Oil Speculator Revealed?

[Leonidas]

For the last two years I have been very curious about what has been driving the price of oil. I’ve made a lot of money on oil industry stocks during that time, but the rapid rise in the price of crude never made sense to me. It did not make any sense to claim that the prices were due to the normal market forces.

Everybody that showed up at the market to buy oil found plenty; they just had to pay more every time they went shopping.

I blamed manipulation from speculators who were masquerading as normal commercial market participants. Somebody was out there playing games and doing underhanded and probably illegal things to make a lot of money.

This June, the Commodity Futures Trading Commission, the Federal Reserve, the Securities and Exchange Commission, the Treasury and the departments of energy and agriculture formed a committee/task force to study the dramatic rise in commodities. They would look at supply and demand factors, trader activities, and what impact some of the new traders (i.e., index funds and speculators) had on prices.

Last month the Interagency Task Force on Commodity Markets released an interim report and said, ” …it found that fundamental supply and demand factors provide the best explanation for the recent crude oil price increases.” At the time I was mystified and stupefied at those remarks.

But now it seems that maybe that was not the case after all.

Regulators had long classified a private Swiss energy conglomerate called Vitol as a trader that primarily helped industrial firms that needed oil to run their businesses.

But when the Commodity Futures Trading Commission examined Vitol's books last month, it found that the firm was in fact more of a speculator, holding oil contracts as a profit-making investment rather than a means of lining up the actual delivery of fuel. Even more surprising to the commodities markets was the massive size of Vitol's portfolio -- at one point in July, the firm held 11 percent of all the oil contracts on the regulated New York Mercantile Exchange.

The discovery revealed how an individual financial player had gained enormous sway over the oil market without the knowledge of regulators. Other CFTC data showed that a significant amount of trading activity was concentrated in the hands of just a few speculators.

Vitol popped up on my radar screen a few months ago when I read an article about a Houston based trader for Vitol who was making what some competitors thought were some very strange trades.

I found the quote I remembered:

We just watched, thinking they were going to get run over…To a bystander it looked crazy.

The trades in question, made by Vitol Capital Management’s Andrew Serotta, made a couple of hundred million in profit. Vitol felt indignant and wrote a letter to the editor:

Contrary to your statements, Mr. Serotta has never visited the Geneva office, and he does not take speculative oil positions, an activity that is inconsistent with Vitol Capital Management’s policies. The trading activity and profits attributed to Mr. Serotta as stated in your article are based on faulty assumptions and are entirely inaccurate.

Vitol is not in the business of taking large positions speculating on the rise or fall of market prices, and Mr. Serotta did not trade speculatively on the direction of crude oil prices. Vitol’s business model includes moving physical oil in the global market, identifying global arbitrages in location, timing and quality, and using sophisticated hedging to manage market risk.

Representative Paul Dingell thinks the CFTC was asleep at the wheel.

It is now evident that speculators in the energy futures markets play a much larger role than previously thought, and it is now even harder to accept the agency's laughable assertion that excessive speculation has not contributed to rising energy prices.

The WSJ and Washington Post ran this story last week, and while the CFTC did not name Vitol as the speculator they caught playing games, the WSJ and Post both claim they learned the identity from unnamed sources with inside knowledge of the investigation.

What did Vitol do? They sold off their refinery, which weakens their case that they are a normal commercial market participant in the crude futures market, and then busily set about buying oil for what appears to be purely speculative reasons. All done while still claiming to be a commercial participant, and thus dodging a lot of regulations – like how much they can buy on margin.

The commission investigation showed Vitol was one of the most active traders of oil on Nymex as prices reached record levels.

By June 6, Vitol had amassed contracts equal to 57.7 million barrels of oil, about three times the amount the United States consumes daily. On that day, the price for a barrel of oil spiked $11 to settle at $138.54, per barrel, valuing Vitol's oil holding at nearly $8 billion…The commission's data show that at the end of July, just four swap dealers held one-third of all Nymex oil contracts that bet prices would increase.

