of Iraq, will undermine support for the militant group the Islamic State in Iraq and Syria (ISIS). For now, Maliki is trying to cling to power, but his days appear numbered.

There are daily multiple sorties by US fighter bombers flying off a US Navy aircraft carrier in the Gulf, some resulting in airstrikes on advancing ISIS forces that have threatened civilian refugees and the Kurdish capital of Erbil. Unmanned US drones are in the air gathering a constant stream of intelligence which is being fed back to a US-manned operations center in Baghdad and then shared with America's allies.

There are close to 1,000 US military advisors in Iraq, including Special Operations forces, divided between Baghdad and Kurdistan and the CIA is believed to be running an operation to supply Kurdish forces, the Peshmerga, with arms and ammunition. Iraqi Kurds have overtaken 2 northern oilfields.  The two oilfields are said to have a combined daily output capacity of some 400,000 barrels per day. The operations are most certainly not entirely humanitarian. France and Germany both say they will send military equipment to help the Kurds defend themselves. Hercules transport planes have been dropping aid to civilians fleeing from the onslaught of ISIS.

While the case for intervention on humanitarian grounds to save the lives of thousands of fleeing refugees is overwhelming, there is now the risk of what is known as "mission creep"; of a small, narrowly defined operation ballooning out of control, sucking in Western countries into a lengthy conflict with no clear exit. Politicians are fond of saying "there will be no boots on the ground" but in practice there are already growing numbers of US military personnel deployed to Iraq behind the scenes. The ISIS fighters are now embedding in residential areas like Mosul, essentially using civilians as shields. Already Iraqi government airstrikes around Mosul have led to reports of civilian casualties. What if advice and air power alone are not enough to prevent the ISIS from taking more towns in Iraq and Kurdistan? What if Baghdad itself or the cities of Kirkuk or Irbil look threatened?

The militants from ISIS have been causing problems in Iraq and Syria for several months, but then they took control of the area around Kirkuk, a gigantic oilfield; then they captured the Mosul Dam, which controls electricity and might serve as a weapon; and then they encroached on the Kurdish capital of Erbil, an oil boomtown which happens to have a US consulate but also has hundreds of employees of companies like Chevron and ExxonMobil; that’s when the airstrikes against ISIS started. To be fair, it was also when ISIS became especially barbaric, and tens of thousands of Yazidi refugees became stranded. The current US intervention certainly has humanitarian purpose, but it would also be wrong to pretend that oil is totally irrelevant to the larger crisis in Iraq.

Meanwhile, the markets are discounting any disruption in distribution in Iraq; Iraq is currently the world's seventh-largest oil producer, churning out some 3.3 million barrels per day; Kurdistan in the north is only responsible for about 10% of the national production; most Iraqi oil exports come from the southern part of the country, and those oil fields are far away from the current fighting, so it’s highly unlikely that there will be a disruption, at least in theory.

In theory, all oil sales in Iraq are supposed to be handled by the central government in Baghdad, which then splits revenues among the various regions according to an existing agreement. Iraqi Kurdistan has been pushing to sell more of its own oil directly to other countries, bypassing the central government entirely, because Kurdish officials claim that the central government hasn't been sending Kurdistan its promised share of oil revenue.

The United States is officially opposed to Kurdistan's direct sales of oil abroad because it might undermine the unity of the Iraqi government. There's currently an oil tanker filled with about 1 million barrels of Kurdish oil parked about 50 miles offshore from Houston that can't unload its crude. State Department officials have been quietly warning any potential buyers of the Kurdish oil that they could face "serious legal risks." But now, the Kurds are stepping up the fight against ISIS.

Iraq has scheduled to export about 2.4 million barrels per day of Basra Light crude in September, up from 2.2 million in the previous month. Libya has resumed shipments of crude. According to the IEA: "The Atlantic market is currently so well supplied that incremental Libyan barrels are reportedly having a hard time finding buyers." If Iraqi oil goes offline, even for a short time, the rest of the world does not have enough spare capacity to replace that production; that would likely push oil prices over $125 a barrel, and that might then increase the leverage for Putin.

And it had been thought that sanctions imposed on Russia over its support for Ukrainian rebels might cause disruptions in oil distribution. Russia is the largest oil producer in the world, at over 10 billion barrels equivalent per day or 13% of world supply. However, the markets are looking at Russia and saying that Putin needs to sell oil even more than the EU needs to buy it. Russia turning the taps off would cause an oil shock in the West as it would cause a steep rise in prices and significant disruption, however it would also bankrupt Russia. At least in theory.

