The spread between the 2-year and 10-year US treasuries has widened with markets saying that a Powell recession is here. We speak to Tony Nash, CEO of Complete Intelligence as to whether he agrees. We also ask him if the recent aggressive job cuts by the tech and now finance sector will be part of the Federal Reserve’s decision-making process at the next FOMC meeting.
Transcript
BFM
This is a podcast from BFM 89.9. The Business Station. The World Market Watch is brought to you by CMB Preferred.
BFM
BFM 89.9. 7:06 Thursday, eight of December. And of course, you’re listening to the Morning Run with Chong Tjen San and I’m Wong Shou Ning. But in the meantime, let’s recap how global markets closed yesterday.
For US markets, the Dow closed flat, the S&P 500 was down by 0.2%. It’s the fifth consecutive day of declines and the Nasdaq was down 0.5%. In Asian markets, they were all in the rip. Nikkei was down 0.7%, Hang Seng was down 3.2%, the Shanghai Composit was down 0.4%, the Straits Times Index was down 0.8% and the FBM KLCI was down 0.3%.
So joining us on the line to tell us where markets are heading, we have Tony Nash, CEO of Complete Intelligence. Good morning, Tony. Always good to speak to you. I want to start with Treasuries for a change, and the two-year and ten-year treasury rate spread is currently very wide. Is the bond market already telling us that a Powell recession is here?
Tony
Well, yeah, I think that’s part of it. I think that’s contributed to a lot of the discussion around the kind of perceived inevitability of a recession in 2023. And what we’ve been saying for months is we’re already there. We already saw negative GDP numbers in the US in the first two quarters of this year. The holdout is jobs. And now that we’re starting to see, some say, turnover in the jobs front, meaning it’s still strong, but it’s not as strong as it was two months ago, there is a feeling that we’re definitely headed in that direction.
BFM
And Tony, I like to tap your expertise on all market. The market is quite divided as to what the G7 price cap and the EU ban on Russian seabourn all will do to oil prices and crude supplies in the coming months. Can you give us some insights?
Tony
Yeah. So what’s happening actually today, Xi Jinping landed in Saudi Arabia for a meeting with GCC leads and Saudi Arabian government. So what’s happening in the oil market is the OPEC countries are being very open about the fact that China is the main price setter for global oil markets. And that really is kicking off with that meeting in the Middle East today. That’s been known for some time, but it hasn’t been as explicit and overt as it is today. We’re seeing more supply with things like Venezuelan crude coming on for the US. But we’re also seeing the price cap for Russia and which we know, pretty much know won’t work. Europeans will find a way to circumvent it, Russians will find a way to get crude on the market. And so that’s why we’re seeing weakness in crude prices.
BFM
But at the same time, Tony, we are seeing more positive news coming out of China. They are easing a range of COVID restrictions, including allowing people to quarantine at home rather than in centralized camps, suggesting that the economy is slowly easing out of the Zero COVID policy. Shouldn’t that be a reason for all prices to go up then?
Tony
Well, I think it will. And if you look at futures I looked a few days ago and a few months out, there’s definitely expectations for higher oil prices. But right now, if we’re looking at spot markets, there really isn’t that much expectation of things moving. So when you look beyond February, for example, there is an expectation that China opens. And yes, that is very positive for crude prices and that is one of the most important economic events in the world. We’re waiting for it, we all need it, whether you’re in Asia or the US or Europe. China opening is good for everybody, but it will be positive commodity prices and it will push those prices up.
BFM
Okay. How else can we position for this eventual reopening in terms of our portfolio? What should we be looking at?
Tony
Well, if we look at things like industrial metals, like copper, we’ve seen some really interesting action copper over the past few days on expectations of China opening up. Over the past, say, probably three or four days, we’ve seen some interesting action in Chinese tech and there’s expectation that Chinese tech and consumer goods will be very positive in the coming months. So we’re seeing that in equity prices right now. So those are some areas that I would look at and be paying attention to because they’ve already proven to have some positive traction. But that will likely improve as China’s opening accelerates.
BFM
And Tony still sticking to the topic of oil and energy commodities, the UK instituted a windfall tax on oil and gas recently. Why have they decided to go down that route? And what effect will that have on energy companies with major investments there?
Tony
Yeah, this came right after the COP meeting and it was a very populist move by the UK government, very populous move by the UK government. It didn’t make any sense commercially and it doesn’t make any sense in terms of energy strategy. We’ve already seen companies like Total and Shell pull back on announced investments that they plan to make in the UK and it’s already making energy prices higher in the UK. So I think the UK government’s calculation there was, we’re going to make a populist move and get some voters behind us, but it was really a really stupid move and they’re going to have to do an about face on that within a few months.
