Episode 6
Winter is Coming

Bill Perkins, Partner & Head Trader, Skylar Capital

“Bad things happen in a market, that’s a guarantee. The trading guarantee is something is going to go wrong. What really matters is, how do you react to it?”
Bill Perkins

This week, we welcome Bill Perkins into the SmarterMarkets™ studio. Bill is the Founder, Managing Partner, and Head Trader for Skylar Capital. SmarterMarkets™ host David Greely sits down with Bill to discuss his trader’s perspective on the natural gas, power, and carbon markets in Europe.

Hosted By

David Greely

Episode Q&A

The following Q&A is created using slightly edited excerpts from the episode transcript, optimized for readability. Download full transcript.

BP: Things are changing every day in Europe right now, but I generally see that we have a situation where the amount of storage is not enough based on the demanding amount of gas they use. So you have a lot of scenarios where you can either get to containment, and prices fall apart, but still not have enough gas to get you through the winter. We used to have that domestically before storage grew maybe 15 or 20 years ago. Then you have all these other factors with the energy transition: Russia cut off the gas because of war, ship LNG, and policymakers getting involved with subsidizing demand via price caps, nuclear issues, and weather issues. There are just a lot of things that digest in the short-term and long-term. Long term, it’s going to take a while for this market to become less volatile. So I see lots of opportunities here just being the insurance agent. That’s what traders are; we ensure against prices going up, and we ensure against prices going down based on how we see the world.

BP: Just like any other winter, they can fill to the brim, and they can still run out of gas – this is what normal situations would look like. But here we have the Russians flowing 1/6 of what they normally flow that’s being met by LNG; high prices cure high prices, but will Russia cut off more gas flowing through Ukraine? Has demand destruction been significant to get us to the winter, or will winter be very warm, and then we’re being flooded with gas? Or will it be cold, and we run out of gas? There are a lot of scenarios that keep playing out. Right now, we’re kind of in a situation where high prices cure high prices, the demand destruction is significant, and the rest of the world is saying we don’t want the LNG at this price, at least a significant portion of it.

BP: So we have to reckon the amount of LNG flowing to Northwest Europe and Western Europe, which looks crazy when you look at it on a map, but winter is coming, and the infrastructure isn’t such that flowing LNG ships can necessarily place flowing gas in a cold weather scenario. So you have a shutoff through Ukraine, and it’s priced high; you are kind of bearish, but maybe the expected value could be fair or high. People are trying to figure this out, and when you start having policymakers get involved, you begin to lose a free market. I’m very good at trading markets, but I am not good at trading Putin; I’m not a good trader trading Putin. These various schemes that they have induce demand, these price caps.

BP: Are you subsidizing demand when you’re running out of gas? This makes no sense. I often say had they made the price a complete pass through, the crisis would be over in a day. And then some retort about what happens to the people who can’t afford it? I say, here’s what you do instead of just blindly paying the bill, give everybody the amount that would be an increase and call it a pass through. Are they going to spend the extra thousand dollars on energy or will they conserve and spend it on the nightclub? I think many people go to the nightclub rather than spending on a high electricity bill. They’re not putting forth schemes to conserve or produce demand destruction; they’re just absolutely subsidizing demand, which is crazy.

BP: No invasions, but you had growing demand and a lack of infrastructure, and no matter what you thought about the energy transition, energy transitions aren’t smooth; they’re lumpy. Infrastructure doesn’t come on perfectly and match demand. You have this storage situation where they’re not building more; no matter how much you fill storage, you always have a risk of running out. In the early days, we were putting down all these gas-fired power plants and growing our demand sided equation and flows but not increasing the storage, which storage is your shock absorber. That’s your shock absorber for volatility, and so I saw a landscape where we’re going to have a lot of volatility depending on what was going on, what was the weather, what happened in global events.

