Cheap Iranian Oil

Private Firms Tout Cheap Iranian Oil to Beat Sanctions

It appears that the Iran sanctions are starting to bite.

If you recall that in response to Iran's intransigence over development of nuclear power plants (aka weapons) the EU and US imposed sanctions on Iran which included banning oil imports from Iran starting July 1 and banning insurance and reinsurance on vessels carrying Iranian oil.  Many oil tanker companies come from outside the EU / US however they still require insurance which comes overwhelmingly from the London market.  Without insurance cover many tanker companies will not transport Iranian oil.  The US further threatened to lock out the banks of any country that did not reduce its purchases of Iranian oil.  Finally the SWIFT banking network - the method by which banks send transaction messages to one another - will no longer do business with many Iranian banks including the Iranian Central Bank.  This move effectively locks Iranian banks out of the international financial system.

The embargo could have hit harder if Japan China and India had all decided to honor the boycott.  All three countries were heavily dependent on Iranian crude oil and have decided to continue importing Iranian oil to some degree.  Japan cut imports of Iranian oil by 17.6% Dec-July but rather that fully cut off Iranian oil imports due to the insurance embargo the Japanese government decided to provide insurance to vessels transporting Iranian oil to Japan.  China is forcing Iran to deliver oil on Iranian state vessels (which obviously cannot buy insurance).  India may try the same method as China but it appears that they are simultaneously looking to source more non-Iranian oil.  India did cut oil imports from Iran somewhat mostly due to banking issues.  The US granted temporary sanction exemptions for Japan, China, and India on the basis of reduced purchases.

Despite the embargo-breakers it does appear from this article that Iran is hurting.  The story of the 7MM bbls of Iranian crude oil stuck in Egypt with no buyers is telling.  It remains to be seen if the pressure induces Iran to give up their nuclear power plant (aka weapons) development.  And for those who buy into the story that Iran is developing nuclear power for civilian power purposes I submit the following
List of countries by Natural Gas Proven Reserves
List of countries by Natural Gas Production
Iran has five times the proven natural gas reserves as the US but is producing just 23% as much.  Iran has 61% percent the natural gas reserves as Russia but is producing only approximately 21% as much.  Iran has plenty of conventional energy resources - if they should choose develop them.

Country/Region	Natural gas	proven reserves rank	Natural gas	production rank
	proven reserves		Annual Production
	(m³) - 2010 est		(m³) - 2010 est
Russia	55,000,000,000,000	1	647,000,000	1
Iran	33,500,000,000,000	2	138,500,000	4
Turkmenistan	26,200,000,000,000	3	38,100,000	22
Qatar	25,470,000,000,000	4	116,700,000	5
United States	7,716,000,000,000	5	619,000,000	2
Saudi Arabia	7,461,000,000,000	6	83,940,000	10
Azerbaijan	6,071,000,000,000	7	16,520,000	30
Venezuela	5,524,500,000,000	8	22,900,000	27
Nigeria	5,246,000,000,000	9	23,210,000	26
Algeria	4,502,000,000,000	10	85,140,000	9

Iran has threatened to block to Straits of Hormuz in order to break the embargo.  However that threat does not appear credible considering.  (1) If Iran were to block the Straits they would shut off nearly all of their own exports as well.  (2) the US 5th fleet is sitting right there (3) there are other ways for countries to get crude out of the Gulf.   Furthermore the country who would likely be hurt the worst by loss of access to Middle Eastern oil would be one of Iran's few remaining large customers -  Japan.  Japan is the worlds third largest oil importer and of its oil imports 86% come from the Middle East.  But you never know...

More on Mitt Romney and Taxes

Should Mitt Romney release his tax returns for the last few years?  Yes.  The public has a right to know where the POTUS's income came from.

Will the contents of this tax returns have an impact on my opinion of him?  Not unless there is something crazy illegal in there.

Should the media spend this much time on the issue of whether he should release his taxes or not?  No.  They should focus on Governor Romney's record tax and fiscal policy not Mitt Romney's record on personal taxes.  If Mitt Romney was a complete no one with no public record perhaps then the contents of his tax returns might give us some small insight into what sort of President he might be.  Perhaps they might tangentially speak to his honesty, respect for authority, etc...  Would the contents of his tax returns tell us about his views on tax and fiscal policy.  Almost certainly not - and this is what really matters.  After all there are lots of people with clean tax returns and most of them would be lousy presidents.  But Mitt Romney has been in public view for years.  He was governor of Massachusetts for four years.  So he has a record on tax and fiscal policy.  He also has stated views on taxes and fiscal policy.