Ukraine vows to stop Russian-supply convoy unless conditions are met. Wary that the Russians may be trying to move military supplies into their country to aid pro-Moscow separatists, Ukrainian officials said they would not allow a convoy of 280 Russian trucks to cross the border unless the Red Cross took over the delivery. Ukraine says the cargo, which Russia insists is humanitarian aid, must be loaded onto other vehicles by the Red Cross. It will take the trucks about two days to make the 620 mile trip from Moscow to eastern Ukraine.

Ukrainian state-run energy firm Naftogaz said yesterday that the ongoing dispute over natural gas prices between Kiev and Moscow may lead to disruption in Russian gas transit to the European Union (EU) countries. Kiev and Moscow have been locked in a dispute for three years over a 2009 contract under which they agreed to tie the price of gas to the international spot price of oil. In June, Russia's energy giant Gazprom has cut all gas supplies to Ukraine after the two sides have failed to reach an agreement on payments. The dispute between the two former Soviet countries triggered fears that Russian gas transit to Europe may be halted. Currently, around 15 percent of EU gas supplies flow through Ukraine.

Yesterday, the International Energy Agency (IEA) said: "Oil prices seem almost eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world." Global oil prices have fallen to their lowest levels in 13 months. Brent crude is trading around $103 a barrel, and WTI is around $97, then 10^th straight session with prices under $100. Retail gas prices have dropped about 23 cents a gallon since April.

And you probably remember back in 2008, when tensions with Iran helped push oil prices up to a record $148 a barrel. So, with all the problems around the world now, why are oil prices dropping? The US is pumping the most oil in 27 years, adding more than 3 million barrels of daily supply since 2008. Supplies from the Organization of Petroleum Exporting Countries, which pumps about 40% of the world’s oil, rose to a five-month high of 30 million barrels a day in July as Libyan output recovered and Saudi Arabia increased production. At the same time, global demand is weak, although it is expected to pick up towards the end of the year. Meanwhile Mexico has privatized its oilfields, at least partially. The state-owned energy group Pemex will lose the monopoly it has held since nationalization in 1938. Mexico’s oilfields had been underperforming and production dropped by more than a million barrels per day in the past few years. So, if we can just hold it together for a couple more years, North America could become energy independent. Until then, it could go either way, at any moment, and send the economy into a tailspin in a heartbeat, at least in theory.

Thursday, December 12, 2013 - Three Strikes

Three Strikes

by Sinclair Noe

DOW – 104 = 15,739
SPX – 6 = 1775
NAS – 5 = 3998
10 YR YLD + .03 = 2.88%
OIL - .06 = 97.38
GOLD – 27.10 = 1226.20
SILV - .81 = 19.60

Stocks down for a third day in a row, and except for that big gain on the news of the monthly jobs report, this has been a nasty start to December. Weekly jobless claims jumped to 368,00 from 300,000 the week before. Overall retail sales climbed a seasonally adjusted 0.7% last month, the most since June.  Auto sales jumped 1.8% in November, the most since June. Meanwhile, there were drops in retail sales of 0.2% for clothing and accessories stores, and 1.1% at gasoline stations. Online and other non-store retailers saw sales rise 2.2% in November, the most since July 2012. Over the past year, retail sales have grown 4.7%. Inventories at US businesses rose 0.7% in October. Maybe businesses are expecting a great holiday shopping season but it isn't looking good.

Neither the jobless claims nor the retail sales will move the Fed’s current position on tapering. Markets have been focused on the timing and the slope of Fed bond-buying tapering and not on anything else. Most likely, the Fed will meet next week and not taper, but they will likely communicate clearly their intent to taper.

The just agreed 2014-2015 US budget deal faces a crucial test today when the House of Representatives votes on the bill, with Speaker John Boehner urging skeptical conservatives to back it. The agreement sealed between top Democratic and Republican negotiators is seen as a chance to end the brutal cycle of fiscal crises that have plagued Washington in recent years. The legislation, which sets spending caps at $1.012 trillion for 2014 and $1.014 trillion for 2015, and repeals billions in a package of arbitrary cuts known as sequestration, appears likely to pass the Republican-led House. It would then go to the Senate for a vote, likely next week before the chamber adjourns for the year-end holiday.

