Dabba Trading Comes to a Halt

As an aftermath of the Demonetization of old Rs. 500 and 1000 notes from the Indian Economy, expected results of curbing the Black Economy to a major scale seem to be positive at least from the stock market point of view. The recent news have shown that the illegal “Dabba Trading” has completely come to a standstill as traders face liquidity crunch with the highest denomination of Indian currency notes been demonetized and no longer considered a legal tender in the fastest growing economy in the world presently.

What is Dabba Trading?

Dabba Trading is an Indian Terminology, which is an illegal form of trading and is considered equivalent to Black Economy in the stock markets.

In dabba trading, a client buys and sells shares or index futures, with a broker who offers the outlawed service. The only difference here is that the trades are based on official (market) rates, but are not entered in any trading terminal and no securities ever change hands; they happen outside the purview of stock exchanges and regulators. The broker with whom the trade has been placed is the counterparty, just like a cricket or horse racing bookie. If the client makes money on the trade, the broker loses an equivalent amount, and if the client loses money, the broker gains by an equivalent account.

Everything is settled in cash. The 'brokerage' is higher than that for a regular transaction, and is usually in the form of a spread; the client will have to pay slightly above the market price in a buy trade and will get slightly below the market rate in a sell trade. Still the savings on margins that have to be maintained with stock exchanges for regular trades and savings on income tax (in case of profitable trades) more than make up for the higher brokerage.

How is Dabba Trading linked to Black Money?

There are brokers who specialize in what can be called ‘unofficial official’ trades for high networth traders who want to avoid the taxman’s glare. The trades are perfectly legal and routed through the broker’s terminal, but the profits and losses are settled in cash. Also, there are no records of the clients who transact with these brokers.

This is contravention of the SEBI rule that insists on all dealings between the broker and client being done through cheques. The 'cash broker' will enter all his clients' orders in his own proprietary book. If the client makes money, the broker pays him in cash, and if the client loses money, the broker collects in cash from him. The benefits for the clients are that they do not have to put up margins, and do not have to pay taxes on the profits earned. The broker charges a higher commission on these trades in return for the ‘facilities’ he is providing.

For this business to be profitable for the broker, there should not be a huge profit on his books at the end of the year. Else, he will end up paying tax on that money, since all the trades are shown in his name. Also, having a good client base is important. It is the cash collected from the losing clients that is paid out to the winners..

Many of the high-volume traders on Dalal Street, and even some of the so-called investment gurus, are known to route a sizeable chunk of their trades through brokers who settle in cash, to avoid tax. And while the brokers manage to balance their accounts at the end of year, the Income Tax department is only too aware of the cash transactions in the stock market and of the tricks resorted to conceal them. Still, with help from skilled chartered accountants and some accommodative assessing officers, the game has been going on for a while.

Effect of Demonetization

The Rs. 500 and 1000 notes, which made up 86% of the cash in the Indian economy, have been scrapped as a legal tender in the country since November 8, 2016. With this, the black market cash economy, which is considered to be consisting money in these denominations, has taken a big hit. Some of the dabba brokers who accept big trades, hedge their bets by taking an opposite position in the official market. This adds to the liquidity in the market.

Black money holders who indulged in Dabba Trading are facing a severe liquidity crunch and the trades of this kind have come almost to a halt and are in turn putting pressure on the stock prices.

So… Finally there are some positive results showing up for the bold step of demonetization that the present Indian Government has taken to curb the Black Economy. A Great News indeed!! The present effects of this may seem to be negative (in terms of Stock Market Reactions), but however, its long term implications seem to be much more positive and are expected to outweigh the present negative impacts.

- Harsh Pathak

Student and Core-Committee Member of Finance Club, MISB Bocconi - Bocconi India

Where is Oil Heading

Major Oil Indexes

Western Texas Intermediate (WTI) – WTI refers to oil extracted from the wells in the U.S. and sent via pirpeline to Cushing, Oklahoma and crude supplies are land-locked. The product is very light and very sweet, making it ideal for gasoline refining, in particular. WTI is the main benchmark for the oil consumed in the U.S.

Brent Blend – Roughly two-thirds of all crude contracts around the world reference Brent Blend, making it the most widely used marker of all. These days, “Brent” actually refers to oil from four different fields in the North Sea: Brent, Forties, Oseberg and Ekofisk. Crude from this region is light and sweet, making them ideal for the refining of diesel fuel, gasoline and other high-demand products. And because the supply is water-borne, it’s easy to transport to distant locations.

Brent is the reference for about two-thirds of the oil traded around the world, with WTI the dominant benchmark in the U.S. and Dubai/Oman influential in the Asian market.

Source: Intercontinental Exchange (ICE)

The preference for Brent crude today stems from the fact that it may be a better indicator of global oil prices. It's also still considered a sweet crude, despite having a higher sulfur content than WTI.

Although most Brent is destined for European markets, it's already used as a price benchmark for other grades.