BFM
Okay, let’s talk about job cuts or the possibility of it. Yesterday we saw a raft of top US bankers warning of layoffs and freezing when it comes to hiring. What does this then mean for the US labor market?
Tony
We already saw this start in tech a couple of months ago and it’s just kind of cascading out to other industries. Right. And so first they announced job freezes. Then they announced job cuts, usually, right? And it’s in things like in banks, it starts in mortgages because house buying has slowed. And it’ll go into other areas, of course. And we’ve seen this in media, too, with BuzzFeed, and there are issues at other media companies because they’re having to compete in those CPM rates, meaning those advertising rates are declining because places like Facebook and Netflix and other places are getting more competitive on advertising. So it just means that companies have to get more productive.
So whether they’re tech companies or banks or media firms, companies are having to get more productive. What we saw through COVID generally, was margin expansion for companies. A lot of companies profits through, say, mid 2020 continued to expand because companies didn’t have to pay for certain things, but they could charge higher prices because people were working from home. They didn’t have to pay for certain things, but yet they could charge higher prices. What we’re seeing now is with wages rising as fast as they are and staying there, companies are having to pay more all around.
And the markets like mortgages or advertising or tech or whatever, they’re not where they were a year ago. So they’re having to cut heads. And you look at Facebook cutting like 13, 14% of their workforce. Look at what these other guys are doing. They’re realizing they’re way overstaffed given where we’re going in 2023.
BFM
Okay, so how does this then inform the Fed decision when they meet this month for the FOMC meeting? Because employment is another indicator that they watch is part of their twin mandate, isn’t it?
Tony
It is. It’s one of their mandates. So there are a couple of things that I’m watching. So first, last week we saw the jolts. This is the job openings, okay? And with jolts, we saw that really turn over, meaning the job openings has declined. Now, it’s still strong, but it’s really turned over in terms of we’re not the highest anymore. That was probably two months ago. So we’re starting to see a decline in the number of job openings and the rate of growth of job openings. And when you look at the employment data that came out, the strength in jobs is really in, say, lower level services and health care. Okay? So it’s not necessarily in the higher level, higher earning jobs as it was, say, a year ago. So we’re seeing I’m sorry to put it this way, but kind of lower quality jobs come through, and that’s when we can tell that it’s weakening. Those are the last to be strong before going into recession. They’re the first to be strong as you’re coming out of it. So what is the Fed looking at? Well, Powell talked about the lag effects of monetary policy at his Brookings speech last week.
And so I think the Fed is being really sensitive to the lag effects of their policy, and they’re likely going to still go with 50 basis points this month and next month.
BFM
All right, thank you very much. That was Tony Nash, CEO of Complete Intelligence, telling us at least forecasting what the Fed is going to do at the next FOMC meeting.
But very quickly, I want to talk about one stock that was really a bit of a COVID pandemic winner, and that is Gamestop. So their fiscal third quarter sales declined while its cash pile sharply dwindled as the brick and mortar retailer had been working to expand its digital presence. Now, for no reason, this stock actually went up. A lot to do with retail investors who just wanted to like, very bullish on this counter. But although the fundamentals weren’t great, there.
Was a documentary on this Gamestop, actually on Netflix. I watched. It was really interesting. So if you’re interested to see what really happened and how they actually lure retailers in and the retail battle between institutional investors and all the renowned hedge funds and how retailers actually trumped in the end, but maybe not in the end, for the moment, it is actually a very interesting documentary or show to watch on Netflix.
Well, because it’s one of those odd stocks, there isn’t much coverage. There’s actually three analysts, they all have a sell on this. Target price is $6. This morning. During regular hours, the stock was actually down one dollars and $0.13 is $22.26. And if you’re wondering whether who won in the end, don’t think the retailers won because on a year to date basis, the stock is down 40%. But up next, we’ll cover the top stories in the newspapers and portals. Stay tuned for that. BFM 89.9 the world market watch, is.
Brought to you by CMB preferred moving forward with you, visit CMB preferred.com dot my for their preferential services. Be banking.
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On Wednesday, Jay Powell talked and said “The time for moderating the pace of rate increases may come as soon as the December meeting.” The JOLTs data that came from Wednesday showed a slowing in job openings and the employment data from Friday was still strong but moderated a bit. With China announcing some changes to lockdowns, how worried should we be about commodity prices, given the “moderating” Fed? Albert Marko leads the discussion on this.