Pemex is the pride of Mexico. Part of the reason may be that it is ubiquitous. Every gas station in Mexico has the green and white sign of the state owned oil company. When all else failed, Pemex was the economic lifeblood of the Mexican government. Today, the Mexican Congress passed legislation  declaring that Mexico still owns its oil, but allowing private companies to drill for oil and natural gas in partnership with Pemex, or on their own, returning international oil companies to territory they were kicked out of 75 years ago.

The stated goal is to stimulate Mexico’s sliding oil production and vault the country into the developed world by tapping vast pockets of oil and natural gas deep under the earth and sea. Foreign oil companies have long been eager to gain access to Mexico’s oil and have quietly lobbied the government to open up for years, while Pemex is known for inefficiency at best, and corruption at worst. Mexico’s oil production has declined by 25 percent from its 2004 peak, to just over 2.5 million barrels a day. Pemex is spending more to pump less: investment has more than doubled in the same period to more than $20 billion a year. It may not be the best run oil company but Mexicans tend to consider it their oil company. In a country where controlling oil is often equated with sovereignty and national pride, the plan has set off furious debate.

And it's just part of a bigger plan. President Pena Nieto is also pushing to break up telecommunication monopolies, raise taxes and weaken the teachers union grip on faltering public schools. Two decades after Mexico sold off banks and the telephone monopoly, Mexicans pay more for credit and phones service than other Latin Americans, and they suspect they will pay more for gas under the new law, too.

Five years ago, Bernie Madoff was arrested in New York for running a Ponzi scheme. Madoff's banker was JPMorgan. Federal authorities suspect JPMorgan continued to serve as Madoff’s primary bank even as questions mounted about his operation, with one bank executive acknowledging before the arrest that Madoff’s “Oz-like signals” were “too difficult to ignore.” And so now, the authorities are going after JPMorgan; apparently close to a settlement that would involve about $2 billion in penalties and criminal action, or what passes as criminal action in the world of Wall Street bankers.

The government would use a chunk of the money, probably less than half to compensate Madoff's victims. The settlement would include a deferred prosecution agreement, which would list the bank’s criminal violations in a court filing but stop short of an indictment as long as JPMorgan pays the penalties and acknowledges the facts of the government’s case. The deferred prosecution agreement is expected to fault JPMorgan for a “programmatic violation” of the Bank Secrecy Act, which requires banks to maintain internal controls against money laundering and to report suspicious transactions to the authorities. And just to be clear, this case involves money laundering by JPMorgan.

The government has been reluctant to bring criminal charges against large corporations, fearing that such an action could imperil a company and throw innocent employees out of work. Those fears trace to the indictment of Enron's accounting firm, Arthur Andersen, which went out of businesses after its 2002 conviction, taking 28,000 jobs with it. Ever since, prosecutors have increasingly relied on deferred prosecution agreements, which is a slap on the wrist and allows the bank to continue, as long as they don't continue with their illegal activities. So the basic idea is that JPMorgan can break the law, pay off the government and promise not to do it again. Prosecutors insist that no one is too big to indict or too big to jail. It will be interesting to see if JPMorgan can indeed clean up its business and manage to stop breaking the law; and if they can't keep their nose clean, it'll be interesting to see if the prosecutors actually have the fortitude to enforce the law.

Two years ago JPMorgan entered an “non-prosecution agreement” to settle antitrust charges. I'm sure there is some sort of fine distinction between a “non-prosecution agreement” and a “deferred-prosecution agreement” but they sound similar; no criminal charges as long as they kept to the straight and narrow for 2 years. Then there was that problem of manipulating electricity markets between 2010 and 2012. The head of their commodities trading division, Blythe Masters, was accused of making false and misleading statements to federal energy regulators. No criminal charges were filed.

Pope Francis is at it again. Francis, who was named Time magazine's Person of the Year on Wednesday, has urged his own Church to be more fair, frugal and less pompous and to be closer to the poor and suffering. A couple of weeks ago he published an apostolic exhortation title, The Joy of the Gospel, where he attacked unfettered capitalism, as “a new tyranny” and  condemned the "idolatry of money".

Now in a new message for the Roman Catholic Church's World Day of Peace, marked around the world on Jan. 1, he also called for sharing of wealth and for nations to shrink the gap between rich and poor, more of whom are getting only "crumbs". And he says that huge salaries and bonuses are  symptoms of an economy based on greed and inequality.

