Thursday, March 24, 2016

Izabella Kaminska's Oil Trade Goes Sour: Shakespearean Tragedy Edition

Default, dear Brutus, is not in our stars,
But in ourselves, that we are underlings.

First rule of bidness: Know your counterparty or use a clearinghouse.

From FT Alphaville:

That time I defaulted on Bloomberg’s Tracy Alloway

Back in October, 2015, Bloomberg’s Tracy Alloway and I struck an OTC futures deal over a teeny, tiny vial of crude oil, which Tracy for some reason felt compelled to nickname “Williston”. 
Read about it here. 
I now plan to default on this contract (a ladies’ agreement, witnessed by “the world” due its publication on Bloomberg) and this is a public notice explaining my reasons for doing so. 
The terms of the contract — henceforth known as the “Williston contract” — were agreed as follows by email: 
The contract was structured on Oct 16, 2015 and agreed a price of $49.78 for oil to be delivered in March. 
The delivering party pre-agreed to take on the full cost of delivery. (She promised to walk it over to the FT’s office in New York, rather than deliver to Cushing Oklahoma.) 
Tracy’s theoretical profit on the contango deal (which this contract was designed to hedge) — bar any basis risk between WTI and North Dakota Light Sweet — was expected to be $2.25 a barrel. 
Since the quantity of the oil being dealt was a small fraction of a barrel — about 1 litre — Tracy’s spot acquisition price was deemed 24 cents in October. At $49.78 per barrel, my contract covered a promise to pay approx 31 cents for the oil in question. Her expected profit from a performing hedge was expected to be about 7 cents. 
It is now March 24, and WTI oil is trading at approx $38.78 per barrel at the time of writing. 
Tracy is in the money on the trade, having wisely hedged her crude in October. I, the counterparty to her hedge, owe her 31 cents in value, in exchange for the delivery of the Williston container to the FT’s office as soon as the transaction is settled. That’s a profit for Tracy no matter what. 
I’m not going to pay her. Instead, I’m going to brazenly default in full view of the world. 
My reasons for doing so are both legal and technical. 
First, the legalities. 
In Tracy’s haste to cut a deal, she made some egregious contracting errors....MORE