And then there is the quote that I really love:

Last month, the commission reclassified a huge oil trader as a noncommercial speculator. Industry analysts immediately began to rethink what might be moving oil prices. (emphasis added)

Makes me wonder what the analysts have been analyzing.

Vitol is denying all of this and claims that the CFTC has not changed their trading status, and that they are not speculators. Okay…

Vitol is a sweetheart of a company. They were involved up to their Swiss necks in the back door rearmament program that Saddam Hussein had the UN running for him (Oil for Food). They pled guilty to grand larceny in a New York court last year and paid a $17m fine for their “…scheme to pay secret kickbacks to the Iraqi government in exchange for oil under the United Nations' scandal-ridden oil-for-food program.”

They also paid $1M to a Serbian warlord to “convince” a Serb businessman to pay for oil shipped to him under a slightly shady, and perhaps illegal, contract that took place just before the war. The businessman thought Vitol screwed him and sued the company to keep the oil they had shipped before the war. Vitol never accepted the deal, and according to the UK Guardian / Observer, hired some guy named “Arkan” to have a little conversation with the man. The guy paid up, but the circumstances were something out The Godfather.

The Observer has established that Vitol used Arkan to 'persuade' Dragovic to pay up. Contacts in Serbia set up a meeting at Arkan's house on 10 April 1996 attended by Finch, Dragovic and Arkan and his henchmen.

Asked how he was introduced to the former bank robber, who was known at the time to have committed atrocities in Croatia and Bosnia, Finch said: 'We do have local people in Belgrade... They said, "Go there. Meet the man. It can be sorted out." And, to be honest, it was sorted.'

Although it was not until 1997 Arkan was indicted by the UN war crimes tribunal in The Hague for crimes against humanity, his brutality was well documented when Finch met him in 1995.

His band of paramilitaries, the Tigers, were the most feared unit of the Serbian murder machine. He was known as the butcher of Vukovar after ordering the shooting in cold blood of 250 patients and staff his unit had taken from a hospital.

By April 1996, Arkan had become one of Serbia's richest men after amassing a fortune from the currency black market, arms dealing and oil smuggling.

The truth really is stranger than fiction.

Anyway, that's the story and I guess we will have to wait until after the conventions and when Congress gets around to going back to work before we get more details.

 

[cute fuzzy bunny]

Pretty amazing stuff.

However, I think its pretty easy to figure out that when the price of something triples in a little more than a year without a shortage of any kind, that there was considerable speculation involved.

I'll bet that $17M fine really stung :

 

[FUEGO]

I'm curious as to why the free market didn't "fix" the speculation "problem" (or maybe a fix is underway and we are seeing that unfold now). Why didn't Big Oil go in and sell like crazy on the futures market to lock in profits? They could have reasonably predicted their marginal cost of production (maybe $40 a barrel?). Why not sell futures at $130 and $140 a barrel and guarantee yourself a huge profit? Sure, it might hit $200 and you sell yourself a little short, but it is a risk if you don't lock it in. Was Big Oil (or other market participants) afraid to start selling and maybe force the price down and destroy the upwards momentum?

It just doesn't make sense to me. If I'm thinking about spending mega billions on a proven new oil sands mine or deep sea well, why not go ahead and book the future oil production at a guaranteed huge profit margin?

 

[Leonidas]

However, I think its pretty easy to figure out that when the price of something triples in a little more than a year without a shortage of any kind, that there was considerable speculation involved.

There were plenty of people saying it was all due to a)normal market activity reflecting supply and demand, and/or b)"PEAK OIL - WE'RE ALL GOING TO DIE IN THE DARK!"

A few of them here on this board. I won't mention names though, that would be unseemly.

 

[MasterBlaster]

So you want someone to blame as to why you had to shell out more than you were used to for ole' Betsy...

Keep in mind that it wasn't just oil but pretty much every commodity that was going through the roof. I have no dought that speculators played their part in this bubble. Also note that some of them have bet wrong recently and have paid the price. These bubbles have a way of working themselves out.

