Tag Archives: Bear Stearns

How Is This Possible?

The latest consumer credit number are out and  the decline we have seen in recent months continues. The US consumer credit contracted to $2415,3 billion in May, from $2424,4 billion in April. That’s another (almost) 10 billion decline, or 4,5% annualized.  But how in hell can the US authorities miscalculate monthly credit numbers by $16 billion?

“Yet stocks, which confirm again they are now completely decoupled from facts, statistics, or reality in general, jump on this very negative development.”

Zero Hedge

Consumer Credit in the US plunged from $2424.4 billion in April to $2415.3 billion in May, a $9.1 billion decline, or 4.5% annualized, on consensus of $2.3 billion. Yet the biggest stunner was the April revision which was whacked from +$1 billion to a revised;  -$14.9 billion!

That means there has been a $24 billion decline in consumer credit in the past two months.

The biggest hit was – as usual – experienced by revolving credit accounts, which fell by a 10.5 annualized rate to $830.8 billion, from $838.2 billion in April, and just north of $910 billion a year earlier.

The bottom line is that consumers continue to retrench as the deflationary wave gets ever bigger.

And the only lender, for the second month running is….. guess who?

The Econotwist’s Blog have a really hard time understanding how the US authorities can miscalculate the monthly numbers by nearly $16 billion. Have they acquired some old modeling software from Lehman or Bear Stearns, or something?

The expression “elephant in the room” just doesn’t cover it.

And I won’t make any attempt to come up with an explanation – or even a comment.

I’ll leave the comment to Tyler Durden at Zero Hedge:

“Yet stocks, which confirm again they are now completely decoupled from facts, statistics, or reality in general, jump on this very negative development.”


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Response To The BP Derivatives Story

The recent post “So, You Thought BP Was An OIL Company?” is currently the most read story ever published at the Econotwist’s Blog. And of course there’s been some comments. There’s particularly one comment I can’t refrain from replying to.

It can be found at Seeing Alpha:

“That article is about as credible as me writing about nuclear technology. Off-balance sheet transactions? SPEs? Interest Rate and Currency Swaps? Has that idiot even looked at a Annual report for BP? Does the moron know the difference between mark-to-market and accrual accounting? Does he understand that Enron and Lehman were both ‘paper’ companies vs. BP which owns $billions in physical assets. And what actual substance other than quoting some Moody’s % is he actually providing? Sure the derivatives market is $trillions, but most of that is paper (i.e. debt securities and currencies which DWARF energy derivatives). In a word, simply a fool that’s probably talking his book…..”

Well. I’m the idiot/moron/fool who wrote the article in question.

This idiot has in fact read several of BP’s annual reports, and let me quote from the 2009 annual:

Derivatives:

Gas and power marketing and trading activity is undertaken market both BP production and third-part natural gas, support LNG activities and manage market price risk as well as to create incremental trading opportunities through the use of commodity derivative contracts. Additionally, this activity generates fee income and enhanced margins from sources such as the management of price risk on behalf of third-party customers. These markets are large, liquid and volatile.”

“In connection with the above activities, the group uses a range of commodity derivative contracts and storage and transport contracts. These include commodity derivatives such as futures, swaps and options to manage price risk and forward contracts used to buy and sell gas and power in the marketplace. Using these contracts, in combination with rights to access storage and transportation capacity, allows the group to access advantageous pricing differences between locations, time periods and arbitrage between markets.”

BP has been able borrow with AAA yield anywhere on the curve and lend to less credit worthy entities at attractive spreads. These lending differentials are the fuel of the $430 trillion Interest Rate Swap OTC market.

BP has been able to spin off $20 billion of earnings for the last 5 years, and $15 billion in cash last year.

Accounting

“Natural gas futures and options are traded through exchanges, while over-the-counter (OTC) options and swaps are used for both gas and power transactions through bilateral and/or centrally cleared arrangements.”

These contracts (OTC) are typically in the form of forwards, swaps and options. Some of these contracts are traded bilaterally between counterparties; others may be cleared by a central clearing counterparty. These contracts can be used for both trading and risk management activities. Realized and unrealized gains and losses on OTC contracts are included in sales and other operating revenues for accounting purposes.”

This moron does in fact know the difference between mark-to-market and accrual accounting, and why the OTC contracts are included in “sales and other operating revenues for accounting purposes,” which totaled $213 billion in 2009, in where sale of crude oil through spot and term contracts amounted to $35, 6 billion.

