Wednesday, March 15, 2017

The Bankers are getting worried

In my February 15th piece Strange Brews in Oil, which looked at the recent phenomenon of a price bump immediately following the EIA's weekly oil inventory announcement (positive builds for the past nine weeks), I suggested the following possible explanation:
I have another theory: Wall Street banks have billions of dollars in loans outstanding with US shale oil producers and prices at $40 or less was pushing many toward bankruptcy.  Between the banks and OPEC, these are two very powerful forces with interest in maintaining higher prices. 
Deep down, I wondered if I was being a bit "conspiratorial?" Recent news gives me more confidence in this position.  First a little contextual reminder of the current oil market situation: with global supply outpacing demand, oil inventories were reaching record highs; (so) OPEC and Russia agreed to reduce output in December; (which led to) record long futures positions held by Hedge Funds at the end of February (they have since been pared down a bit); with prices reaching the mid-$50 range, US shale producers could profitably lock into contracts a year out (they were the sellers to the Hedge Funds buying); and finally, big Wall Street banks have serious loan exposure in the US shale oil market.  Let's start there.

This MSNBC piece from January 2016 provided some detail (from a Goldman Sachs report) on the loan exposure of the banks:
Bank of America leads the list with $21.3 billion. Citigroup is next at $20.5 billion. Wells Fargo is third at $17 billion. JP Morgan Chase is at $13.8 billion. Morgan Stanley is at $4.8 billion, PNC Bank has $2.6 billion and US Bancorp is at $3.1 billion. 
How much is that, as a percentage of the bank's total loans? 
Morgan Stanley leads the way at 5%, followed by Citi at 3.3%, Bank of America at 2.4%, Wells Fargo at 1.9%, JP Morgan Chase at 1.6%, PNC at 1.3%, and US Bancorp at 1.2%.
While the Goldman report didn't list their position, the MSNBC piece quoted Goldman's CFO who said they had $10.6 billion in oil loan exposure. 

So, here's the deal: as recent articles pointed out, OPEC, while previously castigating Hedge Funds for their speculative activity, is now courting them, and they have to because the HF long positions are what's propping up oil prices, at least until last week.

It didn't take a genius to see the situation was untenable: relying on the speculative bets of Hedge Funds to maintain prices is a fool's bet. This brings me to yesterday's piece from Bloomberg.com: Citi tells investors to stop worrying and learn to love oil. Citi analysts came out with a report urging investors to take advantage of the recent price drop because the Saudi's are likely to defend the price. The article also mentioned that Goldman Sachs analysts "called for investors to be patient and said they should go, or stay, long on oil." 

Hmmm....with $30 billion in loan exposure (though I'm sure they've reduced positions some since last year), do you think there might be a little conflict of interest for Goldman and Citi? Interestingly, according to this piece by William Engdahl, banks also "support" the trading of Hedge Funds: 
Goldman Sachs and Morgan Stanley today are the two leading energy trading firms in the United States. Citigroup and JP Morgan Chase are major players and fund numerous hedge funds as well who speculate.
According to the data above, these four banks had a combined $50 billion loan exposure to the US oil industry last year.  This is more than enough incentive for the major players to "rig" the market. However, the Hedge Funds are getting antsy, and have started to pare down their long positions. Given their herding propensity, there is a very good chance of a market rout, which is why the big banks are now publicly urging them to "hang in there." 

The current oil market situation is akin to the prisoners dilemma of Game Theory: it's in the best interest of all to collaborate and maintain higher prices (HFs benefit because falling prices will cause significant losses on their long bets); however, individual HFs may view their best option is to run for the exits (to minimize their losses) before an expected crash.  I'm thinking the exit run is going to win out...

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