Also keep in mind that there are absolutely no (reliable) statistics on either worldwide oil production or of worldwide oil consumption. Therefore rumor and heard mentality drive these markets. If the rumor is that there is a shortage then the markets react as such regardless of reality.

Perhaps the low price of oil and gasoline that we had until recently can be directly attributed to the high(er) prices that we are seeing now. Low prices induce underinvestment in the oil-patch and vice-versa. There is no natural price of oil. It's only worth what buyers and sellers can agree upon. If you think that the price is too high then you can either buy less or buy none at all for Ole' Betsy. It's your choice.

here is an article in Business Week commenting on why speculators actually serve the market.
In Praise of Oil Speculation

God forbid the government steps in to help. That's the last thing we need.

 

[haha]

There were plenty of people saying it was all due to a)normal market activity reflecting supply and demand, and/or b)"PEAK OIL - WE'RE ALL GOING TO DIE IN THE DARK!"

A few of them here on this board. I won't mention names though, that would be unseemly.

The Fat Lady has not yet sung.

Ha

 

[FIRE'd@51]

There is a position limit of 20,000 crude oil contracts on the NYMEX. That would be equivalent to 20 million barrels. How was Vitol able to get around the position limits? Are you saying they were exempt from position limits because they were considered a commercial dealer?

 

[tryan]

Amaranth had lost roughly $4.35B over a 3-week period or one half of its assets due to its activities in natural gas futures and options in September.

SSRN-Natural Gas Futures and Spread Position Risk: Lessons from the Collapse of Amaranth Advisors L.L.C. by Ludwig Chincarini

These speculators are "good" until the market corrects for the trading scheme ... My quess is Vitol will become extinct like Amaranth. You can only hit homeruns for so long.

 

[Leonidas]

There is a position limit of 20,000 crude oil contracts on the NYMEX. That would be equivalent to 20 million barrels. How was Vitol able to get around the position limits? Are you saying they were exempt from position limits because they were considered a commercial dealer?

Good question. Most physical delivery and many financial futures and option contracts have position limits for speculative trades. But a market participant who is classified as a bona fide commercial hedger is exempt. 7USC6a(c):

No rule, regulation, or order issued under subsection (a) of this section shall apply to transactions or positions which are shown to be bona fide hedging transactions or positions as such terms shall be defined by the Commission by rule, regulation, or order consistent with the purposes of this chapter. Such terms may be defined to permit producers, purchasers, sellers, middlemen, and users of a commodity or a product derived therefrom to hedge their legitimate anticipated business needs for that period of time into the future for which an appropriate futures contract is open and available on an exchange.

It goes on later to include brokers and other agents acting on behalf of such commercial participants. Vitol claims that it’s not them in the first place and they are in fact acting as an agent for bona fide commercial participants. I do know that Vitol has had physical storage and refining facilities in the past, and I have read some conflicting reports about sales of those facilities. Some stories say they have no physical exposure to crude while others say it is limited to storage.

And I’m not picking on Vitol, because it could turn out that the WSJ and WP got it wrong. I’m just pointing out how I think the markets have been poorly regulated and how some traders have manipulated the markets to drive prices up way past what the supply and demand structure would have.

The definition of who is a legitimate hedger and who is a pure speculator has been slipping for years now. The so-called Enron Loophole and relaxation of other standards has allowed a lot of speculative trading to come in under the guise of legitimate hedging. In the last two years, the NYMEX granted 100 plus hedging exemptions to swap traders who had nebulous claims to being hedgers. Plus, the access to dark markets allows speculators, and speculators pretending to be hedgers, to trade on the NYMEX via the ICE futures market with zero visibility.

What I found interesting is that concurrent with Congress pressuring the CFTC to better regulate the market, the CFTC ran around to the foreign markets asking for position limits to be placed on WTI crude trades. I know that the ICE and the Dubai exchange agreed to impose position limits within the last month to month and a half. Just about the time that crude prices started taking that downward slide.

The Fat Lady has not yet sung.

My reaction to that is to ask if you have tickets for just the one opera, or do you have a season’s subscription?