We also saw the UK announce windfall oil & gas taxes last week. We’ve seen a slew of announcements to halt investment. This is something that Tracy called out well before the windfall tax was announced. What will the impact be and how did the UK government think this would go over? Tracy explains this in more detail.
Given the LME nickel issues, FTX, etc., credibility is a concern at times. Why do these systems fail? What should people who trade know about exchanges that nobody tells them? Josh shares his expertise on what it’s like to build an exchange.
Key themes: 1. Fed “moderating the pace…” 2. Windfall oil and gas taxes in the UK 3. What’s it like to build an exchange?
This is the 44th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week ahead. My name is Tony Nash. Today we are joined by Josh Crumb. Josh is the CEO of Abaxx Technologies, a former Goldman Sachs, and just a really smart guy who I’ve watched on Twitter for probably eight years. We’re also joined by Tracy Shuchart, of course, and Albert Marko. So thank you guys so much for joining. I really appreciate your time this week.
We’ve got a few key themes to go through. The first is the Fed talking about, “moderating the pace.” We’ll get into that a little bit. Albert will lead on that. Then we’ll get into windfall taxes, windfall oil and gas taxes in the UK. And finally, we’ll look at exchanges. Josh’s started an exchange. I’m interested in that, but I’m also interested in that within the context of, say, the LME and other things that have happened.
So, again, really looking forward to this discussion, guys.
Albert, this week on Wednesday, Chair Powell spoke and he talked about moderating, the pace of rate rises. He said the time for moderating the pace of rate increases may come as soon as the December meeting. Of course, it’s a conditional statement, right?
But with China announcing some of the changes and lockdowns with things like the jobs number out today, I’m really curious about your thoughts on that moderation. So if we look at the Jolts numbers, the job openings numbers from Wednesday we showed that really come off the highs, which is good. It’s moving in the direction the Fed wants.
If we look at the employment data out today, again, it shows a little bit of moderation, but it’s still relatively strong.
So what does all of this mean in the context of what Chair Powell was talking about Wednesday?
Albert
Well, I mean, the Federal Reserve and the Treasury have been really precise in the wording of using soft landing over and over and over again. And let’s make no, let’s not have some kind of like, a fantasy where they don’t see the data a week ahead of time. And all the words and all the phrases and whatever they leak out to the media, like the Wall Street Journal are tailored to try to get a soft landing.
Powell knew what these job numbers were. So for him to come out uber hawkish, which he has to do because the economy is still red hot at the moment, if he came out uber hawkish Wednesday and knowing what these job numbers are and knowing what the CPI is possibly going to be next week, we’d be sitting there at 3800 or 3700. And they don’t want a catastrophic crash, specifically before Christmas. And also the mutual funds and ETFs and rebalancing of this past week.
So from my perspective, they’re going to keep the soft landing ideology. The only thing that could throw in a wrench to this whole thing is retail sales. And if I think the retail sales start becoming hotter than they really want to see then obviously 75 basis points and maybe even 100 is on the docket for the next two months.
Tony
For the next two months? So 50 December, 50 Jan?
Albert
That’s the game plan at the moment, 50-50. If CPI or retail sales start getting a little bit out of hand, they might have to do 75 and 50 or 75 and 25. But again, this is all like all these leaks to the media about softening or slowing down the pace. It’s just another way for them to “do the pivot talk” and try to rally the markets again. So that’s all it is.
Tony
Okay, Josh, what are you seeing? What’s your point of view on this?
Josh
Yeah, so I’m probably not in the market day to day the same as the rest of you from a trading perspective. We’re obviously looking very closely at commodity markets and the interplay between particularly what’s going on in Europe and how that affects energy markets, which I know Tracy and yourself have spoken a lot about.
Yeah, look, I think the last OPEC meeting, I think the Saudis in particular caught a lot of flack for the supply cuts. But now, looking in hindsight, I think they were exactly right. And so I think there really is a softness, particularly that part of the crude markets and of course, in a very different situation downstream in refining. I think that it would be consistent with a softening economy. But I agree with Albert that the Fed, I think, can’t really afford to change their stance, even though even today’s employment report was a very, very sort of lagging indicator, late-cycle indicator.
So I feel, personally, particularly just coming back from Europe, that we’re really already in recession and I think that’s going to be more obvious next year. But I don’t think they can really change their tune for the reasons that Albert laid out.