Off-Balance Sheet

BP uses derivative instruments to manage the economic exposure relating to inventories above normal operating requirements of crude oil, natural gas and petroleum products as well as certain contracts to supply physical volumes at future dates. Under IFRS, these inventories and contracts are recorded at historic cost and on an accruals basis respectively. The related derivative instruments, however, are required to be recorded at fair value with gains and losses recognized in income because hedge accounting is either not permitted or not followed, principally due to the impracticality of effectiveness testing requirements.”

“Gains and losses on these inventories and contracts are not recognized until the commodity is sold in a subsequent accounting period.”

According to the 09 annual statements, financing agreements of $6, 48 billion is held off balance sheet.  Additionally, the BP group has issued third-party guarantees with amounts outstanding at $319 million of liabilities of jointly controlled entities and associates, and $667 million in respect of other third parties – also off balance sheet.

Contagion

BP’s subsidiaries in the Gulf – Arosa Funding Limited, Halliburton, Anadarko Petroleum, Transocean Inc., and Cameron International – are all placed under credit watch with negative outlook.

BP own (fully or partly) 3.689 refineries around the word, and 22.400 retail sites. These retail sites are not just gas stations, but increasingly expanding into new areas like food and clothing.

This fool does in fact understand the difference between Enron, Lehman, Bear Stearns and BP. But he also sees the similarities; these companies failed because their primary assets deteriorated rapidly, which in turn triggered materialization of their exposure to the derivative market, resulting in insolvency and finally default.

BP may have billions in physical assets, so did Enron, but this fool have also noticed that the market value of the company (and its assets) have been cut in half since April 20.

Liquidity

BP borrowed $11 billion in 2009, and have (as of January 2010) $34, 6 billion in debt – most of it cut in pieces and sold worldwide through their banking network as a mighty fine collection of collateralized, securitized, synthesized and highly leveraged fixed income assets.

BP’s issue of CSOs equals 18% of the global total rated by Moody’s.

BP’s credit rating has been cut to junk by Fitch, to BBB from AA. As a result, the price of BP’s Credit-default Swaps has jumped to nearly 600 bps, up from 44.

One of BP’s 5-year bond series, maturing in 2012, was recently trading with a yield of 9, 48%.

And on top of this, BP is supposed to come up with another $50 billion to clean up the oil spill, as public pension funds are preparing to sue the company for the money they’ve lost by investing in BP shares.

Now, before you call someone an “idiot”, a “moron” or “fool”, be sure you know what you’re talking about, or you will be the one ending up looking stupid….

SOURCES:

(1)   06-21-10 BP’s Bankruptcy Would Impair 117 (18% Of Total) Collateralized Synthetic Obligations, Lead To Pervasive Losses Zero Hedge

(2)   06-16-10 BP CDS Curve Goes Nuts, 1 Year Passes 1,000 Bps, No Offers In Market Zero Hedge

(3)   06-25-10 BP Getting Crushed: What Does its ‘Yield Inversion’ Mean? WSJ

(4)   06-28-20 Interactive timeline: BP oil spill disaster Financial Times

(6)   06-25-10 BP reassures on cash pile as shares plunge Financial Times

(7)   06-18-10 Macondo, in historical Hollywood context FT Alphaville

(8)   06-10-10 BP short interest, other facts and stuff (updated) FT Alphaville

(9)   06-24-10 BP Bankruptcy in U.K. Is Obama’s Worst Nightmare Caroline Baum  Bloomberg

(10) 06-21-10 BP and Anadarko turn on each other FT Alphaville

(11) 06-20-10 Internal BP Document Confirms Matt Simmons’ Worst Case Prediction Of Spill Rate Of 100,000+ Barrels Per Day Zero Hedge

(12) 07-01-10  ”Sultans Of Swap” Tipping Point

(13) 02-26-10 BP Annual Report 2009

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So, You Thought BP Was An OIL Company?

In fact, there isn’t that much of a difference between BP and Lehman Brothers – both have been among the major players in the unregulated $615 trillion OTC derivative market. If BP is forced to file for bankruptcy, it will probably have an even greater negative impact on the financial markets than the Lehman failure caused.

“Major BP risk lay in the $615T OTC Market that only the major international banks have any visibility to…. and they are not talking!”

Gordon T. Long


The potential contagion of the BP disaster may eventually show that Lehman Bros. and Bear Stearns were simply early warning signals of the devastation lurking and continuing to grow unchecked in the $615T OTC Derivatives market. What is yet unknowable is what the reality is of BP’s off-balance sheet obligations and leverage positions. How many Special Purpose Entities (SPEs) is it actually operating?