Since the media is busy with more important issues (like will he release his tax returns) in what little time I have today I will do their job and summarize his real record on taxes and fiscal policy.

Mitt Romney was Governor of Massachusetts from January 2003-January 2007.  He entered office with about $3BB deficit to close.   The below is a summary from http://en.wikipedia.org/wiki/Governorship_of_Mitt_Romney

REVENUE SIDE:

• An increase in windfall capital gains tax enacted under the previous administration which went into effect under Romney increased revenue by approximately $1.3BB per year.  
• He increased state fees for services which brought in about $501MM in new revenue per year.  
• A 2 cent increase in the gasoline tax brought in another $50MM.  
• A increase in internet taxes yielded an additional $128MM
• Closing additional business tax loopholes yielded (by the end of his term) an additional $300MM per year.

SPENDING SIDE:

• In total he cut $1.6BB in state spending from previous budget (this does not square with data below btw).
• Of this $700MM was from reductions in aid to cities and towns - many of which made up the difference by raising local taxes.  
• Including both state and local the $1.6BB would be substantially lower.

By the end of 2004 Massachusetts budget had a surplus of $700MM

The Tax Foundation provides this breakdown of taxes for Massachusetts state and local governments.  It appears that during Governor Romney's tenure the state and local tax burden in MA ticked up by between 0 and 0.3% depending on where you decide to start his impact and where you decide to end his impact.  MA rank among states stayed pretty constant.

From the Massachusetts Budget and Policy Center here is a table of Massachusetts state budgets for the period 2002 through 2008 (in 000s USD).  Note this table is only state spending - it does not include local spending.

Budget Category	FY 02	FY 03	FY 04	FY 05	FY 06	FY 07	FY 08	FY 08
								Minus
								FY 02
Education	5,580,245	5,454,928	5,250,912	5,383,585	5,747,780	6,297,014	6,583,749	1,003,504
Environment & Recreation	214,689	170,347	159,633	163,172	234,750	209,869	205,662	-9,027
Health Care	8,209,337	8,584,785	10,164,641	10,041,993	10,226,094	11,223,455	12,196,175	3,986,838
Human Services	2,822,950	2,856,441	2,878,593	3,009,740	3,176,323	3,312,262	3,396,657	573,707
Infrastructure, Housing & Economic Development	1,318,735	1,278,831	1,211,796	1,261,972	1,434,556	1,789,898	1,531,655	212,920
Law & Public Safety	1,942,550	1,892,839	1,958,488	2,041,903	2,191,915	2,428,079	2,573,258	630,708
Local Aid	1,272,092	1,121,970	1,103,646	1,131,646	1,159,746	1,327,596	1,345,296	73,204
Other	3,038,108	2,942,424	3,015,049	3,673,234	3,881,189	4,122,784	4,199,306	1,161,198
Totals	24,398,706	24,302,565	25,742,758	26,707,245	28,052,353	30,710,957	32,031,758	7,633,052

From this table it appears that all categories of spending increased under Governor Romney - but that is not quite fair since that does not account for the effects of inflation.  If we instead deflate by CPI we get

Budget Category	FY 02	FY 03	FY 04	FY 05	FY 06	FY 07	FY 08	FY 08
								Minus
								FY 02
Education	7,179,567	6,867,260	6,469,042	6,438,733	6,622,122	7,071,879	7,129,855	-49,712
Environment & Recreation	276,220	214,451	196,665	195,153	270,460	235,694	222,721	-53,499
Health Care	10,562,167	10,807,467	12,522,680	12,010,159	11,781,669	12,604,533	13,207,818	2,645,651
Human Services	3,632,019	3,596,001	3,546,382	3,599,630	3,659,500	3,719,845	3,678,401	46,382
Infrastructure, Housing & Economic Development	1,696,690	1,609,932	1,492,914	1,509,310	1,652,778	2,010,150	1,658,702	-37,988
Law & Public Safety	2,499,293	2,382,913	2,412,827	2,442,103	2,525,345	2,726,861	2,786,703	287,410
Local Aid	1,636,679	1,412,459	1,359,675	1,353,441	1,336,164	1,490,960	1,456,885	-179,794
Other	3,908,842	3,704,245	3,714,494	4,393,164	4,471,588	4,630,104	4,547,628	638,786
Totals	31,391,477	30,594,728	31,714,679	31,941,693	32,319,626	34,490,026	34,688,713	3,297,236

Under this view it appears that most categories of spending stayed fairly constant under Governor Romney with the exception of Health Care (Romney-Care) and Other.  If we drill down into Other it appears that the categories which increased were Debt Service and Pensions.