Tony
Tracy, we had a revision to Q3 GDP this week, and I was looking at those numbers, and exports were a big contributor to that. And crude was a huge portion of those exports in a revision of Q3 to GDP, it was revised up slightly, I think, to 2.9% or something. Now, a large portion of those exports are SPR, and that SPR release is contributing to, say, lower oil prices and lower gasoline prices here in the US, right?
So SPR release theoretically stops this month in December, right? So it tells me that we’re not going to be able to have crude exports that are that large of a contributor to GDP expansion. First. It also tells me that we’ll likely see crude and gasoline prices rise on the back of that if OPEC holds their output or even slightly tightens it. Is that fair to say?
Tracy
Yeah, absolutely. I mean, I think that everybody’s pretty much looking at they’re going to hold a stance. I mean, they’ve already said this over and over again over the last month. After that Wall Street Journal article came out and said they were thinking about increasing production for the bank. You had all of them come back and say, “no, we’ve had, this is what we have in play to the end of 2023. We can change this, obviously, with an emergency meeting, et cetera, et cetera.” But I think at this meeting, I think they’re probably going to be on a wait and see, or, again, like you said, slight and tightening. Maybe $500.
Tony
I stole that idea from you, by the way.
Tracy
Maybe $500,000. It really depends on what they’re looking forward to, is what they have to contend with right now is the oil embargo in Russia on December 5, and then the product embargo comes in on February 2023. For the EU, also, everything is a lot. It’s predicated on China coming back because that’s another 700 to 800,000 barrels per day in demand that could possibly come back. But I think we all agree, as we’ve talked about many times before, that’s probably not until after Chinese New Year, which would be, you know, March, April.
But those are all the things, along with the slowdown, with all the yield curve inversions, not only here, but also in Europe, everybody’s expecting this huge recession coming on. And so that also has a lot to do with sort of sentiment in the crude market. And we’ve seen this in open interest because what we’ve seen in looking at COT (Commitment of Traders), CFTC data, is that we’ve had a lot of longs liquidating, but we haven’t really seen shorts initiating. It’s really just trying to get out of this market. And so that’s what the current futures market is kind of struggling with right now.
Tony
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Okay, so you mentioned the China issue, and earlier this week we did a special kind of show on what will likely happen in China. Albert was a part of that. We had two journalists as a part of that, long-standing China journalist as a part of that. So we’ll put a link to that in this show. But if China opens at an accelerated pace, Albert, we all expect that to impact inflation, right? And we all expect that to impact crude prices.
Tracy
Not any prices across the board, actually, you’re going to be in especially industrial metal.
Tony
Exactly. So how much of Powell’s kind of “moderation” is predicated upon China staying closed through, say, Feb-March?
Albert
Oh, it’s all of it right now. All of its predicated on it. I mean, right now they’re under the impression that China won’t open until April. But I push back on that, and I think at this point, they might even announce an opening in February. Once they announce it, the market looks ahead for three to six months. So things will start taking off at that point.
I do have a question for Tracy, though, for the Russian price cap, right? I know you know the answer, Tracy, but a lot of followers of mine have always asked me about this in DMs is like, why does it make the price of oil go up? Because from my understanding, is because it limits the supply globally. And then as demand comes back, the supply sector actually shrinks. And I wonder what your opinion was on that.
Tracy
Yeah, absolutely. I mean, I think what you’re going to see with the price cap is that people are going to in Russia already said we’re not going to sell to people that adhere to the oil price cap. Now, again, if it ends up being $60, that’s not really under what they’re selling it for currently at the current discount to Brent. So that’s not that big of a deal. If it’s lower than that, then obviously, yes, that will make a big deal. But they also said that if we have an oil price cap, then we’re going to stop producing, right? Not entirely, but they’ll curb back production, which will in turn make oil prices higher globally, even if that price cap in place. And so that’s kind of their hit back.
But that said, again, I don’t think as much oil is going to be taken off the market with a price cap, particularly at $60. And Russia has already figured out a way around secondary sanctions, obviously, in June as far as shipping, insurance, and certification is concerned. And you have to think, realistically speaking, you’re going to have a lot of shippers, especially Greek shippers, that this is their major business that is going to say, yes, we’re shipping this oil at the “price cap.”
Right. So you just have to keep in mind the games that are played in the industry. But, yeah, some oil will definitely be taken off the market. And Russia also could decide to pull back on production in order to hurt the west to make oil prices rise in the west.
Tony
Europeans love to violate their own sanctions anyway, right? They’ll just buy through India or something, right? And they’ll know full well that it’s coming forward.