As per Bloomberg, “Brent represents the Northwest Europe sweet market, but since it's used as the benchmarks for all West African and Mediterranean crude, and now for some Southeast Asia crudes, it's directly linked to a larger market."

Oil Market Outlook

Oil rose more than 1 percent today (November 7, 2016), boosted by a commitment from OPEC to stick to a deal to cut output.

Brent crude $ 46.20 per barrel at 17:30 IST, up 62 cents, or 1.36 percent, from the previous close. At the same time, U.S. West Texas Intermediate (WTI) crude was up 75 cents, or 1.7 percent, at $44.82 a barrel.

Mohammed Barkindo, Secretary-General of the Organization of the Petroleum Exporting Countries said at a conference in Abu Dhabi that the group (OPEC) was committed to an output-cutting deal made in Algiers in September.

Oil futures posted their biggest weekly percentage decline since January last week with Brent falling as low as $45.08, its weakest since Aug. 11, and WTI hitting $43.57, its lowest since Sept. 20. (Source: Reuters). There are also risks that the oil glut, which has dogged markets for over two years, could continue as OPEC's de-facto leader Saudi Arabia threatened to increase production. Even if Saudi Arabia does not follow through on that threat, its exports could rise.

"Saudi local oil demand is falling, and just maintaining current output could imply higher exports," Barclays bank said in an interview to Reuters.

What Major Oil Companies Expect…

In a recent report by Financial Times, Royal Dutch Shell and BP recently warned investors not to expect a strong rebound in oil prices next year as they set out plans for further cuts in spending to contain rising debts. The UK-listed oil majors both said they were planning for prices per barrel in the low $50s in 2017 — only a little above current levels — in a sign of the industry adapting to “lower-for-longer” market conditions.

Oil prices have stabilised in recent months after the sharp falls from $100-per-barrel crude two years ago but Shell and BP made clear they were not counting on a return to previous peaks.

“We see some firming in prices next year but nothing significantly north of what we see now,” said Brian Gilvary, BP’s chief financial officer, after announcing a 48 per cent drop in the group’s third-quarter earnings. Shares in BP closed down 4.5 per cent at £4.62 after publication of its results, which were dented by lower refining margins at the group’s downstream business as well as losses in upstream exploration and production.

Shell  reported an 18 per cent increase in profits which reflected heavy cost cuts after the group’s £35bn takeover of BG Group, completed in February.  However, Ben van Beurden, Shell’s chief executive, said: “Lower oil prices continue to be a significant challenge across the business, and the outlook remains uncertain.”

The more positive investor response to Shell’s results, meanwhile, reflected relief at its improvement from the prior quarter, when profits fell by 70 per cent (Source: Financial Times)

The continued squeeze on prices was reflected in the latest spending cuts outlined by BP and Shell.

Mr. Gilvary said BP’s capital investment would fall to about $16bn this year, down from an earlier forecast of $17bn to $19bn, and would remain broadly stable at $15bn to $17bn in 2017.

Shell said its capital spending would be about $29bn in 2016. This is almost 40 per cent less than the combined investment of Shell and BG Group two years ago. Spending would fall again in 2017 to about $25bn – the bottom end of Shell’s previous guidance of $25bn to $30bn – in an indication that oil majors intend to keep low spending.

Iain Reid, analyst at Macquarie, said: “They are making sure they do not crash and burn next year. They have cut capex down to almost the lowest possible level.”

In an interview with Bloomberg in Abu Dhabi, Bob Dudley, BP’s CEO said that he expected oil to touch $55 a barrel in 2017. He said, “Oil supply and demand is “generally” in balance, it’s just waiting until the stocks drain out.”

Eni SpA, an Italian multinational oil and gas company headquartered in Rome which posted a greater-than-expected third-quarter loss, is reducing capital expenditure at least through next year, its CEO Claudio Descalzi said in an interview with Bloomberg. As per Bloomberg reports, Eni is among major oil producers that are under pressure since crude prices plunged to less than half their 2014 peak levels. The company pumps crude in Iraq and is developing offshore natural gas fields in Egypt and Mozambique. Descalzi said oil prices would be high enough over the next three years for his company to maintain investment spending and its dividend. “Our number that’s good to cover our investment, and our operating cash flow is $50.” Prices could trade as high as $65 in the next three years, he said.

Exxon Mobil Corp. CEO Rex Tillerson, said:  “Capital spending will be “highly variable” from one producer to the next. There’s still a significant supply overhang and inventory overhang that needs to be worked through.

Energy investment will be 44 percent lower than expected from 2015 to 2020, compared with expectations before crude prices collapsed about two years ago, author and energy consultant Daniel Yergin said in an interview in Abu Dhabi. “‘When you look at all the postponements and cancellations, that will add up later in this decade,” he said.