Titled "Fraternity, the Foundation and Pathway to Peace", the message also attacked injustice, human trafficking, organized crime and the weapons trade as obstacles to peace.

Francis said many places in the world were seeing a "serious rise" in inequality between people living side by side. He attacked the "widening gap between those who have more and those who must be content with the crumbs", calling on governments to implement "effective policies" to guarantee people's fundamental rights, including access to capital, services, educational resources, healthcare and technology. The Pope says: "The grave financial and economic crises of the present time ... have pushed man to seek satisfaction, happiness and security in consumption and earnings out of all proportion to the principles of a sound economy."

I'm going to take a little vacation time over the next couple of weeks. Don't worry, I'll continue to update the blog on a kind of regular basis.

Monday, August 12, 2013 - The End of Mandatory Draconian Punishment

The End of Mandatory Draconian Punishment

by Sinclair Noe

DOW – 5 = 15,419
SPX – 1 = 1689
NAS + 9 = 3669
10 YR YLD + .02 = 2.60%
OIL+ .19 = 106.16
GOLD + 22.60 = 1338.30
SILV + .87 = 21.53

This week's economic calendar includes retails sales reports tomorrow, plus a look at inflation on the wholesale level tomorrow, and inflation at the retail level on Wednesday; also reports from the Philly Fed, plus a look at industrial production, housing starts, and consumer sentiment. The over-riding question is whether the economy is seriously showing strength or if we are just grinding along. Most of the expectations for this week's data suggest more of the same old, same old. It's doubtful we will see anything that could sway the Federal Reserve to change policy, and that means the stock and bond markets may have gotten ahead of themselves in pricing in an improving economy.

The Treasury Department reported this morning that the US government spent $98 billion more than it took in last month, with the deficit driven by spending on healthcare programs, pensions for the elderly and the military. So far in the current fiscal year, which began in October, the federal government has run $607 billion into the red, a narrowing from the $974 billion deficit chalked up in the same 10 months of fiscal year 2012.

A major change today from the Justice Department; Attorney General Eric Holder is calling for sweeping and systemic changes to the American judicial system. Holder made the announcement today during a speech to the American Bar Association, outlining a reform plan he calls “Smart on Crime”.

Holder says the Justice Department would direct federal prosecutors to charge defendants in certain low-level drug cases in such a way that they would not be eligible for mandatory sentences now on the books. Prosecutors would do this by omitting from official charging documents the amount of drugs involved in a case. By doing so, prosecutors would ensure that nonviolent defendants without significant criminal history would not get long sentences.

The Smart on Crime reforms also include allowing for the early release of non-violent elderly federal defendants who had served significant portions of their sentences, thereby helping to reduce the overall federal prison population. Holder also called for greater use of incarceration alternatives and renewed focus on prevention, pointing out reforms in typically conservative states that have steered funding towards treatment and supervision, rather than funneling more money into prisons.

Holder said: “The bottom line is that, while the aggressive enforcement of federal criminal statutes remains necessary, we cannot simply prosecute or incarcerate our way to becoming a safer nation. To be effective, federal efforts must also focus on prevention and reentry. We must never stop being tough on crime. But we must also be smart and efficient when battling crime and the conditions and the individual choices that breed it."

He also noted that sentences are often racially disproportionate, referencing a February report indicating that, in recent years, black male offenders have received sentences nearly 20 percent longer than white offenders convicted of similar crimes.

Since Richard Nixon declared the "war on drugs" in 1971, US prison numbers have soared to account for 25% of all the world's prisoners even though it has only 5% of the world's population. Drug-related offenses drive the vast majority of the increased prison population.

Some of the proposals unveiled by Holder, such as giving federal judges the leeway to depart from mandatory minimum sentences for some drug offenses, require congressional approval,and getting any consensus in Washington DC is tough, even though this should be an issue that attracts bi-partisan support.

Forty years of a failed war on drugs has destroyed communities and families all across our land. Hard earned tax-payer dollars have been wasted on ineffective policies that have resulted in over-incarceration, pushing state and federal budgets to the brink of bankruptcy.

The attorney general said 17 states have directed money away from prison construction and toward programs and services such as treatment and supervision that are designed to reduce the problem of repeat offenders.