Tracy
They’re buying Russian LNG. It’s not piped in right now. Right, but they’re still buying LNG. They’re having it shifting, and they’re paying massively.
Tony
Let’s turn off the pipeline and raise prices on ourselves. Okay.
Albert
They learned from Bible in the keystone, right?
Josh
Maybe I’ll add one more perspective here. You have to remember that oil is Russia’s economic lever and gas is their political lever. And so I actually believe that Russia is actually trying to maximize, we haven’t lost a lot of Russian barrels since the beginning in March, but I think they’re actually trying to maximize revenues right now because not that I want this to happen, but I could see much more extreme gas measures coming from Russia through perhaps some of the gas that’s still coming through the Ukraine as soon as January. You know they want to maximize those political levers, and they’ve already been sort of playing every game they can to contractually even break contracts and minimize gas even since end of last year. So, again, oil is the… They’re always going to want to maximize their oil exports for revenue and maximize their political power with gas.
Albert
Yeah, they do that often, especially in North Africa, where they try to limit the gas that comes in there using Wagner and whatever little pressure they can to stop it. They’ve done that so many times.
Tony
Great. Okay, let’s move on from this and let’s move on to the windfall oil and gas taxes in the UK, Tracy. We saw the UK announced this last week or two weeks ago.
Tracy
November 17, they announced the increase. Yeah.
Tony
Okay, so we’ve seen a slew of announcements, and I’ve got on screen one of your Tweet threads about Shell pulling out their energy investment and Ecuador doing the same and Total doing the same.
So can you talk us through kind of your current thinking on this and what the impact will be? And how on earth did the UK think this would go over well?
Tracy
Well, I mean, that is a very good question. How did they think this would possibly go? I mean, we know that if you’re going to place the windfall tax, they raised it from 25% to 35%, which is very large. And that’s in addition to the taxes that companies are already paying, which in that particular country is some of the highest in the world. Right. And so this is just an added on. So, of course, you have Shell and Ecuador now rethinking what they’re going to do with huge projects going on there. And Total literally just said, we’re cutting investment by 25% entirely in that country.
And so what happens is what’s interesting is that this whole thing occurred after COP27. And what we saw is kind of a change in the language at COP27, where countries were more interested in energy security rather than green energy. Of course, that was part of the discussion, but we did see sort of a language change and people start worrying about countries start worrying about energy security, which makes sense after the Russian invasion of Ukraine and everything that has happened.
So for the UK to kind of do this on the back of that without realizing the implications of what’s going to happen. What’s going to happen is that they’re going to see less investment. Obviously, we already have majors coming out saying we’re just not going to invest here. Right. And that’s going to raise prices in particular for electricity in that country. We’re not just talking about oil and gas, but everything attached to oil and gas, you know, the secondary and tertiary things that are attached to oil prices and gas prices within that country. And so that, you know, that’s going to keep inflation high in their country and, you know, and it’s a very dangerous territory if you’re talking about energy security. Right.
Because UK is an island and they have assets right there. So everything else that they cannot produce there, they have to import. And that’s not cheap either. So you have to think about that. And this all comes at a time where Capex is already dangerously low since 2014 in this particular industry. So it seems like it’s self inflicted harm not only on the citizens that are going to have to pay for this via inflation higher, right. But also their energy security is compromised. Yeah.
Tony
I love the irony of a French company telling the British that they’re taxed are too high.
Albert
Yeah, it’s actually amazing because, like, the Swiss today has stalled all electric vehicles from being registered or imported to secure their grid from blackouts.
Tony
Wow.
Albert
Yeah, that was just maybe like an hour or two ago.
Tracy
And they said that they’re prepared to have like a four tier energy system and basically if you have on your third tier, they’re cutting you off of like you can’t charge a car in third tier.
Albert
Like Tracy was saying, nobody thinks about the second and third order of things, like the electrical grid going out and industrial sector having to buy diesel generators so the power doesn’t fluctuate and ruin their machinery. Nobody thinks about these things, they only think about the marketing material out of Tesla.
Tracy
Right.
Josh
Probably maybe add one more lens to look at this through. And that’s the geopolitical and political lens. I think we’ve had enough three decades of sort of Laissez-faire economics that any politician knows the effects of announcement like that. So I don’t think this was a naive approach, particularly as Tracy mentioned, that this was coming on the back of COP.
