Several months ago, I attended a meeting of private bankers and financiers on Cyprus. Much of the out-of-sight finance activities underway was either initiated by Russian sources or facilitated by them. That much was well- known. However, what has been occurring recently with this money flow is very different.
Cyprus has been recognized as a primary Russian money laundering venue for some time. Traditionally, such capital moves occur on behalf of private Russian holdings through correspondent accounts elsewhere, usually employing one of the main international banks on the island. But a combination of the Cypriot financial crisis in 2013 and later US moves to pressure Russian usage of the Cypriot banking network changed that.
My sessions were held at the Hilton in Nicosia, the capital of the Republic of Cyprus. That government has sovereignty over the entire island, although beginning in 1974 the northern one-third has been under the self- proclaimed Turkish Republic of Northern Cyprus (TRNC). Only Turkey across the Mediterranean directly to the north recognizes the Turkish Cypriot enclave.
But the tensions have remained and are occasionally felt in the capital. Nicosia sits close upon the de facto partition with a UN Peace Keeping Force serving as a buffer zone across much of the border.
There are considerable natural gas reserves emerging off shore Cyprus, the palpable reason for my visits. The TRNC has threatened to obstruct their development.
Meanwhile, another energy-related Russian money matter has surfaced recently. This one indicates how sophisticated the Russian money path has become. It also testifies to the vulnerability of the global oil trading market.
Situated on the southern coast and a center for tourism, the city of Limassol is now the locus of Russian money interests in Cyprus.
In a less than four-block area in Limassol, my latest estimates conclude at least 212 Russian “banks” are registered. These are documented as private or merchant. Most have no staff and use as legal addresses the law firms overseeing their paperwork. The number has been reduced after the Cypriot financial crisis earlier this decade, and some money has been moved out following US moves against money laundering operations.
But the volume of funds moving through these shells is actually increasing.
Estimates put the total amount of Russian funds in Cypriot banks at anywhere between $15 and $25 billion. But such figures usually calculate only those amounts that can be documented as either deposited in overt accounts in larger banks or local business investments. Aggregate Russian shadow banking is easily many times the “official” total. And most of that traffic is moving through financial conduits housed in Limassol.
Greetings from Limassolgrad!
While Cyprus remains a lynchpin in the flow of Russian money laundered into the international system for any number of reasons, increasing amounts of the remaining still heavy activity has morphed into two areas. The first is local real estate where Russian finance is the driving force. Despite there being less than 200,000 calling the city home, there are so many Russians living or listed as property owners in Limassol that locals jokingly refer to it as “Limassolgrad.”
A Limassol beach front housing development clearly catering to Russians.
Some of this real estate is essentially used to “park” assets meant as collateral for other ventures, both domestic and foreign. For example, local banking contacts acknowledge that more than half of the units in new high-rise buildings like these springing up in the trendy Enaerios area along the water are designed with that purpose.
Image: Cyprus Property News
Limassol real estate brokers have been unanimous in the conclusion that the prices are unsustainable, severely disjointing the market. In short, there is little reason to assume the investments are meant to render a profit.
The second target for Russian money involves a far more sophisticated approach and is the actual subject of this ECRG Intelligence. The funds are being used to influence, or in some cases to control, global oil market transactions.
At least a portion of these moves are geopolitical rather than profit-incentive directed. Trading sources in Switzerland, Moscow, London, and the Netherlands have confirmed a significant rise of funding traffic into crude oil futures contracts and credit swaps paralleling the collapse in oil prices kicking off in mid-October. From highs on October 3, the two primary benchmarks – WTI (West Texas Intermediate) in New York and Brent in London declined 44.3% and 41.6%, respectively, through close of trade on December 24.
Those same market players note the largest single money source has been funding via Cyprus to Swiss and Dutch commodity holding companies, each one of which has either a controlling or significant Russian partner/owner.
Crude But Effective
Of greater interest is the corollary movement into derivative paper bridging the WTI and Brent futures themselves. In this secondary market, the spread between the two becomes more important than the nominal result. Consider it the commodities market version of betting the over/under in a football game. And here the object appears more to keep the forward pricing pressure artificially below market value than it is to establish any concrete trading position.
Now, there have certainly been underlying reasons why the market price of crude may have experienced pressure. However, it has been less the direction than the degree of the decline that is highly instructive.
There are two important points here. First, while running shorts on underlying oil contracts or arbitraging between paper barrels (futures contracts) and wet barrels (actual consignments in trade) have always been residual ways in which traders have generated near-term returns, there has not been an underlying justification for the degree and extension of these movements.
There are several ways in which this is demonstrated, but the most striking involves tracking the weighted options used by these manipulators to hedge risk. Unless the conclusion is made that the primary exercise is to depress the price for its own sake, these secondary moves make no sense.
That brings about the second point. Some time ago, I developed an algorithm used when advising private clients on the genuine market price for crude oil. It is designed to strip short plays, derivative moves, credit swaps and similar artificial machinations from the underlying market price.
Of course, what results from this exercise – determining what I subsequently labeled the Effective Crude Price (or ECP) – is another benchmark indicator. There are always aberrations from a “perfect market.” Once again, the usefulness is recognizing how much the actual quoted market price departs from the ECP.
What we have now is a wider distortion than at any time in the past 26 months (or as long as I have been running ECP calculations). As of close of trade on December 27, market prices are running some 18% (WTI) and 21% (Brent) lower than where the ECP says they should be.
The Russian thumbprint is all over this. As one of my veteran European trading colleagues told me last week,
“Your analysis is a substantial contribution to the conclusion [some of us] have already made. The Cyprus connection is another indication that Moscow wants to punish US and Saudi production.”
Another contact pointed out the obvious: “There is no reason to pursue a policy that will guarantee a lower return on investment unless other motives are afoot.”
Keep in mind a seminal ancillary point. If one can parallel these futures moves (the paper barrels and various paper cut on them) with the actual consignments of oil subject to trade (the wet barrels), you have an effective insurance against major loss. That can be done if the finance discussed here is connected to Swiss and Dutch trading houses controlling the actual oil.
In an unsettling recent development, anecdotal information has emerged pointing toward US-based participation in the Russian-Cyprus vehicle. The most disturbing element is the way this is apparently operating within the US system and how some of this may be used as collateral in non-energy American investments.
As such, this story is hardly over. This week’s trading may well telegraph how long the “Cyprus express” will chug along. I have another meeting in Nicosia upcoming. Perhaps we may simply dispense with the subterfuge and hold the parlay in Limassolgrad.