Budget Category FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 08 Minus FY 02 Other 3,908,842 3,704,245 3,714,494 4,393,164 4,471,588 4,630,104 4,547,628 638,786 Constitutional Officers 92,352 92,107 87,120 89,306 87,281 94,427 89,709 -2,643 Debt Service 1,991,999 2,015,936 2,104,619 2,233,188 2,195,229 2,304,498 2,210,588 218,589 Executive & Legislative 91,811 74,641 83,876 71,085 72,332 72,375 74,580 -17,231 Libraries 43,491 32,649 31,417 32,413 34,055 35,574 35,579 -7,912 Other Administrative 663,682 464,729 539,991 511,726 614,114 623,758 622,559 -41,123 Pensions 1,025,506 1,024,185 867,472 1,455,448 1,468,576 1,499,473 1,514,610 489,104
The Massachusetts Budget and Policy Center has some great information.

Taxing Mitt

New Thoughts About What's Hiding In Mitt's Tax Returns
Ann Romney Says Enough Is Public About Mitt's Money
Tax Professional's Scrutinize Mitt's Returns
Mitt Romney Taxes For 2010 Not Fully Disclosed
Google Mitt Romney and Taxes

It seems like everyone is speculating about why Mitt won't release his tax returns.  The only one thing we know for certain is that he is not releasing them (yet).  So before he releases them and spoils my post here is my take on possible reasons why Governor Romney will not release his tax returns.

(1) Rope-A-Dope:  There is nothing bad in the tax returns however Romney's team saw the media and Democratic operatives start focus on Mitt's taxes and decided to play rope-a-dope with them.  There is limited money and media time / space for Dems to get their anti-Mitt message across.  By keeping the enemy attacking on the tax return issue it takes up the bandwidth for other attacks that could be leveled at Mitt.   Then later on in the campaign Mitt will release his tax returns, there will be nothing bad in them, the tax issue will disappear, and the Dems will have wasted their resources.  I would not be surprised if this is a conscious strategy that the Obama team employed with the birth certificate issue.

(2) Matter of Principle:   The Romney's feel that as a matter of principle they should not have to open up their life to the public in order to run for President.  I don't think that that is a winning argument in the long run.  Polling says that the majority public agrees that they should release more returns.  I am going to go out on a limb and say that the public believes that in general people have a right to a sphere of privacy, however if a person chooses to run for a high public office there are certain privicies that they give up - one being the sources of their income.  If the Romney's were going to hold out on principle one would think they would want to be more vocal about what the principle is exactly.  If they go this route my guess is that they end up releasing more information.  And it is possible that when they do there is nothing particularly bad in the returns.  Hence by rope-a-dope there may be little harm to standing on principle even if you end up capitulating later on.

(3) Something Illegal:  Governor Romney can afford some pretty sharp tax advisers and he has been running for office for a while - so I would be shocked if he did anything blatantly illegal with his taxes.  It may be possible that they were on the edge of legality and the location of where the edge is got reinterpreted.  We know he had money at UBS in Switzerland and UBS got hit for helping wealthy Americans hide income - so I guess that is possible.  But I would bet against it.

(4) No Taxes:  There is a lot of speculation that Governor Romney may have paid little or no taxes in years prior to 2010 - and that this will be very unpopular.  Now despite being a partisan Democrat I am going to come to Mitt's defense.  If he paid no taxes but did it legally I don't have a problem with that.  Or at least I don't have a problem with his actions  If a tax shelter is in the tax code then he has as much right to use it as anyone else does.  What I do have a problem with is that fact that there are tax shelters in the tax code that could allow a multi-multi-millionaire with millions in income to avoid paying any federal income tax.  But if this is in fact the case then Mitt is clean so far as I a concerned.

I may be an army of one on this, but I am way way more concerned about Governor Romney's views on overall US tax policy than I am with his personal tax returns.

What He Saw At The Revolution (Really)

One thing I love about Chicago is the diversity of our taxi drivers.  The drivers who line up outside my building are a veritable United Nations.  There are two young Romanian women who drive cabs.  There is the guy from the Ivory Coast - who freaked out when a story about his home country came on NPR.  There is the Palestinian guy who went on a rant about how horrible Israel was until I shut him up by making the offhand comment that I am Jewish.  There was a guy from Nigeria who argued with his girlfriend about her mother back in Lagos.  There are a number of other African's - but I can't identify the country.  Last week I caught a ride with a Russian guy.  One driver had been buddies with Studs Terkel (he was from Chicago).  But today was the most interesting.