I think this was something to sort of give to a sort of a populist base around inflation and we’re going to go after big energy. But at the end of the day, I totally agree with Tracy that everything’s pivoted to energy security and almost wartime footing. And so I think we’re not used to looking at policy announcements or sort of economic policy announcements in that lens the last 30 years. But increasingly we’re going to have to look at all of this through almost a wartime footing way of thinking. So what are they likely doing there? In my view, again, I think they’re kind of giving a, you know, buying some goodwill on the populist front and maybe environmental front while at the same time realizing that they’re going to start having to maneuver all they can to secure hydrocarbon supply. So that’s the way I might read something like that.
Albert
Yeah, I could have said it better myself. Josh I mean, the thing I try to stress to people when you’re looking at foreign affairs and foreign politics is you need to see what’s happening domestically in the country first because that’s what writes the script for what their international needs are.
Tony
And it’s interesting that you both say that populism drove this, it seems in the UK, although it’s impacting the electricity prices, we see populist movements in China, we see it in Pakistan, here in the US. I think a lot of people thought populism died when Trump lost in 2020 and it’s just not true. There is just so much of a populist drive globally. People are tired of the current structures and they want more. So it’s interesting to see and it will be interesting to see the fallout. Tracy do you see other companies moving in that direction of a windfall tax?
Tracy
We did see India, they enacted a windfall tax as well. They’re kind of pulling back on that right now. We have Germany talking about a windfall tax, but at the same time they’re giving subsidies out like candy. But then again, that country is like an enigma right, as far as energy policy is concerned. But I think that’s… What’s interesting about the UK is now they’re also talking about a windfall tax on green energy.
Tony
Oh, good. Interesting.
Tracy
So they are talking about that too, and they’re talking about almost a 90% tax because of all the subsidies they’ve been receiving that will be end up. So we’ll see if that comes to fruition or not. But that would really I mean…
Albert
They going to have to give them loopholes because everyone is going to look at what’s going on in Germany and then spending tens of billions of dollars to bail out the energy company that supplies all their consumers. It’s just silliness. They’re just playing through the populous voice at the moment.
Tracy
The US talked about a windfall tax too, over the last year, but it has just not found footing yet.
Tony
Don’t do it.
Tracy
I don’t think it’ll pass. I didn’t even think it’ll pass with if you had even with like a Democrat-controlled Senate, I still don’t think that’s going to pass because you have too many of those senators in Hydrocarbon that represent Hydrocarbons states.
Tony
Okay, great. Let’s move on to the last segment, which is really looking at exchanges. And Josh, your company has built an exchange, continues to build an exchange. We’ve seen some real issues around exchanges. Well, for a long time, but really most recently with say, the LME and the Nickel issue. And we’ve seen FTX kind of called an exchange and we’ve seen FTX fall apart. I’m really curious first of all, can you help us define what is an exchange and then why do these problems emerge?
Josh
It’s a great question and thanks for that. So I think maybe I’ll step back and just mention kind of how Abaxx have been thinking about because we went out and set off to build a regulated exchange and the first physical commodity focused clearinghouse in Asia about four years ago. And for us, we looked at an upcoming commodity cycle. I had a view that we really bottomed in the energy cycle around 2015, 2016, but we still had to wear off a lot of excess inventories. And probably ten years ago, the market was spending almost $2 trillion a year in energy infrastructure. That number has fallen down to something like one and a half trillion a year. So even though population is increasing and wealth is increasing, we’re actually spending less and less on our infrastructure. So it was only a matter of time until we kind of wore off any excess capacity from the last commodity cycle. So for me, I looked back at you go through these cycles, but the market inevitably is always changing.
Josh
So if you think back to, you think back to sort of 2007, 2008, and that part of the commodity cycle. We were still mostly focused on WTI. Brent wasn’t even a huge price marker. It was really only 2010, 2011, 2012, when you started increasingly see the markets changing. So our view is that this commodity cycle, for all of the reasons and the green energy transition, the focus on net zero, we thought a whole new set of commodity benchmarks was going to be needed because different commodities were going to be featured more prominently this cycle. So that’s why we set out to build the exchange. And I will answer your question. I just wanted to kind of walk through this history.
The other thing that I think happened over the last two decades is with the digitization of the trading space. Again, remember, it wasn’t that long ago that commodity trading was floor trading and people yelling and pushing each other in a pit, right? And so you always have to look at the evolution of markets that kind of evolved with the evolution of communication technology and software and really what’s happened since everything went electronic is we had a massive consolidation of the exchanges and the exchange groups across the world. There used to be like the Nymex itself, which is obviously the core of the Chicago Mercantile Exchanges energy business that had something like five contracts for like 100 years and now there’s thousands of contracts.