I’ve been consistent in saying that it looks like demand will outpace supply in the future, and at that point crude prices will be driven up by those forces. But when every refiner buying in the market says “we are not having any problems buying oil”, there is no shortage.

So you want someone to blame as to why you had to shell out more than you were used to for ole' Betsy...

I have to know, what did you read in my original post that made you think my interest here had anything to do with how much I pay for gas? This is about the markets we invest in and what happens to the economy when a vital commodity is subject to radical price increases that are at least partly the result of manipulation. It’s not about personal elasticity in regard to the commodity; it’s about the effect that a manipulated market has across broad areas of the economy.

In regard to the rest of your post, your comments about speculation would be valid in many markets. But crude oil trading is a market that is one in which “excessive speculation …may cause sudden or unreasonable fluctuations or unwarranted changes in the price of such commodity."

There is nothing wrong with speculation, and it is present in any efficient market. It has always been present in crude trading. But speculators who had no use for the physical commodity were not given the advantages that have been afforded to commercial participants who have a use for the commodity. It’s one thing to be a participant and take a hedge, or to be an agent acting on behalf of a commercial participant, and it’s something different to be solely motivated by profit in the commodity. When the speculators masquerade as hedgers and are allowed to take trade without restrictions on position limits or margin limits, they can exert excessive moves in the market that are gross exaggerations of moves that market conditions would normally create.

When you have companies like MS or Vitol that are hiding their speculative positions, and in the case of MS (at least) holding the physical commodity in storage, how can it be anything less than manipulative when they give statements to the media like "Oil is going to $200 before the end of Summer"? They control more of the commodity than they should be allowed to, are part of the dominant group in the market that shares their speculative interests, are hiding their intent and holdings, and they have nearly unfettered access to the media.

The market ran just fine for years with the old restrictions in place and being enforced. It was only after the government loosened the restrictions and created loopholes that all the new participants came in and created the current situation.

 

[Finance Dave]

I'm curious as to why the free market didn't "fix" the speculation "problem" (or maybe a fix is underway and we are seeing that unfold now). Why didn't Big Oil go in and sell like crazy on the futures market to lock in profits? They could have reasonably predicted their marginal cost of production (maybe $40 a barrel?). Why not sell futures at $130 and $140 a barrel and guarantee yourself a huge profit? Sure, it might hit $200 and you sell yourself a little short, but it is a risk if you don't lock it in. Was Big Oil (or other market participants) afraid to start selling and maybe force the price down and destroy the upwards momentum?

It just doesn't make sense to me. If I'm thinking about spending mega billions on a proven new oil sands mine or deep sea well, why not go ahead and book the future oil production at a guaranteed huge profit margin?

This is an excellent post, and one I've been talking about to friends. I'm no expert on speculation, but I do understand commodity hedging...our company does it and I work in the Treasury group that does the actual hedges.

I'd first like to point out that hedging is completely different than speculation...our company does NOT speculate. And the commodities we are involved with are not oil...for us it is certain metals.

But back to your point, I think the market WILL take care of this in due time. At some point the speculation will end, and the whole thing will come crashing down (I don't mean the price...I mean this underground story of speculation).

What would cause this to happen? Anything that has a major affect on either decreasing the price of oil or increasing the quantity available. For example, if someone figures out this hydrogen fuel cell car and we stop needing oil...watch out. Gasoline prices will start to come down, the speculators will worry and start liquidating (pun intended) their positions, and this will trigger a massive price drop in oil. Another example? Let's say there's a huge find of easy oil in Canada that would increase supply by 10% within a year...that would also do it.

I think it's already started to happen somewhat...but not yet on enough of a grand scale. Gasoline has dropped from about $4.30 here to about $3.70....quite significant. I doubt we'll ever see $1.90/gallon again...but I think it's possible (note that I did not say likely) that we'll see $3.00 again.

Edit: regarding your point about big oil not buying/selling futures, I'm guessing that the reason they don't is that it's not their business model to speculate on oil. Publicly traded companies must be accountable to the shareholders, and I'm sure the shareholders want them extracting/producing/distributing/transporting/refining oil...not betting on whether the price of it would go up/down. If they started doing as you describe, these "positions" would show up in their financial statements, the analysts would easily figure out what they were, and shareholders would vote the Board of Directors out immediately IMO.

