Oil Speculation part 2

To continue the previous post, some commentators have suggested that the run up is not just speculation, but deliberate market manipulation. This overheated post by Philip Davis compares these manipulations to previous manipulations, such as those by Enron in the California power market.

Just ponder that those 378,974 contracts were traded on the NYMEX today 425,099 times. That’s a churn rate of 115%! The net change in price was 1% and the net change in open interest was less than 1%. What would you think of a stock or option contract where the entire float turned over in one day? This is what goes on EVERY SINGLE DAY at the NYMEX. 425,099,000 barrels of oil were traded yesterday, readily available to any trader who wants them delivered in July, with another 136,725,000 August barrels traded and another 73,297,000 September delivery contracts written, yet in not one of those months will more than 42M barrels ever be delivered because that is the transfer capacity at Cushing, OK.

(I think Phil needs to understand that while the contract specifies delivery at a particular place--in this case Cushing, OK, actual delivery usually takes place elsewhere. In fact, there are contracts you can use to hedge basis risk--in this case, the difference in cost if you have to take delivery of your oil in some place other than Cushing, OK. Since obviously, not all oil--not even most--is delivered to Cushing. But Cushing is used so that the contract will be standard for everyone.)

So the ENTIRE thing is a joke. People are ordering barrels they don’t want with contracts written for a place that will never accept delivery AND, if anything actually happens to disrupt supply, there is a loophole called "Force Majeure" which allows the contracts to be cancelled by the shipper due to "supply disruptions" so they are not even buying insurance. The only thing they are insuring is that they will bleed you dry by forcing you to pay $130 a barrel for something that has a global average production cost of $42 a barrel.

This is nothing less than the single largest con in human history and your "reliable sources" are a government that was elected thanks to hundreds of millions of Petrodollars of campaign contributions and a media that is owned by companies that either are energy companies or accept millions of dollars from energy companies. The 30M barrels of oil that were actually accepted for delivery in July set someone back $4Bn, that sounds like a lot until you realize that that $4Bn locked in a price increase of $25 a barrel during the month of May x 85Mb a day worldwide or $65Bn bonus dollars paid to the same people who are churning oil contracts in the pits.

What if you had 15 shares of IBM at $100 and the price of the last trade on June 24th will set the price you can sell IBM for in July. What if you could buy that last contract for $150 and that would let you sell the ones you are already holding for $150. You would spend $50 extra for a single contract but would collect $50 more on the 15 you have for a net profit of $7,450! Would you do it? Do you know anyone who would? Do you think no one would? That’s how the NYMEX works. Those 30M barrels that are "accepted" at the contract close determine the price of the 85M barrels PER day that are delivered for the 31 days of May. That’s 2,635 barrels over 30 or 1/87th.

This is how you are being ripped off, this is how the manipulation operates, this is the only reason that oil is over $70. There is no shortage, there is no great demand, there is just a greedy cadre of immoral people who manipulate a system that costs the American people $500Bn a year (the premium we’re paying over $70) just so they can skim a few million for themselves.

Whew. Phil, take a valium. But even though he is an options trader and financial adviser, he doesn't seem to know much about oil trading. It's hard to take his fulminations seriously.

But... It now turns out that the Commodity Futures Trading Commission has been secretly investigating market manipulations for several months.

Federal regulators — in a highly unusual move — revealed today that they have been conducting a wide-ranging probe into oil trading practices for the last six months.

And in response to growing concerns about the role speculators may be playing in driving up oil prices, the Commodity Futures Trading Commission said it will require energy traders to begin providing more information so the government can better assess what effect they may be having on the markets.

Platts gives more detail:

Among the CFTC initiatives is an agreement with the UK Financial Services Authority and ICE Futures Europe to enhance information-sharing between the two agencies for energy commodities, including the West Texas Intermediate crude oil futures contract, which trades on UK-regulated ICE Futures Europe and settles off the traditional NYMEX crude oil contract.

So maybe greater transparency and some threat of government intervention (like jail for manipulators?) will change things. The big question, though, is what can the CFTC do about OTC contracts, which are not regulated?

One final thought to leave you with. If you are worried about oil manipulation, what is the craziest, most horrific solution you could think of? I think I found it, courtesy of Martin Hutchinson. Take it away Martin!

We could invade somewhere. […] The obvious place to invade is Venezuela (even if current estimates of Venezuelan and Saudi reserves are wrong and there is in reality more oil in Saudi Arabia that could be unlocked if ExxonMobil and the boys were given free rein, the Saudis are nominally our allies, so an invasion would be considered unsporting by world opinion.) Since the 1.8 trillion barrels of Venezuelan oil deposits consist largely of the Orinoco tar sands, a Venezuelan oil-related invasion would impose an additional requirement: to keep the environmentalists away, in order that reserves could be exploited with maximum efficiency.

Well, whatever happens, I assume the grown-ups--and not the Martin Hutchinsons of the world--will be making the decisions.