BP: Nobody wants to trade the boring, 3%, 6%, and 10% Vol product. We were trading the 80% vault product, and back then, I thought – 40 Vol is cheap, or 60 Vol is cheap, and now it’s double. We have scenarios where things will be moving around significantly. Since there are not that many insurance agents in Europe, not that many people want to put their risk capital and be risk warehouse shops there, the premium or the edge we get paid is significant. When there are 30 insurance agents, the insurance margins are pretty thin. There are not that many of us that want to put our capital at risk in that market.

BP: The world went crazy with equities. It’s just you went to raise money looking for your discretionary long-short commodity trading, and they were like, do you trade equities? Are you long equities? Are you long equities? Can we buy the equities? That’s all you heard. And you had this massive run-up from the fed printing, and I guess it was the right thing to do because they were printing money all the time, but that’s changed. They could lose 50% of their portfolio and still want to be in equities before they jump into a commodity long short. And people are starting to pay attention to commodities, but we’re always an afterthought.

BP: Yeah, they are too risky. It’s a strange world, but I guess that’s what’s marketed the most to these risk allocators of the world, the pension funds, the family offices, et cetera.

BP: We hired Nathan Lorentz, he is from the LNG days, and he’s opening up the office, and I’ve already been trading small significant as a percentage of our portfolio, but we wanted somebody full-time with the time differential, so I’m not up at 1:30 am trying to figure out what’s going on. We’ll be building out that risk book and the desk as time goes on. When I was in high school playing football, I remember the coach used to say: “Run where they at! Perkins run where they at!” You have to go where they are, and so many people are not in Europe, they’re bailing out, they’re blown up, they’re not allocating risk, and that’s where you want to be. That’s where you want to be in that market. You want to put all your fundamental analysis, your programs, your research, and that data you’re buying over there. I think you’ll have a very positive expected value position in Europe.

BP: We clearly have the run-out of gas scenario. That’s interesting because the EU isn’t the United States because they’re kind of loosely together. What I mean, do you have certain states go that would go about it like we’re not going to ship the gas, no transit fees, or we’re not shipping you power? The European Union has stressed itself, and those are secondary effects of scarcity. There is also a lack of proper planning, years of the policy of we don’t drill, we don’t put in infrastructure, we rely on Russia for our natural gas, and that’s coming home to roots. You have scenarios where there has been demand destruction. They have sent out a signal; the market is set, here take the LNG, China says, we’ll burn all the coal in the world – we don’t care, take back your LNG. You could have a normal to mild winter, and just be flooded with gas in storage at the end of March. So I think both tails are on the table. They’re completely on the table right now, and I would say that the no-shutting-off Ukrainian flows scenario with normal weather is actually bearish.

BP: You have a lot of demand destruction and flows. You’ve sent a price signal, and high prices cure high prices. The problem in Europe is that the person using the gas and paying for the gas is often not the same person. In industry and commercial, you will pay for it if you use it. They’re shutting down aluminum plants and smelters all the way through, and you just have enough demand destruction. There are 92 LNG ships on their way to Europe right now. There are 260 ships on the water. If they’re all going to Western Europe, and it doesn’t look like they want to stop. The storage is 90-91% full in Northwest Europe is what we defined as Northwest Europe. It’s on its way!

BP: Once you get to 92%, you start to have injection issues, you can’t stuff it at the ground at the same rate, and it starts to drop off precipitously, and so you’re seeing that cash was trading €30 back on futures and you could see it in the front spread, which was a premium and now it’s €15 back, call it five bucks back, I mean, it is €30 back printing today, and I see that scenario getting worse as long as the weather is normal. So you have everything on the table here, weather normal down the fairway, slightly bearish, but the volatility is so high, but as time evolves, that will start to get more solidified one way or the other.

BP: That’s an education question. It’s really hard. I guess people respond to visual cues, so maybe show them the distribution of events, like what happens and some prices you estimate going on. That’s how we look at it, so here’s the world as we see it now. This is the S&D; this is the demand destruction, run me the last 30 winners through scenarios and show me in how many outcomes we’re running out of gas, et cetera. I think every trading shop does that this is no fancy witchcraft here, and then you could start saying that what if Russian flows of this run the weather scenario? What if Russian flows of that? What if LNG flows of this, and you run that deck, and then you have the distribution of what we see and what’s possible, but you don’t want to see a 30% chance of running out of gas; you never want to see that. You don’t even want to see 10% or 5%, so that’s what’s pretty scary.