Oil Outlook Ahead

According to a report by McKinsey & Company published in November 2016 – “Energy 2050: Insights from the ground up”, Fossil Fuels will dominate energy use through 2050. This is because of the massive investments that have already been made and because of the superior energy intensity and reliability of fossil fuels. The mix, however, will change. Gas will continue to grow quickly, but the global demand for coal will likely peak around 2025. Growth in the use of oil, which is predominantly used for transport, will slow down as vehicles get more efficient and more electric; here, peak demand could come as soon as 2030. By 2050, the research estimates that coal will be down to just 16 percent of global power generation (from 41 percent now) and fossil fuels to 38 percent (from 66 percent now). Overall, though, coal, oil, and, gas will continue to be 74 percent of primary energy demand, down from 82 percent now. After that, the rate of decline is likely to accelerate.

As per the Monthly Oil Market Report by OPEC released in October,

• ·         World Oil Demand

World oil demand in 2016 is seen to average 94.40 mb/d. In 2017, world oil demand is anticipated to rise by 1.15 mb/d, unchanged to average 95.56 mb/d. (Demand for OPEC crude in 2016 is estimated to stand at 31.8 mb/d, an increase of 1.8 mb/d over last year. In 2017, demand for OPEC crude is forecast at 32.6 mb/d, a rise of 0.8 mb/d over the current year).

• ·         World Oil Supply

     Non-OPEC oil supply in 2016 is expected to contract by 0.68 mb/d to average 56.30 mb/d. In 2017, non-OPEC supply is anticipated to show growth of 0.24 mb/d to average 56.54 mb/d, mainly due to new projects coming on stream in Russia. OPEC NGLs are expected to average 6.43 mb/d in 2017, an increase of 0.15 mb/d over the current year.

• ·         Demand for OPEC crude in 2016 is estimated to stand at 31.8 mb/d, an increase of 1.8 mb/d

     over last year. In 2017, demand for OPEC crude is forecast at 32.6 mb/d, a rise of 0.8 mb/d overthe current year.

According to Bloomberg data, “Oil producers in the North Sea are poised to ship the most crude in more than four years. This expected surge is in line with the expectations that OPEC will try to contain a global surplus with coordinated output cuts. Shipments of North Sea grades will increase 10 percent month-on-month to about 2.16 million barrels a day in December.”  The surge poses yet another challenge to the Organization of Petroleum Exporting Countries as it seeks to curb production to steady markets in a world with plenty of oil. OPEC ministers will meet in Vienna on Nov. 30 to decide how to trim output to a range of 32.5 million to 33 million barrels a day. Libya, Nigeria and Iran are claiming exemption from cuts because of their own circumstances, and Iraq has contested how its output has been measured.

While supplies from some nations outside of OPEC are indeed falling, non-members boosting their crude output include Kazakhstan, Brazil and Russia, which last month pumped oil at a post-Soviet era high (Source: Bloomberg). OPEC itself increased production to a record 34.02 million barrels a day in October, according to a Bloomberg survey of analysts, oil companies and ship-tracking data. In addition, the U.S. is now freely shipping its oil across the globe, following the removal of export restrictions last year.

On November 7, 2016, Mohammed Barkindo told reporters in Abu Dhabi that, Russia – the world’s biggest energy producer – is “on board” with an OPEC agreement to limit crude oil production to help re-balance the market. “OPEC producers remain committed to an agreement reached last month in Algiers to trim output, and cooperation from non-OPEC producers will help bring the oil market back into balance” he said. Russia is due to join OPEC for talks later this month in Vienna, where OPEC will convene for its bi-annual meeting.

The Organization of Petroleum Exporting Countries, which pumps about 40 percent of the world’s oil, is trying to persuade producers from outside the group, such as Russia, to join the cuts. OPEC wants to put the changes into effect when it meets in Vienna on Nov. 30. The group has held talks over the past weeks with producer nations Russia, Azerbaijan, Brazil, Kazakhstan and Mexico.

According to Bloomberg report, Russia, the world’s largest energy producer, pumped at a post-Soviet record of 11.2 million barrels a day last month. With new fields ramping up production and more due to start producing before year-end, its output may climb further. Energy Minister Alexander Novak indicated that Russia was willing to freeze production for six months or more, rather than cut, and only if OPEC reached an agreement first. Bottom of Form The Algiers accord helped push oil prices to a 15-month high above $50 a barrel, but crude has subsequently fallen as several OPEC states disputed production estimates that would determine the size of cuts by individual members of the group. Without a deal, OPEC will return to the policy of pumping without limits to secure sales.

Author and energy consultant Daniel Yergin said in an interview, “OPEC members Iraq and Iran represent a “sticking point” that needs a resolution if there is to be agreement to limit production. If there isn’t an agreement, it’s back to battle for market share.”

As per the World Economic Outlook report published in October 2016 by International Monetary Fund (IMF), by the end of FY17, Brent Crude is expected to see the levels of $51 a barrel sighting the fact that demand in Developed Economies will be stagnant and major of the growth in demand that previously came from them will be balanced by the growth in demand from Major Emerging economies like India and China.

From here, oil is seen to meet the levels of $53-55 a barrel. In the mean time, let us watch what happens in the U.S. presidential elections!! 

- Harsh Pathak 
Student and Core-Committee Member of Finance Club, MISB Bocconi