Well, this it what we know so far:

Remember, during the Enron debacle Andrew Fastow, the Enron CFO, asserted in testimony nearly 10 years ago that General Electric (GE) had 2500 such entities in existence.

BP has even more physical assets than both Enron and GE.

Furthermore, no one knows the true size of BP’s OTC derivative contracts such as Interest Rate Swaps and Currency Swaps.

Only the major international banks have visibility to what the collateral obligations associated with these instruments are, their potential credit event triggers and who the counter parties are.

They are obviously not talking, but as Gordon T. Long explains in a recent article, they are aggressively repositioning trillions of dollars in global currency, swaps, derivatives, options, debt and equity portfolios.

The Murky World Of Off-balance Products

“Once again – as we saw with Lehman Brothers and Bear Stearns – we have no visibility to the murky world of off balance sheet, off shore and unregulated OTC contracts, where BP’s financial risk is presently being determined,” Long writes.

“At a time when understanding a corporation’s risk position is critically important investors are in the dark. When markets are uncertain, bad things are certain to follow. The new financial regulations under the Dodd-Frank legislation does absolutely nothing to address this. This was the central issue in truly understanding and corralling TBTF risk. It has not been addressed and the markets will likely make the tax payer pay for this regulatory failure once again,” he adds.

Mr. Long is a former senior executive with IBM and Motorola, a principal in a high tech public start-up and founder of a private venture capital fund. He is presently involved in private equity placements internationally along with proprietary trading involving development and application of Chaos Theory and Mandelbrot Generator algorithms.

“Major BP risk lay in the $615T OTC Market that only the major international banks have any visibility to…. and they are not talking!” he writes in the article called “Sultans of Swaps”

Enron Times Ten

This is what Jim Sinclair at jasmineset.com says:

“People are seriously underestimating how much liquidity in the global financial world is depending on on a solvent BP. BP extends credit – through trading and finance. They extend the amounts, quality and duration of credit a bank could only dream of. You should this financial muscle behind a company with 100+ year of proven oil and gas reserves. Think about that in comparison to a bank with few tangible assets. Then think about what happens if BP goes under. This is no bank. With proven reserves and wells in the ground, equity in fields all over the planet, in terms of credit quality and credit provision – nothing can match an oil major. God only knows how many assets around the planet are dependent on credit and finance extended from BP. It is likely to dwarf any banking entity in multiples…. The price tag and resultant knock-on effects of a BP failure could easily be equal to that of a Lehman, if not more. It is surely, at the very least, Enron x10.”

Sound Familiar?

As long as an energy giant can manage its cash flows throughout the volatility of price fluctuations, it becomes a money and credit generating machine.

It can borrow with AAA yield any where on the curve and lend to less credit worthy entities at attractive spreads.

These lending differentials help fuel the $430 trillion Interest Rate Swap OTC market.

BP has been able to spin off $20B of earnings for the last 5 years and $15B in cash last year.

All of this suddenly comes to an end if its credit rating is significantly impaired.

But what could possibly cause this to happen?

It would take a black swan event. An outlier. A fat tail.

Sound familiar? Heard this discussion before?

“The Gulf Oil Disaster may be the fat tail to end all fat tails and show the exposure behind the entire risk models of the vast majority of derivative algorithm models. To suggest that BP would need to take impairments north of $20 billion would have seemed out of the realm of possibilities less than 90 days ago. Now, if it is contained to only $20B, it would be considered a blessing. Fitch dropped BP’s credit rating an unprecedented 6 notches on June 15 from AA to BBB which followed June 3rd’s AA+ to AA cut. This is what happens when a fat tail occurs and it has only just begun,” Gordon Long writes.

BP’s Derivative World

Here’s what rating agencies, analysts, bloggers and journalist have managed to dig up, so far.

The CSO’s (Credit Synthetic Obligations):

A study by Moody’s outlines that a BP bankruptcy would impair 117 Collateralized Synthetic Obligations (CSOs) which would lead to pervasive losses by a broad range of holders.

The 117 effected is a startling 18% of the total CSOs outstanding, which is an indication of the scope and impact of BP financing globally.

For those that remembthe 2008 financial debacle, you will recall its epicenter was the collapse of Collateralized Debt Obligations (CDO) associated with mortgages and Credit Default Swaps (CDS) of financial companies impacted.

