Arbitrage and Fuel Oil: "High" Finance Explained without the Waffle
*An excerpt from Slippery
It’s almost midday. There’s a lack of construction noise in this part of the city, most of the old buildings in the immediate vicinity are heritage listed and safe from Bangladeshi operated jackhammers. This means I am actually able to wake up leisurely and with a degree of peace. I stay lying in bed, checking my emails on the Blackberry, nothing urgently important in the hundreds of subject titles I scan over amongst the unread list. Week one. Done. Not fired yet. That’s better than I’d expected.
I head to the bathroom, catching a quick glimpse of myself in the mirror. I’m still holding on to my Mexican glow and, if I’m not mistaken, I think there could be visible musculature in my shoulders and chest. Back on track, baby! My guts are still laden with cellulite that belongs in a pensioners’ aquarobics class, but I’m cool with that. Six packs are for homos anyway. I shower and shave before reading properly through all my unread emails and munching away on a bowl of Weet Bix.
Joel has shot holes through my Arb sheet. ‘Arb’ is short for ‘arbitrage’. And arbitrage is one of the abundant overly used and poorly understood words in the finance industry. The finance industry, some call it ‘high’ finance, because you no doubt have to be blazed off your head to believe any of the garbage entrenched in the world of finance. The industry is full of these sorts of words, these syllables that roll so effortlessly off the tongue and yet very few of the market participants actually have any real idea of what they’re waffling on about.
Crowds of published economists will tell you arbitrage means taking advantage of price differentials for the same product, which are simultaneously available in different markets. So, if you could buy a schooner of Heineken for $5 from the downstairs bar of your favourite pub, then walk upstairs and sell it to your mate for $6, you could make $1 risk free profit provided, of course, you were blessed with a steady hand, the ability to not sneak a cheeky sip of that fresh Heinee the moment it arrived in your grasp downstairs, and, most importantly, able to nonchalantly be a complete cunt.
The economic theory goes that such price differentials close quickly. It’s only a matter of time before your mate upstairs realizes you’re ripping him off and either undertakes the walk himself for the cheaper groundfloor schooie or just smacks you in the head and glasses you in the jugular. Either way, the price gap won’t last long, contrary to popular belief, people aren’t that stupid, apparently.
Now, in terms of fuel oil, there are two major global price benchmarks. One in Singapore, the land that fun forgot, and the other in Rotterdam, Holland, the land that fun’s had a fucking gutful of. That poor fuel oil molecule that emerges from a three day bender in Rotterdam only to get shunted into the storage tank of an oil tanker and shipped to the most uptight city on Earth must be rightfully pissed off it’s been shipped across the planet in the name of arbitrage.
But, in Europe, fuel oil is relatively cheap, most power utilities use higher quality inputs and the European shipping industry is a little hamstrung by somewhat stringent environmental regulations. By ‘somewhat stringent’, I simply mean, ‘some’. Demand is weak. While in Southeast Asia, fuel oil is needed for shipping and power plants alike. Ship it in, baby, we’ll take it.
The price difference, the ‘Arb’, between the two locations is usually a simple, direct relation corresponding to the shipping costs. Obviously, fuel oil in Rotterdam can’t jump aboard a KLM flight. No, it has to trudge the English Channel, round the Rock of Gibraltar, cruise the Med, snap a few photos of the pyramids on the way through the Suez, pray like hell Somali pirates are bedridden, nursing a HIV or Ebola outbreak as the Arabian Sea flows around the hull, then time the Indian Ocean crossing with a dearth of tectonic silly bugger activity and, finally, slide through the Malacca Strait reflecting on Charles Darwin’s Origin of Species.
It’s quite a journey and is usually valued somewhere around $20 per metric tonne. That differential is known as the ‘East-West’. Let’s say the price per fuel oil metric tonne in Singapore is $610, the price in Rotterdam is $590, fuel oil traders are so efficient with linguistics they’ll spit all day the ‘east-west is trading 20’.
Now, what I’m charged with providing is an analysis of this east-west Arb. Assuming the quoted east-west price is $20, and let me just qualify, that is a derivative ‘paper’ price. You know, a price on an exchange. A price which is nice to look at, a quote which newsreaders may include in their daily ‘markets summary’ and a risk analyst will likely call upon to summarise a trading firm’s Value at Risk. But it really is quite meaningless.
When you do actually stump up to some grouchy cunt in possession of barrels of fuel oil, he won’t necessarily deal at that exchange quoted price for real live physical barrels. It’s a bit like cash starved battlers pawning their inherited gold jewelry to slimy Indians in suburban shopping centers. The price they may receive for that gold is not going to correlate too closely with any London Metal Exchange sanctioned bid-offer.
The Arb sheet has to include shipping, financing, insurance, the whole kit and kaboodle and provide a specific price we can sell fuel for in Singapore if we buy it in Rotterdam and undertake the journey east. Like all things theoretical, it’s piss easy. We’re all Einsteins when we can dwell in a theoretical wonderland of fantasy and unicorns. If I’m traveling in a train at the speed of light…you’re dead, that’s the answer, you are dead, your internal organs no longer the required degree of internal thanks to unbearably powerful forces. No, the problem is providing a theoretical basis for physical trading in an eternally practical universe.
My best summary at the moment shows the Arb being closed by $10, meaning, if we buy oil in Rotterdam at $590 per metric tonne, ship it to Singapore, we will spend $30 per ton for the privilege, but the price in Singapore is only $610, so we’ve expertly burned $10 of God’s money, which he will not be happy about, multiplied by a few hundred thousand tonnes. No, entry inside the pearly gates to welcoming arms handing out heavily zero-laden bonus cheques with that approach is mighty ambitious.
I reply to Joel’s email that the numbers simply don’t stack up for moving an arbitrage cargo right now. He replies back instantly, saying ‘other companies are shipping in oil from Europe, I’m certain, something must be wrong with your numbers. But fuck it. It’s Saturday. Rest up. We’ll fix it Monday’.
Thank God for that. I rinse my Weet Bix bowl in the sink and call a cab.
*Slippery is available on Amazon and www.capebardo.com/slippery in paperback, ebook, audiobook.