Dave

 

[FinanceDude]

Edit: regarding your point about big oil not buying/selling futures, I'm guessing that the reason they don't is that it's not their business model to speculate on oil. Publicly traded companies must be accountable to the shareholders, and I'm sure the shareholders want them extracting/producing/distributing/transporting/refining oil...not betting on whether the price of it would go up/down. If they started doing as you describe, these "positions" would show up in their financial statements, the analysts would easily figure out what they were, and shareholders would vote the Board of Directors out immediately IMO.
Dave

Spot on. BP and Exxon shareholders want them to pump, refine, and distribute as much petroleum products as they can as fast as they can. They are NOT end-users like the airlines are........

 

[haha]

Edit: regarding your point about big oil not buying/selling futures, I'm guessing that the reason they don't is that it's not their business model to speculate on oil.

I must have missed that. Could you point me to it?

BTW, I would be amazed if some of "big oil" companies do not sell crude and or product forward. This would not be speculation, it would be hedging just like a farmer selling corn forward to hedge his crop in the field.

Of course some integrated oil companies are more or less naturally hedged, as they are both consumers and producers of crude. Still, plenty of reason to sell product forward to hedge same in inventory.

Ha

 

[FUEGO]

BTW, I would be amazed if some of "big oil" companies do not sell crude and or product forward. This would not be speculation, it would be heging just like a farmer selling corn forward to hedge his crop in the field.

Of course some integrated oil companies are more or less naturally hedged, as they are both consumers and producers of crude. Still, plenty of reason to sell product forward to hedge same in inventory.

You are getting at what I'm questioning. For net sellers of oil, why not sell like crazy on the futures market (while the selling is good). If I can develop a field (traditional oil or sands) with costs of production way less than the current forward prices, why not lock in huge profits on at least some of that future production today. I, as a shareholder, would love to know that my company is essentially guaranteed to be able to sell a barrel of oil that cost them $40 to produce at a forward price of $120 a barrel in a few years. This type of hedging would take a lot of risk out of new ventures to get more production capacity and not put big oil producers at risk of pricing approaching $0 per barrel in an oil glut which seems to happen periodically. It just seems like prudent risk management to me.

This type of forward selling of a future stream of production isn't speculating at all.

 

[cute fuzzy bunny]

I think the answer is "because the price just might go up some more!".

 

[FUEGO]

I think the answer is "because the price just might go up some more!".

That darn greedy Big Oil! 200% gross profit just isn't enough. Why not hope for $160 a barrel and get a 300% gross profit!

Given the highly inelastic demand for gas/oil, it sounds like a plan to me!

 

[cute fuzzy bunny]

Well heck, they can just let it sit in the ground until the price gets to where they want it to be, right?

 

[Art G]

Hmmmmmm, a huge hedge fund type company manipulating the market? Who could ever see that coming? .....oh yeah, it was me.

 

[haha]

This type of forward selling of a future stream of production isn't speculating at all.

Not only that, it is SOP. For explorer/producers who must be borrowing all the time, the lenders usually insist that at least some production is sold forward at a price that will service the loan.

Ha

 

[FUEGO]

Not only that, it is SOP. For explorer/producers who must be borrowing all the time, the lenders usually insist that at least some production is sold forward at a price that will service the loan.

That's good to hear. Something that makes "sense".

 

[headingout]

Don't many of the precious metals mining companies sell some production forward? Why would their business model would be so different from big oil?

 

[haha]

Don't many of the precious metals mining companies sell some production forward? Why would their business model would be so different from big oil?

Many of the large oil companies have more refining and marketing capacity then they have production, so they are net buyers of crude. They might be natural buyers of forward contracts, not sellers. It depends on production vs refining capacity.

I can't say what the integrated companies actually do, because I don't own any and so don't read their filings or listen to their webcasts. My guess would be that they are all different in how they approach this.

Ha