I had just stopped off at the pet store and loaded up two bags with BFF (Best Feline Friend).  Considering I also had my laptop and some books I waved to a cab that was sitting on the curb.  He motioned that he was on the phone.  So I started looking for other cabs.  After about two minutes of no luck the sitting driver yelled out that window that he would drive me if I didn't mind if he talked on the phone - which I did not.  Halfway through the ride he hung up and apologized for speaking on the phone.

Driver:  I was speaking with my family back home.

Me:  Where is home?

Driver:  Tunisia

Me:  Oh you just had elections.

The moment that came out of my mouth I felt like an idiot.  Libya just had an election.  Tunisia had an election last year sometime.  But he reacted as though he was just thrilled that someone knew anything about his home.  Maybe I fooled him.

Driver:  yes! yes! and I voted in the election.

Me:  you guys were the first to start the whole thing

Driver:  yes we started the ..how do you say it...heated things up.....I actually participated in the revolution.

Me:  you were home at the time?

Driver:  yes.  I was home for my wedding in late December and I was supposed to leave in early January.  But then the man burnt himself in late December and I could not leave.  I needed to stay.  We were on the streets protesting.  I never thought I would be shot at.  But we won and the dictator left.

Me:  he was smart he got out of there quick.

Driver:  yes.  But some others learned from him and it has been much worse in other countries.

Me:  yes....Wow that is so exciting.   I have so much respect for you.

Driver:  I brought a baseball glove and bat to teach my nephews how to play baseball.  After the dictator left his thugs tried to make trouble so that people would want the dictator back.  But the people said no.  I put the baseball bat to good use.

Me:  that is an experience that happens once a century maybe for a country.

Driver:  I am very happy now

Credit Default Swaps for Dummies - Part II: Index CDS

With the 'Whale' and his fellow marine mammals leaving J.P. Morgan I thought it was high time that I put out Part II of Credit Default Swaps for Dummies.  In Credit Default Swaps for Dummies - Part I we focused on the basics of how a single name CDS works.  This part will focus on Index Credit Default Swaps.

First lets take a step back and look at an analogous situation in stocks.  Say you have a large portfolio of stocks for which you want to hedge out the risk.  Perhaps there is an upcoming event which could cause the stock market to fall so you temporarily want out of the market.  Or perhaps you think you are able to pick  stocks which can outperform the market - so you want to be able to go long your portfolio of stocks and short the market.  Either way you want to be able to take a short position in the stock market.  One way to protect against the temporary event risk might be to get out of your whole portfolio and then buy it back after the event - but that could be very expensive.  Another way would be to buy put options on the individual stocks in your portfolio but that would also be expensive and expose you to other risks.  You could try to short a representative basket of stocks but that is also potentially very expensive.  A much simpler way would be to take a short position in futures on an index (S&P500 or Nasdaq 100 or DJIA).  Assume you choose to take a short position in one S&P500 future (CME SP).  This contract settles to 250 USD times the value of the S&P500 index at some later preset date.  Since you are short the futures, for every one point the S&P500 index falls you would make 250 USD on your futures and for every one point the S&P500 index rises you would lose 250 USD.  Hopefully the stocks in your portfolio would be closely enough correlated to the S&P500 futures to hedge out most of the risk that you are concerned about.

A similar situation can exist in the credit markets.  You hold a portfolio of $100MM of credit obligations (bonds or debt) and you want to hedge out the default risk either on a permanent or temporary basis.  You could try to short the debt of each of the names in your portfolio but debt markets tend to be very thin so that may not be doable - and even if it were it may be very expensive to do.  You could buy single name CDS protection on each of the names in your portfolio and that would work but it could be very expensive since you would need to negotiate each one separately.  What you would really like is a instrument that protects you from the default risk of a representative basket of credit names (like S&P500 futures do for stocks) and with luck you can find a basket that is closely correlated with your portfolio.  Enter the index CDS!

Once again you head off to your local CDS dealer and see about taking a short position in the credit (or selling the index) using an index CDS.  In this case "selling the index" is equivalent to buying default protection which is what you want to do to protect your portfolio.  In the single name CDS world the terms of each CDS are negotiated individually with the dealer - but in the index CDS world there are standardized products.  Say you think your portfolio is closely correlated with the CDX.NA.IG.  This is an index of 125 North American (NA) investment grade (IG) credit names.  Each name makes up 1/125=0.8% of the index.  So buying protection on 100MM USD of the CDX.NA.IG is equivalent to buying protection on 0.8%*100MM USD = 800K USD of each of the 125 names.  Each name in the index is assigned a reference asset which is generally an issue of their senior debt.  There is a new version of CDS.NA.IG every six months.  The names in the index will change slightly every six months.  In general you choose the most recent vintage but you could choose an older vintage if it is more correlated with your portfolio than the on the run vintage.  You will also need to pick a term.  You can buy the standardized CDX.NA.IG for either a 5.25 year term or a 10.25 year term.  Say we choose the newest vintage for 5.25 years.

