Friends tell me Blackstone already walked out on Trafi. Capital and LOCs is exceedingly hard to come by in this space and part of the reason you saw oil pricing blow out to $130 and then collapse back below $100. A thread 1/n
Following the initial invasion we saw mismatched books and back-to-back trades start to blow up as reflected in the Urals discount imploding vs skyrocketing Brent. 2/n
The requirements to post greater margin during the blowout in futures and associated liquidations created a level of volatility that blew through VAR and control limits, and forced both commodity desks and HFs/CTAs/systematic trend followers to cut exposure, both long & short. 3/
The ‘tell’ that this interpretation is correct would be to see a significant decline in Open Interest amidst high volume. This is in fact what has happened, as Open Interest has *collapsed* to lows not seen in over FIVE YEARS… see Brent ICE on left, Nymex WTI on right: 4/
Why does OI matter? Imagine it’s the 80s, you are looking out on a pit of 300 people screaming oil quotes at each other. Many participants. Lots of quotes and order book depth. Penny wide bid/ask, 10-20 contracts on each side. Heterogenous participants. Efficient. Continuous. 5/
Now imagine one day 250+ of them are dead. You see much less open interest. One or two contracts on the bid/ask which is now a nickel wide. Mkt topology is homogenous because the survivors operate similar styles in a thin order book. Inefficient. DISCONTINUOUS. 6/
This is precisely where the oil futures market is today. My suspicion is the culling of OI was completed in that final “look” below $100 this week. So what happens next? 7/
The market is now illiquid and discontinuous. Expect to see gapping on minimal volumes that pre-February would have been easily absorbed and executed without moving markets. Air pockets. 8/
The issue comes back to VaR, volatility, and risk controls. Market makers and trading desks do not have the balance sheet to make markets in sizes to which we grew accustomed. 9/
Previously if you bought a future, chances were good that a desk would open that contract shorting to you. Not so much now. So if you want to buy futures, you may have to go and find a guy who already owns a future to sell to you, but he may only sell a dime or quarter higher. 10
The price move from $130 to $95 had almost nothing to do with supply/demand modeling and is entirely attributable to the vol mechanics I described above: books were disrupted, vol went nuts, and traders cut size. 11/
But the fundamentals of the oil market have not improved. We went into the invasion tight on the inability of Opec+ to increase production as measured by growing “overcompliance,” difficulty in expanding shale due to labor/input shortages, plus roaring demand. 12/
If anything the market has only grown tighter due to disruptions which will *increase*, not decrease, from here as new trading routes need to be drawn up, tanks at Black Sea ports hit tops, and production is shut in. 13/
The oil market imho has now ceased mass OI liquidation, will now begin to reassume its primary function: price discovery.
14/
Now think about the psychology of participants here. Equity market bullsht “look through the conflict” has infected participants to the point where people are entirely misreading why oil collapsed from $130 to $95. The relief is palpable - especially among equity tech longs. 15/
But put yourself in the position of the head of jet fuel procurement at United. Oil ripped in your face to $130, you can explain to your CEO why you are not fully hedged and supply guaranteed through 2024 because “invasion.” 16/
Now the oil price washed out - emergency is over. The market will “find a way” from here. But then oil starts rising again - $2-3/bbl a day grinding higher. And then it gaps over $125. CEO calls you asking what you have been doing about it. What do you do? 17/
Simple. You try to save your job by panicking. You try to buy oil futures but they are illiquid. So you start calling Valero directly and ask them for 5mn gallons of jet next month and are shocked to hear “we might be able to do 200k.” 18/
This is when the “come to Jesus” moment happens and the DISCONTINUITY of a low OI futures market reveals itself in all its glory. Because now oil is at $150, and the red bar on Bloomberg hits reminding everyone that we are now at new all-time highs… 19/
… but them the commentary of “actually in real terms that $147 2008 high is closer to $200 today” starts coming in droves and everyone knows that if we go to $150, we are going to $200.
And then the market is a complete and total sh*tshow. 20/
Side note: what goes through equity investors’ minds when they start thinking of $150 oil as not an aberration spike but rather a ‘new normal’?
