Gary Gensler - CFTC gets some teeth

Looks like the CFTC, for long seen as a country cousin of the SEC, may finally be getting some teeth with Gary Gensler...

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Debating Peak Oil

The Oil Drum blog today posted a rebuttal to both a NYTimes article and Scientific American article that it feels painted a far too optimistic picture about our proximity to “peak oil”, in particular pointing to physical possibilities that have a questionable economic reality. It’s an interesting debate which you can find at:

Peak Oil Not a Problem According to NY Times; Scientific American - Our Response on the Financial Aspects

I will warn, however, that this blog tends to be a bit of an echo chamber of “oil peakers” but it’s always worth reading a different point of view if you’re used to the more tame views available in mainstream press.

Without risk-taking there is no banking industry

Bob Diamond, the chief executive of Barclays Capital, said recently in a radio interview that without risk-taking there is no banking industry (link to radio interview).

This is correct, though may be a concern for those who believe the traders who take the risk are to blame for the banking crisis. Of course, traders should be rewarded for successfully making money from the active use of risk though the real question is whether the risks are properly understood and therefore whether the returns are sufficient and rewards appropriate.

Actually, what this highlights is the need to properly measure, manage and report the risk being utilised in a relevant way, perhaps pointing the finger at the accounting and audit practices; do they expose the risk sufficiently to help its management or just to meet fiduciary and regulatory requirements?

Another outstanding question, emanating from the same underlying issue, is why did the Lehman Bros' published and audited accounts not give a proper warning of their impending and sudden failure; surely it wasn’t due to new trades after the accounts were published but a consequence of risk in the books not being recognised.

A further side effect of the existing accounting policies is that they potentially put incentives in the wrong place, particularly those for companies that actively manage the market risk of their own assets. For example, trading decisions driven primarily by hedge accounting policies, rather than for risk management, could result in the diversion of P&L from assets to trading groups while leaving some unmanaged risk with the asset. Interestingly, recent results published by a leading utility with an active trading group show huge trading P&L and weak asset results; leaving the investment analysts questioning the organisational set up.

The common factor is that accountants and auditors are really only reporting a snapshot of the financial state rather than the real risk in the business that can impact future performance; this could be an underlying reason for the recent problems. These accounting driven decisions are also the reason many organisations are structured in such a way that helps to satisfy accounting standards rather than to best manage the asset's profitability and risk. This is not a matter of MTM or accrual accounting but how to represent the state of the business risk.

In the rush to blame the traders and their bonuses, the regulators and the industry commentators appear to have completely missed that the current accounting rules are a significant contributor to the crisis we have seen in the markets!

A “non-electric” plug-in hybrid?

Kleiner Perkins hints at plug-in car launch this week and they have said it “it is not an electric vehicle” and then said “do not think batteries”. My guess? It IS an electric car but it doesn’t use batteries. I mean what other kind of propulsion system would the car run on? It’s really annoying but modern vernacular confuses automotive propulsion with energy storage with regularity. For instance, a “hydrogen fuel cell” car IS an electric car … it just uses H2 as is energy storage and a fuel cell to convert it to electricity.

My guess is that this car in fact does use a fuel cell technology -- possibly hydrogen fuel cell -- and the real breakthrough is that they’ve come up with a more efficient way of using on-board electrolysis to make hydrogen gas (or whatever gas the fuel cell consumes). If that is true and the economics of this storage system compete with battery technology that could have a huge impact on the automotive field.

Regulator influences the oil market or an unintended consequence?

It is perceived wisdom now that the activity of investors in the commodity market during recent years may have inflated prices, particularly oil, via the inflow of significant investment capital to indexed based long-only commodity funds and ETFs.

Essentially, if the premise is correct, the investment funds swamped physical supply/demand fundamentals pushing up prices, above some undefined ‘appropriate’ level. The view expressed being that commodity markets were under invested and higher prices would result; in fact that higher prices would be required if future supply is to meet potential demand requirements. In truth nobody really knows and that is the nature of risk.

Why this investment activity, often described derogatively in terms of speculation, is considered different to investment flows in to other markets may not be entirely clear; surely investors have as much right to put their money in commodities as equities. Some might say it is no coincidence that most non-professional players in other markets are happy to see higher prices as it benefits the economy and their pensions. Does this make the ‘positive’ benefit of investor speculation in the non-commodity markets more acceptable, whereas increases in commodity prices come straight out of our pockets? The answer should be no, as should any action that unduly influences the price down as well; short sellers should not be vilified for this either as they are really only the messenger expressing nervousness of over valuation.

Interestingly, few commentators have uttered any scepticism about last week’s reasonably significant (>6.5%) drop in the entire oil forward curve. However, one of the strongest rumours in the market is that it was due to the action of a large player, in fact a nameless FED15 bank, who was unwinding a sizeable portion of a long oil position. The talk amongst the trading community is that the bank’s compliance department was concerned about the impending increase in regulatory reporting and a potential knock-on impact on capital requirements.

Currently the market consensus is that fundamentals in the oil market are reasonably supportive. Without any exogenous factors the trend could be back on the ‘up’, though one of the main risks to sharp downside is the uncertainty whether more of the FED15, particularly the larger commodity players, will also feel it necessary to unload their investment in long index strategies and ETFs.

Is this undue influence or an unintended consequence of the regulators’ involvement in the commodity market?

Floating Wind Turbines

One of the key issues with offshore wind turbines has always been that they need to be pretty close to shore. However, the wind is much stronger far out to sea. Bit of a Catch-22. Well, not any more - thanks to the floating wind turbine which will hopefully allow much more efficient wind power...