Nov 14, 2014

Brent Crude - An index detached from the fundamentals ?

To Hedge or Not to Hedge - That's the billion dollar question puzzling everyone from industry heads to govt policy makers in the wake of crude oil collapse . Before even attempting to answer that, it may be prudent to to look at the way indices work - and the economics behind it.

What should a market index reflect ?  It should be a consistent & fair representation of the underlying supply & demand. Is that the case behind petro price indices ? Lets look at a few data points first.

Globally, there are two main crude indices  - Brent & WTI . Brent crude index is computed as a mathematical function of spot & future prices of North Sea oil ( Click for details ) . Similarly, WTI or West Texas Intermediate is function of primary crude contracts settled in Cushing, Oklahoma . Both have different Sulphur content, density etc - which means there are different costs to refiners, though the end - market - Consumers is largely the same

For most part of the last 5 years, Brent has been higher than WTI. If you look at the Brent - WTI spread (   ) , you will see a few interesting points. The spread has been highest ( $20+ ) at the peak time of quantitative easing.  Or in other words, loose money often tends to flow into easily accessible commodity markets.  The intermittent spikes have largely coincided with the political flare-ups. And, as of today, the spread stands at $3.09.

Suppliers naturally tend to lean to higher indices as it suits them.  A large portion of oil purchase agreements are ( were ? ) based on Brent. But, is Brent, a fair representation of the market ? Most of the Brent Crude flows to Europe  ( Of late, Russian oil also has a sizable market share there ) . When the market is largely limited to a region,  is it really prudent for a consumer - in say China / India - to strike a contract based on an index that is not really favorable to them ?

The geo-political realities today are much different from the last decade.  ONGC & CNPC - which represent two large consumer nations today have taken stakes in a lot of African / Russian oil fields. And these are driven by large volumes - which dwarf North Sea capacity ( It is depleting as well ) .

What this essentially means is that, in terms of producer - consumer combinations, the oil market has become a bit more fragmented / decentralized . In a decentralized market, centralized indices that predominantly cater to the demand of a region will lose relevance.   Imagine, LIBOR being used as a standard to price securities world-wide.  Using Brent to price crude is in some ways equivalent to that  .  As more and more consumers realize that, a large number of them will move away into different modes of pricing  -  Governments will tend to take stakes in oil fields  ,  Companies will tend to rely on more localized & independent indices .

Another problem with these indices is that it is kind of self-reinforcing. Suppliers strike contracts based on indices - & indices take those contract settlements to recalculate themselves.  It is somewhat debatable as to how quickly the demand signals get reflected in such a mechanism. What gets easily reflected are the speculative positions taken based on external political events.

How can indices stay relevant ?  Can we imagine a world in which a consumer strikes a petrol contract with a next door petrol pump based on XYZ index ? I would say, fuel market will be truly deregulated only on such a day.

Oct 10, 2014

Kailash Satyarthi's Nobel - A slap on the face of mainstream Indian Media & System ?

Like most of the fellow Indians, till 10-Oct-2014, I've never heard of his name.  Nobel prizes are not announced out of thin air. Extensive evaluations are done on the nominations. Even the fact that an Indian was on the shortlist should have made the news, but our media was so bankrupt on information about this personality so that some of them even quoted the wikipedia articles blindly.

This day kind of made me aware how hollow the Indian media system is.  The so called grass-root journalism - even if it is done - rarely gets the deserved attention. To a public which enjoys gossips & cleavage talk much more than anything like this, Indian news channels spit out a continuous stream of that.
All that even the well networked channels like NDTV could do is to trace couple of children saved by him - tell them to narrate their stories.

I took a look at Satyarthi's Wikipedia page as well.  There are 13 'awards & honours' including the Nobel 2014 listed there. But whats striking is that, there is not even a single Indian accolade. So whose fault it is ?  Media's fault in failing to highlight his work ? The Indian system's fault in failing to support people like him ? Or the Indian public's apathy in turning a blind eye towards the social issues ? I think it is a collective failure in which you and me are a part of.

PS:- The important factor in Satyarthi's work is that, its not just about rescuing a child worker -which many can do - It is also about creating an eco-system or enabling environment for the kids to study & develop themselves without ever wanting to go back to the clutches of exploitative employers.

Aug 30, 2014

Uber-mess - Why RBI is right ?

 Reserve Bank of India has kicked up a storm by preventing the use of foreign payment gatways in local transactions.. The first casuality of the move is Uber. Traditional media & social media is up in arms against RBI quickly for killing innovation with archaic laws. Even some of the most learned economists have written against RBI move ( )

In reality, is the RBI really a regulatory villain in this case ?
Here's the link to the original circular

There are three main things that are emphasized in this circular, directly or indirectly

(1) Transctions between two residents of India should be in INR. 
(2) The INR credit card transaction should be acquired by an Indian bank through an Indian payment gateway if the card is issued in India. .I.e, there should not be any forex flow in such transactions.
(3) There should be a two-factor authentication in Card -not - present (CNP ) transactions.

Make no mistake, Uber is a great step forward in terms of convenience.The iphone-app based billing is a true innovation. Taxi cabs across the world is feeling the heat of market disruption resulting in strikes in London , Paris and many more.

From a consumer's perspective, the convenience that Uber brings about is really un-paralleled.
However RBI has multiple responsibilities. Its not a pure consumer rights watch-dog. One of its mandate is to ensure currency stability. While, advocates of free market mechanisms scorn against this role, the reality of India is that your INR exchange rate has a great bearing on inflation. 

And, insisting that the transaction between two residents ( driver and the passenger ) should be entirely in INR is perfectly justified. Why should such a transaction cause a foreign exchange flow ? In Uber- model, the credit card transactions are routed through a gateway in Netherlands, and the payment to the driver comes from a different US / EU bank account. Meaning, in every transaction, there is a foreign exchange inflow or outflow that puts Indian banks at the possible risk of gain/loss depending on the exchange rate fluctuations. Add to that, the settlement risks in CNP's is much higher. Any chargeback claims will additionally result in forex flows.

What I find more disturbing about this model of currency flows is that the state loses its right to tax such transactions. These transactions are not going to hit Uber - India's bank account, and there is no way for the taxation authorities to assess the flows as gateways, banks etc are located abroad.
There's this well known method of tax avoidance in movie industry in India. If you look into the financial statements submitted by actors, production houses etc, you would see that the lead actor/actress was paid, only about say , 1 million INR.  In reality, much of the actual financial transaction takes place in tax havens outside of India. 

To curb volatility in currency markets, it is essential that these forex flows are controlled . To me , the spirit of this ruling is more on forex flows than on two factor authentication.

The point on two factor authentication is more from a consumer protection front to prevent incidents of card cloning and reducing chargebacks. From a systemic perspective, how do you build more faith in the credit card system - by reducing chargebacks and making consumers feel that the card is secure.
Two factor authentication does bring more comfort to that front, at the cost of convenience.

If Uber routes all these transactions through Indian gateways and Indian banks, then the concerns of RBI on forex flows is addressed. The only remaining point would be this consumer protection argument  of two factor control. If adequate auth controls and checks are present at the time of enrolment into this app, then the two factor auth at the time of actual transaction can be done away with .

As I put it initially, this ruling is more about forex flows. On that front, RBI is fully justified.