Right? So there’s always this evolution of markets. There was this consolidation in markets, but in our view, the exchanges themselves got away from specializing in the industry or the product they serve. And so we think it’s a little bit of a mistake of history that the two biggest energy markets in the world were acquired markets. They see me buying the Nymex and Ice buying the IPE, which was the Brent markets. And so in our view, we actually don’t think the physical market builders really exist in the big exchange groups anymore.
So we saw this sort of classic opportunity. This economy of scale or whatever to actually hyper focus on physical commodities and the physical commodity benchmarks that are going to be needed for the next commodity cycle.
So getting back to your question. So what is an exchange? Again, this problem of the digitization of everything, we end up creating a lot of conflicts between what is a broker, what is an exchange, what is a clearing house, you know, different entities playing on both sides of the trade. And of course, I have my Goldman Sachs background, so that was always the big debate about Goldman in the 2000s. They’re on every part of the trade.
And really we used to be in this market infrastructure where you really separated all the conflicts in exchange itself for a long, long time as a nonprofit organization, almost like a utility. And you bought seats again to push each other in the pit. That’s where the private entities were, were in the exchange memberships.
So now what we have today is we have broker dealers like Coinbase calling themselves an exchange, even though they’re applying for an FCM license, a Futures Commission license, which again, it shows that they’re a broker, they’re not an exchange. So I think there’s a lot of confusion on what an exchange is. And what you really want to do is separate those conflicts of interest.
An exchange should never have a house position. Exchange is really just the place that matches trades. And a broker dealer is the one that’s someone that nets two clients and then puts that trade onto an exchange. So there’s been a lot of regulation, particularly after DoddFrank and after a lot of the problems in the financial system in 2008, to try to separate these conflicts out. But unfortunately, with crypto and other things, we’ve been starting to consolidate everything again into a conflicted model. So we’re trying to get away from that and focus very much on physical commodities and an unconflicted model.
Tony
Is it possible to separate those things out? I know it’s conceptually possible. But since we’ve gone beyond that separation, I know that’s what you’re trying to do as a company, but how hard is it to convince people that these aren’t the same things? Because obviously there’s conflicts if they’re combined. Right. There’s margin, I guess, in those conflicts, right?
Josh
Exactly. So we wrote a risk net article on this because FTX actually came to the CFTC proposing that they bring their highly centralized conflicted model into the CFTC. And to their credit, the CFTC and the Futures Industry Association, I think they recognized this problematic approach, that they wanted the exchange in the clearinghouse to be separated from the Futures Commission merchants. And at the end of the day, you know, the FCM’s, which is really the prime broker that connects to the clearing house, they do more than just handle administrative work and collect margin.
At the end of the day, they’re the ones really looking and really knowing their customers’ overall position. So if you look at something like the LME problem, what it really was is you had this big OTC position in one of the brokers that was sort of Texas hedged or had a bad hedge into what was actually so it was a Ferro nickel. It looks like it was a Ferro nickel and sort of integrated stainless steel producer that was hedging against the deliverable contract in an LME nickel that they actually couldn’t deliver into. And there’s actually nothing new about that.
That’s actually how the Nymex really came to be the top energy market. You had the Idaho Potato King, hedging into a main potato that he couldn’t deliver into and cause an epic short squeeze. So this stuff is not, there’s nothing new in these markets. And the main thing is we want to maximize decentralization. We want to maximize the amount of FCMs involved in managing that delivery risk and knowing what their clients’ positions are, and the exchange having enough knowledge to know where the risk sits as well.
So it’s that check and balance. If you leave all of the risk to one entity or to one regulator, it becomes very problematic. That’s why we have the separation of all these pieces of market infrastructure, so that everybody is looking at the risk from their perspective, so that overall we can try to minimize the risk in a more resilient system.
Tony
Okay, Josh, I’m just curious, what should people know about exchanges that nobody tells them? I know that’s a really broad question, but it seems extraordinarily simple. But there’s got to be something that people should know that nobody ever tells them about what an exchange is.
Josh
Yeah, I think that an exchange should never have… We like to say that the exchange should be the scoreboard, not the referee. The exchange should really only be transparently, showing a price, showing that data, executing the price, but it should never have a position and it never should be telling the market what to do. The exchange is the scoreboard, not the referee.
Tony
That’s a great statement. Albert, what questions do you have?