/End
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A few real gems from the past few weeks’ oil responses.
🧵
There are many like this - flat and reasonably polite. I didn’t realize down 5-10% from basis constituted “shambles” but some people have tighter risk limits than others I supposed
Again “bust,” like “shambles,” seems somewhat strong, but one man’s correction is another man’s financial crisis.
Regardless of how all the wild speculation around the US Executive ends up in the coming days, weeks and months, the current uncertainty is growing my conviction rapidly in one way specifically:
1/4
Oil powers the machine everywhere. The economic machine. The activity machine. The war machine. The Machine. It is the substrate of power and might.
The uncertainty splintering the minds of many in the market could end in up with “oil as the next gold,” in the following way.
2/
For almost two years we heard “but, but real rates are going up, how is gold going up??”
We now know why the divergence. Hindsight = 20/20.
Similarly, in 2024-25 the refrain could be “but, but US is flirting with recession and Asia is vulnerable — how is oil going up??”
3/
My buddy @kevinmuir wrote one of the best things I have read all year:
Rate hikes have been net stimulative as borrowers termed out lower while higher govt rates generate income accruing to debtholders with a tendency to buy financial assets vs spend, fueling mini-bubbles. Lower rates from a slower economy will have the opposite effect on stocks.
I have said ad nauseum how we are speaking Portuguese and don’t realize it in the EM-ification of USA. A key mechanism to turning Brazil into one of the highest gini coefficients in the world is precisely an elevated nominal/inflationary feedback loop environment which, taken to BZ’s extreme, has resulted in payroll loans and consumer credit at 30% *per month* while the rich would park in BZ sovereigns earning 20% nominal/10% real and send their money to swiss mountaintops while flying private. Modern day Gilded Age robber baron shit handed down from the era of sugar plantations but without the production of Carnegie steel and Rockefeller oil — just constant gini tightening.
2/
Because the economy became uncompetitive (protectionism, lack of education, horrendous waste and public corruption) and woefully inefficient, the feedback loop of fiscal creating money that the CB would try to stanch would further reallocate/siphon wealth in classic Austrian style from the working/poor classes to the politically well connected and rich.
This is the subtle link between Mises and Mosler and where MMT and Austrian have more in common than perhaps they would ever admit.
3/
Putting this here rather than behind the stack paywall and doing it before 6pm because I am seeing a lot of really shit takes on why this was a nothingburger since Iran didn’t hit anything major, “all bark no bite,” and so gold and especially oil should be faded.
1/7
I think people who are thinking this way about oil in particular are scarred by 3 - THREE - successive physical dumps over the past 2 years and that is Martingale thinking gone awry.
1) Russia invaded, and Biden that summer cratered oil with a historic centimillion bbl sale.
2/
2) Oil tried to rally fall 2022 and Russia smoked positioning with a 40mm bbl crude dump in Nov-Dec22 followed by 40mm bbls diesel. Positioning took months to rinse.
3) 3Q22 rally into Oct 7th and Iran sold something like 80mm bbls of crude and naphtha on water. 4Q23 plunged.
3/
If inflation misses for March and maybe April before scorching later in 2Q as I expect, the Fed has cover to be dovish *which is a shitshow negative for the long end of the curve* as it reinforces the policy mistake made months ago.
2/
If it comes hot, then inflationists have confirmation and pour it on again and consensus longs freak TF out because inflecting growth AND inflation is literally kryptonite for bonds.
While everyone screws around with AI this week, this glorious year for macro continues unabated. Will try to drop a note on the Fed via the blog in my bio tomorrow, but meanwhile here is a rare drop from behind the wall/chat earlier for those who care about the BoJ and yen:
1/
JPY - just occurred to me maybe I have had this all wrong. I should have been listening to myself from early 2022 all along when I dropped the Velociraptor thread that many of you liked back when JPY was <125 on its way to 150.
2/
BOJ will slow walk this to 50bps next year. This still makes yen the ultimate carry trade. And weak jpy works for them in lieu of negative rates. It’s a form of easing.
3/