Our story begins with the narrator sitting at a desk, writing his memoirs on a typewriter. It is 2017, but he still writes a draft by hand before posting it online. His body is hunched over, but mind is sharp. He briefly closes his eyes and smells the sweet summer air, which takes him back in time to a day when he was twenty years old. Skim-boarding on a gulf island where he first someone who would change his life forever.
Her name was Sandra. It was 1985 and she was more grease lightening than cheerleader. She was a pretty tomboy who travelled and gambled. She was twenty-five years old and she took a quick liking to our hero, Gordie.
His memories of that year are hazy, but he has bank records to help him piece together much of what happened. He ended up in Louisiana with eighty-five thousand dollars and an ability to gamble. She was gone, but he learned something from her: how to lose. It came in handy later when he was day-trading in the nineties.
Sandra was a bully at the card table. A cute little girl who could upset a whole room of players without saying a word. When she did open her mouth, which was often, anything could happen.
She bulled her way through a lot and made more than she lost. She never went full broke, always scaling-down her bets before she lost everything. It worked great, until it didn’t. She ended up deep in a bad place and just disappeared from New Orleans. Not even one full year after Gordie first met her. Theirs was a flash of love and lust. Money and power outside the system going into the climax of the late eighties in America. He thought of her often for the rest of his life.
Gord opens his eyes again. He is sitting at a desk in an empty room with mirrors all around. He is amongst the tops of tall trees, looking out at the Pacific Ocean. He gets up to go down to the beach and wake his tired bones. The cold morning air will soon give way to the heat of summer sunshine.
When he was forty, Gord joined the BC Provincial Government. He joined late and left early compared with others there. He never lost his sense of awe for government power, but he did become more cynical. Quite quickly, really.\
He started with a think tank dedicated to policy that could support resource development in BC. A tough area for political maneuvers between deeply entrenched interests and aggressive new entrants. He had lots of ideas, from run of river hydroelectric projects to hemp-based biodiesel and even algae-based biodiesel. In 2005, these were relatively new and exciting ideas. He spit-balled some really exotic stuff around 'aid and trade in water', but that didn’t make it past the meeting minutes. Soon after he started getting some traction with Vancouver-based run of river companies, the Government leadership bumped everything to focus on Liquefied Natural Gas. The BC Government had huge plans for LNG export facilities. They had international players at the table with other Provinces and Federal representatives. He started to see the way things were happening, or not happening, when he decided to move on. When he left, he went back to what he had done since he was twenty -- gambling.
It was 2007 and he was forty-two years old. The sounds and sights were so new and different; he could relive his first night in Tokyo a decade later while walking through the woods on the way to the beach. He stopped in a clearing just above the beach and though of the Japanese Buddhist monks he met. The sushi chefs. The investment bankers. In fact, Michael Lewis writing from his time there had inspired Gord to start writing his memoirs during that trip. He found that he enjoyed talking about his stories, but all of the writing made for a lot of extra work. He was grateful that he found a good transcription software in recent years.
Gord went to Tokyo for one purpose: to try and put on a trade that seemed obvious to him -- betting that the premium in global natural gas prices over North American prices would shrink. It was a huge premium when he worked in government. Global prices were approximately fifteen dollars per cubic foot of natural gas, double the North American prices at seven dollars. It was such a big difference that it incentivized the BC Government to aggressively pivot their entire policy agenda towards LNG. The Government was betting that those premiums would stay large, and Gord wanted to bet against them in some small way.
It wasn’t easy to put the trade on. He found a banker in Japan who would sell him Contracts For Difference on the global prices. They were based on pricing at an export hub in Japan that released high quality price and volume data. This was the hardest part of the trade. He bought a bunch of different contracts that would payoff if global prices fell. He tried to replicate a put option with the CFDs, but it was clunky and expensive. The banker learned to love him real quick because Gord took terrible prices when he first started the trade. As he rolled the positions, the banker loved his business even more. Gord's initial positions were may 40% above the model-price for the CFDs.