Albert
As soon as he said that I was in absolute agreement. Everyone that knows me knows that I abhor crypto. Right. And what they’ve done. That’s an understatement, I know. But I’ve always said, if you want to do something with blockchain digitalization, you have contracts, whether it be real estate, whether it be commodities, something like that, to create transparency and trust in the system.
Exactly what Josh is talking about, because I’ve seen and personally heard of manipulation in the oil futures and commodities market that is just outrageous. Absolutely outrageous. And it’s not fair to people like me that trade futures where for some reason I can’t buy a contract because the prices, like the price discrepancies, are just outrageous at the moment. And everyone knows the brokers are intermixed with the exchanges and so on and so forth. But something like this, where it’s digitalized and you’re just a scoreboard, is a great idea.
Josh
Yeah. And I think the other big problem is we look at every price for different assets and think all prices are fair. And if there’s anything the last two years has taught us, that efficient market hypothesis is not right. And so, you know, we look at these prices like they’re all the same. You see a WTI price, you see a nickel price, you see the price of Google, you see the price of a ten year, you see the price of a real estate bond. At the end of the day, it’s the market structure, and you can’t fundamentally change the liquidity or lack of liquidity in a market. Right? And so one of the other problems that we saw, again, this is why we exist, is we think that the commodity markets have gotten hyper financialised and digitized, where people have gotten away from what is the actual underlying price.
So LNG is where we’re focused. We think LNG is the most and this has been our view for five years before, most people didn’t know what LNG was before it was front page news, is that LNG was the most important commodity for probably two decades. And at the end of the day, what is the price of LNG? There is not a clean, transparent price of LNG. LNG is not the Dutch title transfer facility. LNG is not the five people that report on a voluntary basis to the JKM. Right. There really isn’t a price for LNG. And more importantly, right now, there’s not a buyer and seller of last resort market. You can’t go in and buy futures and go to delivery in LNG. That doesn’t exist.
And next year, I think it’s going to be absolutely critical because there’s going to be an all out bidding war for probably the next 30 months between Asia and Europe for that marginal cargo of LNG. We haven’t seen anything yet this year. Next year, and the summer of 2024 is when it gets really bad.
And we need a market that actually, as one of my former colleagues used to say it needs to be a knife fight in a phone booth. Right. You need absolute market discovery. And that physical price has to converge with that futures price. That’s the only fair price. It’s the only fair benchmark. And that’s what we’re doing is doing the hard, hard work to figure out what is a physical long form contract look like to go into delivery of these hard commodities like LNG.
Tracy
And I just want to add on that because everybody’s talking about how European storage is full right now. This year was never going to be a problem. It’s next year there’s going to be a problem. Because you have to realize that they were 50% full. Russia got them 50% full on piped natural gas really cheap. Now that’s gone, right? And so they were paying higher spot prices just to get LNG shipped in. Right. Those cargoes are going to be, next year is where you’re going to see a real problem because a lot of other countries already have long term contracts. And as Qatar said, we have to service the people that we have long term contracts with first. You’re secondary sorry, Europe. Right?
Josh
In Europe, I think, also loses something like 8 million tons per annum capacity up from longterm contracts next year as well that roll off. So there’s actually more spot market bidding. And then on top of that, China is likely to be back in the market. And China last year became the largest LNG importer and they really weren’t even in the market this year. But the one thing that they did do is they’ve been buying all the long term contracts. So even though they’re not buying the spot cargoes this year, they’ve been the biggest player in buying new long term contracts so that they have the optionality. Look, at the end of the day, you know, heating is always going to demand, particularly residential heating in the winter is always going to demand the highest premium because there’s just no elasticity there. You can cut industrial demand. You can probably substitute and power substitution. But if I’m China, I really want the optionality of having that long term agreement. And if prices are high in Europe, I’ll just divert the cargo into Europe or I’ll divert for political reasons diverted to Pakistan or India.
So they’re buying all the optionality, whereas Europe is not buying the long-term offtake. And in fact, they’re buying very short term infrastructure because they’re very focused on, oh, it’s going to be a stranded asset under 2030. So we needed to convert it into hydrogen or something else, right. So there’s a lot they’re really handcuffing themselves, which is going to be again, we need better market infrastructure so the market can sort this stuff out.
Tony
It’s great. Guys, you never disappoint. Thank you so much for this. This has been fantastic. Josh, thanks for coming on. I know you’re a super busy guy. I really appreciate it. And thanks, Tracy and Albert really appreciate this. Have a great weekend. Have a great week ahead. Thank you very much.
