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News : US Economy Last Updated: May 26, 2011 - 8:25 AM


US charges oil traders with manipulation; 40% speculator premium on price of crude oil
By Michael Hennigan, Founder and Editor of Finfacts
May 25, 2011 - 5:08 AM

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Share of non-commercial/speculators in US oil futures market -- from Who is in the Oil Futures Market and How Has It Changed? (pdf)

US regulators on Tuesday charged oil traders with manipulation of the price of oil in 2008 during a period when the US benchmark rose over $147 a barrel. Separately, the speculator premium on a barrel of crude may be as much as 40%.

The Commodity Futures Trading Commission (CFTC) accused the traders of making more than $50m in early 2008 from a fraudulent scheme and the agency is seeking triple damages and disgorgement of gains, which could amount to up to $200m.

As alleged in the CFTC complaint, the defendants - - Parnon Energy Inc. (Parnon) of California, Arcadia Petroleum Ltd. (Arcadia Petroleum) of the United Kingdom, Arcadia Energy (Suisse) SA (Arcadia Suisse) of Switzerland, James T. Dyer of Australia and Nicholas J. Wildgoose of California - - traded futures and other contracts that were priced off the price of the US benchmark West Texas Intermediate light sweet crude oil (WTI). WTI is delivered to commercial users at Cushing, Oklahoma, a major crude oil delivery point. The price of WTI is a benchmark for a third of crude oil production around the world, and the supply of WTI at Cushing is an important driver of WTI price.

Early in 2008, supplies in Cushing were at their lowest level since 2004, at about 15m barrels, making them sensitive to signs of a shortage.

The CFTC says the defendants purchased large quantities of physical WTI crude oil during the relevant period, even though they did not have a commercial need for crude oil. They purchased the oil pursuant to their scheme to dominate and control the already tight supply at Cushing to manipulate the price of WTI upward and to profit from the corresponding increase in value of their WTI futures and options contracts (WTI Derivatives) on NYMEX (New York Mercantile Exchange) and Intercontinental Exchange (ICE).

Next, once WTI reached artificially high prices and they had taken profits from their long WTI Derivative position, defendants allegedly engaged in additional trading activity - - selling more WTI Derivatives short at the artificially high prices. Finally, defendants allegedly strategically sold off their physical holdings of WTI, mostly all on one day, to drive the WTI price back down and to profit from their short WTI Derivatives position. Pursuant to this manipulative cycle, driving the WTI price up and then back down, which they conducted in January and March 2008, and attempted in April 2008, defendants realized profits from their WTI Derivatives trading that exceeded $50m, according to the complaint.

Surge in speculators since 2000

The CFTC reported in early May that non-commercial/speculator purchasers of oil futures were at 68% in the preceding week compared to 32% of contracts for actual users of oil.

A policy paper in 2009 by Rice University’s Baker Institute for Public Policy shows a clear increase in the size and influence of noncommercial traders, or “speculators,” in the oil futures market since regulations were eased by the Commodities Futures Modernization Act of 2000. The authors said apeculators now constitute about 50% of those holding outstanding positions in the US oil futures market, compared with only about 20% prior to 2002. The report also finds that the correlation between oil and the dollar has strengthened significantly over the past several years.

The co-authors of Who is in the Oil Futures Market and How Has It Changed? (pdf) -- Kenneth Medlock and Amy Myers Jaffe -- advocate that the government should revise its policies to reverse these trends.

Using CFTC data, the authors state that the previous claims by the commission that speculation wasn’t influencing oil futures markets were based on inappropriate analysis. The authors present new evidence that speculative trading is playing an increasingly important role in the oil market.

They note that while the question of what has produced sharp swings in oil prices since 2005 is a complex one that requires further and deeper study, there are “inescapable facts” that need to be part of the debate about regulating the activities of institutions betting on movements in oil price purely for financial gain. Specifically, speculators, which the CFTC designates as any reportable trader who is not using futures contracts to hedge, have increased their footprint in the marketplace dramatically since the late 1990s.

Hedgers are typically producers and consumers of the physical commodity who use futures markets to offset price risk. By contrast, speculators seek profits by taking market positions to gain from changes in the commodity price, but are not involved in the physical receipt/delivery of the commodity.