As the seller of the index - or buyer of default protection - you pay the CDS dealer a fixed coupon on a quarterly basis (Mar 20, Jun 20, Sep 20, Dec 20) for each of the next 5.25 years.  Say the fixed coupon coupon is 40bps annually then you would pay 0.40%*100MM USD = 400K USD annually or 100K USD per quarter.  In order to keep the products standardized each index CDS has a preset coupon - in our case 40bps annually.  However as conditions change the risk on the basket may increase or decrease such that the fixed coupon gets out of line with the market's perception of the risk on the basket.  Hence in most cases you will either pay or receive an initial up front payment to/from the dealer to make up the difference.  We are marking the index CDS to market at the outset.

Now what happens in the case of a credit event?  For North American indices including CDX.NA.IG credit events are defined as bankruptcy or failure to pay.  European products also include restructurings as credit events.  ISDA is the adjudicator who decides when a credit event has occurred.  If they decide a credit event has occurred for a particular name in your index then an auction of the name's reference asset will occur.  The auction is supervised by Markit and Creditex.  The price that the reference asset sells for at the auction will be denoted as the RecoveryPrice.  Let us assume the reference asset of the defaulting name sells for 0.70 USD on the dollar at the auction.  Following the auction you would receive a payment of 800K USD * (1-RecoveryPrice)=800K USD  (1-0.70)=240K USD.  Since one of the names in the index has defaulted the index will now need to be rebalanced.  Going forward your CDX.NA.IG will now have a notional value of (124/125)*100MM USD = 99.2MM USD and you will pay a coupon of 0.40% * 99.2MM USD=396,800 USD per year or 99,200 USD per quarter.  This will continue on until the 5.25 year term expires or until you close out your index CDS position.

This is the basic idea of an index CDS.  There are many different indices and most behave similarly.  Since there is a new basket for each index every six months there are many vintages of each in existance at a time each denoted by a series.  Here is a quote page from Markit.

Whale Watch

JP Morgan:  'Whale' Clawbacks About Two Years of Compensation

"J.P Morgan Chase & Co. threw the book at the traders behind the "London Whale" blunder, seizing millions of dollars of compensation in what it called the "maximum permitted clawback" under its policies.  The New York company said Friday the clawbacks cover three London-based managers who had "direct responsibility" over the synthetic-credit portfolio at the center of the trading losses the company first disclosed in May. People familiar with the situation said the traders are Achilles Macris, Javier Martin-Artajo and Bruno Iksil, the trader nicknamed the "London Whale" for his outsize trading positions at the bank's Chief Investment Office, or CIO."
 
Hope their compensation was somewhere in the $5.8BB range.  Does anyone else see how the clawback could go really really badly for J.P. Morgan? J.P. Morgan is not going to get anything like their $5.8BB back so this is in large part a statement of principle and throwing a bone to investors.  However Iksil et al may choose go to court to get their compensation.  In doing to they are sure to claim that J.P. Morgan managers knew exactly what they were doing - which is going to open J.P. Morgan records up to subpoena  and that probably won't look too good for J.P. Morgan.  Just my two cents.

Tea Partiers For Obama (Socialists for Bush!)

Data is from FRED.   The series I used to construct the above charts were Population (POP), Consumer Price Index (USACPIALLMINMEI), Federal Government: Current Expenditures (FGEXPND), State & Local Government Current Expenditures (SLEXPND).

The impetus for these graphs was this -I was out last night with some friends and one mentioned that he thought President Obama was a socialist.  I said I thought he was slightly left of center.  Which I then followed up with the claim that I bet that real government expenditures (including federal state and local) per capita had actually fallen over his administration.  It turns out that I was not quite correct about that  - however what was true was that the growth rate of real government expenditures per capita has been very low under President Obama.

Today this article came up on Google News.  (Note to self - you are supposed to be ignoring Forbes!).  It appears that MarketWatch did a similar study and their numbers are a bit different (below).  Why the difference? First they are just looking at federal spending while I included federal, state, and local in my comparison.  Second they start with year two of a president's term because the spending in his first year is predominantly set by decisions of the previous  administration.  Their method may be better than mine at attributing to the president what they had direct control over.  But either way we come up with the same general conclusion - our current "socialist" president has presided over one of the smallest rates of growth in government in recent times. Perhaps the Socialist International will be forced to revoke his membership now.