BP: And that’s what you can see in somebody’s cards you pull up or these scenarios. In my view, policymakers want to get elected, and look good, so they say they’re the bears of good and sometimes false news or, often false news.

BP: Right now, we’re much smaller than we normally would be, and that’s just a function of all margins. I guess everybody’s smaller, but the other thing is that we’re waiting for very extreme, high favorite scenarios and tighter spreads. One of the things that recently we were looking at is that the winter might be crazy, and there’s always going to be this like kind of war premium and Putin premium, but there’s a significant chance that they can run out of storage. They can’t inject as much gas as they’d like to carry to prepare for the winter, although they’re going to send that price signal out. A month ago, I knew we should be short the front and long the back, even though the market is backward dated, this market should be contango because there’s this x probability of getting to a hundred percent full.

BP: Things happen, and it changes to even 95%. So we started running numbers and saying, what’s the odds that we get to 90% full by today? Right, what are the odds we get to 95% full? What are the odds we get to a 100%, October the 15th – 95% is a really dire situation with the amount of flows you’re flowing right now. In a normal weather scenario, is there enough space, is there enough demand plus injection demand to handle that, and there were just too many scenarios that were like there’s going to have to be some discount. Then there were all kinds of discussions about what could they do floating storage and then there was a debate on how do you store if all the slots are already taken to re-gas in the winter?

BP: You don’t have firm re-gas rights in the winter. So you can’t just sit there with a $100 million cargo hoping to get a $20 spread. I don’t know the exact answer, but I felt that enough of the distribution was that this thing backwardated or flat or even down a dollar is too tight, so we stay kind of tight within season. It’s one of the ways you could kind of trade, trade around containment and running out. On a longer-term basis, that’s tougher; the further you go out, your accuracy decreases with time. When you go from, let’s say to the summer, we call that three trade lifetimes away because each season is a trader lifetime. After all, you can die in any season.

BP: We look in the range of the extremes what’s going to happen, what’s going to happen with demand destruction, are these distributions reasonable? Can we put on a trade that expresses that we can survive being very wrong because the name of the game is to stay in the game. The market will provide you with outsized returns. You just need to stay alive. Even if you get cut in half, you’ll have a chance to really come back and thrive as long as you stay in the game.

BP: Just don’t get knocked out. You could get knocked down bloody, you can do a nine count, they can cut your eye, but make sure you’re able to go back in a ring, and you’ll eventually win.

BP: I generally view them to be who they are, and their primary concern is not solving the problem; it’s solving the problem of how I stay in office? How do I look good? How do I get reelected? It’s simple; energy is a pass-through. It is over. You will get 30% conservation out of the RC sector you’re worried about. They’re just not paying that much, and then, their concern is about people’s high bills, that they’re angry, and that they will not get reelected.

BP: So that’s how they’re always going to behave. So whether it’s like we’re going to move the index over here, it’s never solving the demand problem. It’s not solving the LNG problem, it is just hiding it. It may push it further down the road and make it worse further down the road, but it’s never really actually solving the problem. Here’s something where you can solve the problem and get reelected. Just say, let’s say your bill was $100, and now it’s going to be $1,000 and you don’t want them to see the increase, so usually what they do is they just cap it, and they pay the bill for them, so you have no demand destruction.

BP: Give them $900, but just tell them the price is the price. So the consumer, they’re not paying anything extra, but they have $900 to make a choice, spend it on energy or conserve energy and go out and party. The price is a pass-through so there’s no harm to the consumer, but then what’s going to really happen is that these guys are not going to like take the $900 and ship it back to Juniper, which is now a government-controlled entity. They’re going to take that, turn down their thermostats, winterize their houses, and you’re going to see conservation that on a scale you’ve never seen before in the RC amount, and you’re going to solve the problem crisis over immediately.