He put on approximately one hundred and fifty thousand dollars to work short global gas, then he got to work hedging the currency and building matching longs to isolate the premium in global prices over American prices. It wasn’t an exact science, but it was a basic pairs trade and he put it on in size relative to his personal bankroll.
By the time the Global Financial Crisis occurred, he was in a holding pattern with his CFD position. He was working on a new way to put the trade on with swaps. He would pay a variable rate based on global prices and receive a fixed rate. He was the first person to ever do this trade with any Japanese investment bankers. They loved the trade.
He put on the first generation swap trades in 2010, the same year that "The Big Short" book came out. He knew the story before it came out. He had been reading Grant's Interest Rate Observer too, and even got a pre-release copy from Michael Lewis himself based on their long-term correspondence. In 2011, he put on a second generation swap, with better terms. In 2012, he put on a third and final swap trade, and an options-based trade with the same premise. He got lucky finding partners to help him fund the trade. In 2013, he put on another options trade, but didn’t trade global gas at all in 2014 -- he was heavily involved in the North American markets during the polar vortex and subsequent fallout.
He started closing the trades in 2016, starting with the first swaps from 2010. He was even so bold to try and take the other side of the trade after that, but the bankers were a lot less keen to trade with him after all that had happened.
The way he created the trades in the first place was to propose a model for pricing the instruments. Real back of the envelope type stuff, but it helped make the bankers feel comfortable and confident that he was not going to be a problem. It worked.
At first, he chose to accept poor prices just so he could put the trade on. He was targeting a big move, big enough to overcome any slippage on the way in or out. Not only was it an illiquid market, he was a difficult customer. An outsider asking the banking industry to accommodate his wild fantasies. The bankers made so much money on these deals, at first, that they got comfortable with him and gave him better pricing as he scaled-up the size of the trades. That worked just fine for him. He didn’t like taking losses on the early trades, but he found solace in Dr. Michael Burry's story and stayed the course.
The mathematics of the swap trades were pretty straightforward. The options trades were a different story and even he wondered what exactly happened with some of those trades. They worked, after a while.
The swap was fixed for floating, tied to gas prices at a particular export hub in Japan. He even got the industrial company to write the second and third generation contracts, and then the same investment banker who sold him the CFD securitized them for other bankers. The hub operators thought it was a cute little trade and were happy to be counterparty because they were, understandably, bullish on gas.
The first swap had notional value of one million US dollars. This was the reference value for the fixed payments. The fixed rate was six percent, which meant the contract paid Gordie fifty thousand dollars per month over the term. Gord received this amount monthly and could renew it annually at his discretion. His counterparty could bid to close the contract at any time.
Gord paid a variable amount each month that was calculated as the average price at the export hub multiplied by a reference quantity of gas. When they struck the first contract, prices were around twelve to fifteen US dollars per cubic foot. The reference quantity was fifty-thousand cubic feet.
All this meant that Gord was paying approximately sixty-five thousand dollars per month and receiving fifty thousand per month, paid quarterly. It was a terrible cash burn for him, but that helped convince the bankers to take the other side of the trade. He looked at the net cash burn as a premium that he was paying for the downside exposure to global natural gas prices. If prices went down then he would pay less per month, but receive the same amount. If prices went down enough, then he would actually make money.
Getting the first swap deal done was such a hassle that he didn’t even hedge the first swap by buying upside exposure to North American gas prices. By the time the ink was dry, the bankers were figuring out how to give him a deal that looked more like a futures contract. They figured it out and the second swap trade really allowed him to isolate the difference between global and American gas prices.
"The rest is history," he yelled out loud when he jumped in the cold ocean. The shock made him forget all the names and dates. His chest tightened up from the shock and he smiled to himself. The familiar feeling of anxiety had been with him for years. He was eager to tell these stories so that they didn’t have to stay bottled inside him anymore, but he was scared to commit himself to any one version the story. Scared that he would lose the chance to tell the story the right way. Scared he would miss the best bits, the things that he would hardly believe if he hadn't seen it. He always seemed to miss something in each retelling. He though back to Sandra again and decided he could afford to take the loss from telling the story.
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By @Newton, August 15, 2106
