Market 3.0

Transition through Gas

Chris Cook

15 May 2012

Market 3.0

Market 1.0 – decentralised but disconnected; physical market presence; Money 1.0 was a physical object

Market 2.0 – centralised but connected; market presence by middlemen; Money 2.0 is a credit object

Market 3.0 - decentralised but connected; network market presence; Money 3.0 will be a relationship

October 2008 - R.I.P. Market 2.0

Peak Credit

Collapse of Lehman Brothers

QE necessary to prevent debt deflation

Systemic and persistent solvency problem

Credit intermediary banks systemically short of capital

Adjacent Possible

Exchange Traded Funds and Index Funds

Quasi-equity ownership claim not debt claim

Passive 'inflation hedger' risk averse investors aim to avoid loss rather than make transaction profit

Market risk is dis-intermediated – 'capital lite'

Intermediaries retain credit risk

Profit from service provision eg HFT, asymmetric info

Financialisation

QE and 0% $ interest rates – 'buy anything but dollars'

Correlated bubbles caused by 'inflation hedgers'

Price curves cease to reflect market price expectations and reflect $ price expectations ie $ yield curve

Commodity prices lose touch with production, consumption & inventories

Equity prices lose touch with underlying flows of dividends and retained profits

Market 'cardiac arrest'

Correlated Commodity Bubbles

Market Cardiac Arrest

Oil Markets

Macro Oil Market Manipulation

If producers can support prices they will eg tin, copper

Such 'Macro' manipulation can persist for many years

Enron-style 'Prepay' contracts eg Chesapeake Energy

Producers lend oil to passive investors

Passive Investors lend $ to producers

Investment Banks intermediate producers & investors

A two tier – false - physical market and Dark Inventory

Asymmetric information re inventory is profitable for privileged banks and traders

Bubble 1.0

2005 to July 2008 – Bubble 1.0

BP and Goldman Sachs joined at the head from 1995

GS creates Goldman Sachs Commodity Index fund

GS invents 'inflation hedging' meme

Prepay - GSCI lends $ to BP via GS

BP lends oil to GSCI via GS

Bubble 'spiked' in July 2008

July/December 2008 - Collapse

Price falls from $147/bbl to $35/bbl

Saudis cut production by 1.5m bpd

Combination of price fall and production cut = Pain

October 2008 - $ billions of passive fund money flows into funds in response to ZIRP and QE

Saudis receive an offer they cannot refuse - Prepay

Saudi Oil Production

Pain

Prepay

Bubble 2.0

Jan 2009 to March 2011 – Bubble 2.0

In or before January 2009 prepay programme begins

Market goes into 'super contango' and is re-inflated

Market price pegged for 18 months between $70 & $90

Unstable equilibrium

March 2011 - Libya supply shock & Japan demand shock

Saudi Oil Production

Pain

Prepay

Unstable Equilibrium

Shocks

End Game

March 2011 to Date – End Game

May 2011 - Libya/Japan shock subsides

September 2011 - passive investors pulling out

November 2011 - Iran risk premium commences

March 2012 and May 2012 Saudis deliver 20m bbl to the US – who are awash in oil (inventories @ 20 year high)

Prepays result in massive Saudi deliveries to US buyers

Market 1.5m to 3m bpd over-supplied

Iran risk premium subsiding

May 23rd Meeting in Baghdad

Muppets, Speculators & Shocks

03/04/10 19

Libya Shock

Iran Shock

What Shock?

Managed decline or Meltdown?

The market is going down as we speak

The risk is a market discontinuity

In 1985 the tin price collapsed from $8,000/tonne to $4,000/tonne overnight

WTI risk maybe $50/bbl drop

Brent risk maybe $60/bbl drop

This would wipe out speculators, some clearers and disrupt private 'too big to fail' clearing houses

What is the next Adjacent Possible?

ETF redeemable in gold recently launched

Fund units redeemable in payment for underlying asset reduce liquidity risk and credit risk

Stock – undated IOU returnable in payment for value

Pre-dates modern banking (from 1694)

Back to the Future

Next Adjacent Possible

'Peer to Asset' investment

Intermediaries become 'capital lite' service providers

Networked and resilient market with risk distributed to sellers and buyers collectively

Flight to Simplicity

Energy Doctrine

Stability – dis-intermediation reduces volatility and enables long term investment

Equity – fair balance between producers, consumers, service providers

High Carbon price – investment in renewables and energy savings funded out of shared surplus

Energy Standard – energy unit of account (not currency)

Energy Economics – investment decisions made on the basis of least energy cost rather than least dollar cost

Transition through Gas

Generic Gas Transaction Registration - GasClear

Gas Market Framework Agreement/ Clearing Union

Gas Market Instrument

Gas Market Domain eg Dot Gas

Global Energy Institute – networked public/private institution for joined up R & D and energy policy

Now: oil is priced against $ and gas is priced against oil

Future: price dollars and oil in gas