In Kentucky, legislation has reserved prison beds for the most serious offenders and refocused resources on community supervision. The state, Holder said, is projected to reduce its prison population by more than 3,000 over the next 10 years, saving more than $400m.

Holder also cited investments in drug treatment in Texas for non-violent offenders and changes to parole policies which he said brought about a reduction in the prison population of more than 5,000 inmates last year. He said similar efforts helped Arkansas reduce its prison population by more than 1,400. He also pointed to Georgia, North Carolina, Ohio, Pennsylvania and Hawaii as states that have improved public safety while preserving limited resources.

Five years after Wall Street's malfeasance nearly caused a global financial metldown, and after four years of hearing Jamie Dimon whine about how regulations would hurt his bonus, and long after tens of billions of dollars have been lost to bankster fraud, we're about to see the first arrests of Wall Street bank employees. What's more, the suspects work at JPMorgan Chase, a bank which, ironically enough, politicians and pundits insisted was the "good bank" after the financial crisis hit in 2008. This in connection with the London Whale case.

Despite the overwhelming evidence of criminal behavior in a large number of cases, this will have been the first time since the financial crisis that a banker's been arrested on criminal charges, assuming the arrests take place as planned, of course.

Let's be clear: These arrests are a good thing. Justice demands that anyone, no matter who they are, be made to answer for their deeds. What's more, bankers at "too big to fail" institutions have the power to shatter, and even bring down, the global economy. The lack of arrests up to this point means there's been no deterrent effect, no reason for them not to keep committing fraud. And when you compare and contrast the banksters antics, compared to the kid who smokes a joint and goes to jail under mandatory sentencing laws, well it makes a mockery of justice. But even if arrests are made, it is expected to be junior level traders, it won't be Bruno Iksil, the trader known as the London Whale; he's worked out some sort of deal and he's cooperating with investigators. It won't be the Whale's boss, or anybody higher up the corporate food chain. It'll be low-level guys.

There is good reason to look up the corporate chain. Senior management was either complicit or asleep at the switch. The bank's own risk management rules and guidelines were violated 330 times. JPMorgan Chase stonewalled their regulator and as losses grew, Chase provided less and less information to the OCC. Dimon ordered the bank to omit critical data from its standard reports to the OCC.

Now sometimes the Department of Justice arrests low-level workers in an attempt to get them to provide information against upper level management; they use them to build a case. Sometimes, the low-level guys are nothing more than sacrificial lambs. We'll see.

News out of Mexico today that could have a big impact on the energy sector. Mexican President Enrique Peña Nieto proposing to end a ban on foreign firms taking part in the state-run oil industry. Now, this is not a new idea, and in the past it has not been well received.

The proposal would allow state-oil agency Petróleos Mexicanos, or Pemex, to partner with foreign firms and share profits, a practice prohibited by the Mexico constitution. It would also allow more private participation in electricity generation in an attempt to drive down prices that the government says are 25% higher than in the United States.

Peña Nieto says the oil and electricity industries would remain under government control and that private companies could not claim petroleum reserves as their own even as opponents railed against changes they say run contrary to the national interest and risk handing over the country's greatest treasure to foreigners. Pemex has not been employing new technologies, and the thinking is that bringing in foreign firms might modernize practices. Oil output has dropped from nearly 3.4 million barrels per day in 2004 to 2.5 million barrels per day in 2012. The flip side is the fear that foreign firms will do more than modernize, they will claim Mexican reserves as their own, or employ environmentally harmful drilling techniques.

Meanwhile, north of the border, Texas has been employing modern techniques for quite some time; the result is a boom in exploration and production; the oil is flowing, but the water supply is running dry. Three years of drought, decades of overuse, coupled with the oil industry's demands on water for fracking are drying up reservoirs and underground aquifers. The Texas Commission on Environmental Quality says 30 communities could run out of water by the end of the year. And while most of those communities are small rural towns, there are nearly 15 million people living under some form of water rationing, barred from freely watering their lawns or refilling their swimming pools or in the case of the small town of Barnhart Texas, they've just run out of water; turn the faucet and nothing happens.

Fracking is a powerful drain on water supplies. In adjacent Crockett county, fracking accounts for up to 25% of water use. Fracking isn't the only reason for water shortages. Big cities soak up plenty of water, agriculture takes its share, climate change and the drought have added to the problem, but fracking seems to be the straw that might break the camel's back. Last week, heavy rains hit much of Texas, but it wasn't enough to recharge the aquifers.