BP: It’d be empowering the consumer so that would be a policy shift where they are doing the socialist thing, but we’re doing it the smart way. We’re distributing it to the end user and letting them decide whether you’re not; you’re not subsidizing demand in that way. You’re actually destroying demand in that way, but I haven’t heard that once out of anybody, out of any policymaker. They’re politicians; they’re not economists, they’re not commodity traders. They don’t necessarily do that, and their focus is on getting reelected and staying in power.

BP: I’m just proposing a way that they can actually be superheroes. It’s just like I got $900 and I got to keep $200 more to spend. it’s also an economic boost. It’s a direct ejection.

BP: Definitely a trader first. I wouldn’t call myself highly successful. I’ve been successful in tournaments, but cash games, I’ve gotten beaten up early enough and I’ve gone through the school of hard arts learning poker, but when I was like a clerk, I got introduced to playing no limit at holding them and all the traders, they have this natural inclination to risk, they like to gamble as entertainment. When you’re always a house, sometimes you just want to get lucky, and socialize, and that’s kind of the mentality of the floor, at least when I was coming up.

BP: There’s certain people focus on the downside. They’re just risk averse, and there are people who are always at missing the opportunity costs, and I think that’s more traders. They’re always like, what could have been, what could I make, they’re not thinking about the downside. I think that’s the bent of traders and so they like action.

BP: I think what they both do in different ways is trading and poker let you know about yourself. You go in the market, it doesn’t care, it doesn’t have a vendetta against you. You play poker and they don’t have any vendetta, they’re going to come away. It’s really how you react to every scenario. For instance, there’s winning traders and and losing traders. it’s really how much did study, how did they react to each scenario. So you really learn about yourself when trading . Yound the same is true with poker. When you find your leaks in your poker game, for example, you over bluff or you under bluff or you call too much or those things you find like there’s something personal to you and your personality, the way you are maybe, in your childhood that wired you to be this way. You need to unwire and fix this thing in order to get better at poker.

BP: And I think the same is with trading. Like if you’re the type of guy that gets upset when you lose and get irrational or you hold onto a trade too long, when you should be getting out because whatever you become attached or whatever; there’s all kinds of trading leaks that are out there. I’m not a trading psychologist, but I am very well aware of when things go right or I’ve done things wrong, it’s me; it’s not the market. Bad things happen in the market. That’s a guarantee. Like the trading guarantee something is going to go wrong. You’re going to have this perfect thesis and boom, polar vortex in your face. It’s bullish as all get out, and the market goes into infinity, and Freeport LNG blows up, and there’s a ton of gas on the market, and boom, we vaporized 2-3$. These things are just going to happen. You don’t know when they’re gonna happen. That’s the bargain of life. That’s the bargain of trading and what really matters is how do you react to it.

BP: I guess one of the things I would say is that even when bad things that are happened when you’re making your thesis that volatility that got you is also what’s going to pay you. This is part of the game. Do not get too upset. If you’re in that game that is what’s going to pay you this volatility, this structure has set up. We’re all complaining about margins are crazy, and I can’t trade that much. This is because it is, don’t worry. There is lot of juice and you’re needed. Many people, look at the trading as useless. And I say, we’re needed, we’re risk warehousers. So you’re needed, hang in there, keep your wits about you, and be rational. They should use the word – risk warehousers. We take the risk that you don’t want.

BP: We’re really glorified insurance agents. If you’re a fundamental trader, we’re glorified insurance agents, producers come out and they’re say, we want to sell a gajillion contract so we can make the widget and where do we buy this thing you; it looks bullish here. I’m going to buy it, and then it’s like we’re worried about running out of gas. We go to buy it, and we’re like you actually could run out of gas. Where would I sell this thing? That’s what we do. We’ve just glorified insurance agents.

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Ranting on the inadequacies of our systems and riffing on ideas for how to solve them …

SmarterMarkets™ brings together the icons and entrepreneurs of technology, commodities and finance to examine how market systems can be redesigned and improved to address the most important challenges of our time.