While there were short windows of time before 2001 when the oil price and value of the dollar were correlated more strongly, a dramatic sustained period of high correlation emerged during the 2000s, according to the Baker Institute study. Given this new strong correlation, the authors note, the threat to the US economic health and national security is that the dollar risks getting caught in a vicious cycle where continually rising oil prices feed the US trade deficit, leading to increased US indebtedness and thereby an even weaker dollar, which further drives oil prices higher.

The authors conclude that new policies are needed. When oil prices started rising in 2007-08 from $65 per barrel to $125, governments around the world, including the United States, engaged in building strategic stockpiles. This policy signaled to oil-markets participants and the Organization of the Petroleum Exporting Countries that governments would not use strategic petroleum stocks to ease prices under any circumstances except major wartime supply shortfalls. This allowed speculators to confidently expand their exposure in oil market futures exchanges without fear of repercussions and revenue losses from a surprise release of US or International Energy Agency strategic oil stocks. “We need to re-evaluate our policies for how we utilize strategic oil stocks in light of the oil/dollar linkages,” said Jaffe. “Clearly, our government needs to fashion a better response.”

US banks such as Goldman Sachs, JP Morgan Chase and Morgan Stanley together with hedge funds are among the big speculators and we reported in 2009 that a Citi energy trader had personally made $100m in 2008 from the oil price spike.

CFTC commissioner Bart Chilton said on May 5: "There are now more speculative positions in commodity markets than ever before. The number of futures equivalent contracts held by these types of speculators increased 64% in energy contracts between June of 2008 and January of 2011.  In metals and agricultural contracts, those speculative positions increased roughly 20% or more."

Exxon Mobil CEO Rex Tillerson said in testimony before the Senate Finance Committee two weeks ago that current fundamentals and production costs would dictate oil in the range of $60 to $70 a barrel - - $43 below this year's WTI high of $113 a barrel reached in late April and early May.

At the current price of $99 a barrel, that would put the speculator premium at more that 40%.

Tillerson refused to comment on the role of speculators, saying only that the price of oil
"will be wherever it will be."

Goldman Sachs' estimates in March indicated that the total speculative premium in US crude oil was between $21.40 and $26.75 a barrel, or about a fifth of the price.

Kevin G. Hall and Robert A. Rankin of McClatchy Newspapers recently wrote: "There is no shortage of oil stocks by historical standards. There's an estimated 3m to 4m barrels per day (bpd) of excess oil production capacity in the world today. That's much more than when supplies were tight in 2008.

US oil production, too, continues to grow. It rose from 4.95m bpd in 2008 to 5.36m bpd in 2009, followed by 5.5m bpd last year - even with the BP disaster in the Gulf of Mexico. The Energy Information Administration forecasts US production to hold at that level this year and rise again next year, to 5.54m bpd.

US crude oil stocks on April 29, the date oil peaked this year above $113 a barrel, stood at 1.768 billion barrels, according to the EIA. That's about 700,000 barrels more than in July 2008, when oil prices hit all-time highs.

And that's plenty to meet US needs, because consumption isn't growing.

The US consumed 20.68m barrels per day in 2007. Then came the financial crisis, and consumption dipped to 19.5m bpd in 2008. Last year the number was 19.5m bpd. This year's projection is 19.28m bpd.

So if supplies are plentiful and consumer demand isn't rising, why are prices?"

CFTC commissioner Chilton recently said that there is now proof that "one trader held over 40% of the silver market."

As to why there isn't greater urgency to address the issue of rising speculation, Commissioner Chilton commented on May 5: "Recently, a bill was introduced in the House of Representatives to delay the new (financial industry) rules for 18 months -  - after the next presidential election, which I don't think is a coincidence. Washington can be forgetful, but this seems like advantageous amnesia. Remember, the crisis was avoidable and another one will be avoidable if we get in gear and get this law implemented.

Part of the reason for the reticence among some could have something to do with money.  It was just announced late last month that the financial industry spent more money lobbying in the first quarter of this year than it did in the first quarter of 2010—when the bill was being debated on the Hill.  There are 10 financial service sector lobbyists for each Member of Congress. Those forces and that money are now also directed at regulators.  It tells you why there’s a swarm of lobbyists and others in the lobby of our building every morning, replaced by a different swarm by noon and another in the afternoon.  I’ve said often that we want to hear from people as we implement the new law, and I do, for sure.  However, I don’t have much patience for those who come in and tell us how to exclude them or delay the rules."

Getting Speculators Out of Oil?

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