CSOs are even more leveraged and more toxic.

This is what Moody’s writes:

The CDS’s (Credit-default Swaps):

On June 25th BP’s Credit Default Swaps shot up 44 to 580 on the 5 years CDS. This meant it costs $580,000 per year to ensure $10 million in BP bonds over a 5 year contract period.

Anything approaching 300 is considered

serious risk. For counterparties willing to pay this amount means their dynamic hedging models are working overtime, and a near panic scramble is taking place.

On June 16 the blog Zero Hedge reported:

The Bond Inversion:

With Credit-default Swap consern we would expect this to be reflected in BP’s yield curve spread.

What is interesting is that the curve is inverted as BP’s CDS curve. Usually short term yields are less than longer yields because of inherent risk over a longer period of time.

This suggest that the market is pricing in a credit event.

A credit event would have a profound impact on OTC contracts, which we have no visibility to.

What we do know, however, is that BP has between $2 and $2,5 billion in one year commercial paper to rollover that is required for trading operations and working capital.

This is going to make it both more expensive and harder to secure, and will be a liquidity drain for BP.

The Liquidity Requirements:

To the commercial paper roll-over ($2-$2.5B in one year), ongoing new and rollover debt issuance, we need to add the $20B it has agreed with the White House to put in place, though we know of no detailed agreement actually being signed.

The Short Interests:

The Financial Times Alphaville via Data Explorers reported the short interest through June 4th.

By stripping out the spike related to the last dividend payment, the underlying level of stock outstanding on loan (SOOL) has barely budged since the Gulf spill.

So, short sellers can’t be blamed for the plunge in the share price; the selling must be coming from somewhere else, such as long-only funds.

Roumors circulated on June 10 that the Norwegian Government Pension Fund, who is the fourth largest shareholder in BP, was looking to offload 330 million  shares.

Brokers said the total transatlantic volume of stock traded in BP on June 9 had a value of $8 billion.

To put that figure into some perspective, the total volume traded on the entire EuroStoxx index on the same day amounted to $15 billion.

Moreover, since the Deepwater Horizon rig exploded on April 21th, 70% of BP’s market cap has turned over, most of it the US.

Trading volumes in BP American Depository Reciepts (ADRs) are usually 19% lower than the ordinary shares in London.

Since the spill, that position has been reversed and the ADRs have traded 3,5 times the ordinaries, all of which suggests BP’s largest US investors base have been dumping stocks.

The Option Activity:

The Wall Street Pit wrote on June 19 that “Option volume on beleaguered oil company, BP Plc, is fast approaching 750,000 contracts, fueling a more than 79,7% upward shift in the stock’s overall reading of options implied volatility to a 5-year high of 120,96%. Options activity on the stock can easily be described as frenzied as volume continues to grow in both call and put options across multiple expires.”

The cost of capital is skyrocketing for BP which as fundamentally an energy financing corporation can be terminal.

Way Too Big To Fail

According to Gordon T. Long, the most likely scenario is that the US operations of BP will voluntarily attempt Chapter 11 bankruptcy proceedings.

“This the worst possible scenario for claimants. The problem here is that this triggers a credit event which has daunting repercussions to the highly leveraged global financial markets. Like AIG before, the government does not want to tamper with the ramifications and fall out of a CDS event. Lehman was one too many.”

“If a US voluntary bankruptcy is stopped by the US and there is a BP corporate bankruptcy, then there is a strong possibility that the British Government will be forced to step in and bailout BP. In the end, the tax payers will pay as the ongoing game of Regulatory Arbitrage is playing masterfully once again.”

“Deleveraging associated with BP may be the event that triggers the $5 trillion quantitative easing spike we have been warning about for some time now. It will be needed to complete the final process of manufacturing of a Minsky Melt-up to avoid the looming pension, entitlement and US state financial crisis.”

“The ability of the government to achieve this is anything but certain. However, we need to expect the unexpected and watch out for fat tails to trip over,” Mr. Long concludes.

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Here’s a copy of Gordon T. Long’s comprehensive article on BP – “Sultans of Swap”

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Read also:  Response To The BP Derivatives Story

Related by the Econotwist:

Norway’s Oil Fund Among BP’s Largest Shareholders As Bankruptcy Rumors Hit Market

Gulf Oil Spill: A Carefully Planned Inside Job?

Oil Spill Makes Waves

BP Is Drowning In Its Own Oil Spill

Dockwise To Assist BP In Gulf Oil Spill Clean Up

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