Monday, June 30, 2008

Speculation 101

(Herman Tiu Laurel / Infowars / Tribune column for 6-30-2008 MON)

“Oil speculators” and “speculation” have become household wonderments these days, yet few really understand what they mean and how they wreck the lives of people and nations, even the most powerful of countries like the USA. Here’s an attempt at a short course on the subject, where we immediately begin with the problem understanding the term “speculation.” One website gave out over 20 ways of understanding it, but we sum it up to 3. Market speculation is:

1) Taking large risks, especially with respect to trying to predict the future; gambling, in the hopes of making quick, large gains; 2) Speculation should not be considered purely a form of gambling, as speculators do make informed decisions before choosing to acquire the additional risks; 3) As speculation is deregulated, market speculation transforms to market manipulation when traders, financial agents and corrupt high level politicians connive.

In the third sense, risk is practically eliminated and windfall profits are guaranteed. Reading and explaining the plethora of discussion on oil manipulation has been difficult enough, but a useful summary of the article Oil Market Manipulation by Chris Cook guides us through the complex history and present reality of oil speculation:

“By way of a history, the ‘Brent 15 Day’ contract was a set of contract terms developed by Shell in the late 70's/early 80's which—unusually--allowed the resale of ‘Cargo –size’ parcels of crude oil produced by their North Sea Brent crude oil field… The purchase and sale of Dated Brent cargoes is as close as one gets to buying ‘Spot’ Brent crude oil on a market… Enter IPE (International Petroleum Exchange)… In the late 1980's, the IPE tried twice to introduce standardised, physically deliverable Brent Crude Oil futures contracts, and failed because of incompatibilities between the 1000 barrel contract size and the delivery size of 500,000 barrels… So the IPE introduced in the end a futures contract which was ‘cash settled’ on the expiry date some six weeks before the relevant contract month…against an ‘Index’ of the prices reported by market observers like Platts…

“Through the late 1990’s, the decline in Brent Crude Oil production was already causing problems, because market players would often try and ‘squeeze’ the market by buying up as many forward cargoes as they could, and then ‘squeezing’ financial players/traders, who had speculatively sold 15 Day contracts in respect of oil they did not have. Also during this period…new trading tools developed to enable market players to ‘hedge’ the price risk they had between the expiry of the IPE contract and the actual ‘Dated’ delivery…related to manipulation of the IPE contract daily settlement price. This was ‘micro’ (short term) manipulation, as distinct from major market medium term plays involving big trading positions, which I characterise as ‘macro’ manipulation. This ‘micro’ manipulation created losses for the traders ‘on-exchange’ which were more than offset by profits ‘off-exchange’…”

The article goes on: “Developments Post 2001…(on) Brent CFD’s (Contract for Differences)… Important developments in recent years to give rise to a BFO (Bunker Fuel Oil) complex, and a plethora of trading in the ICEFutures (Intercontinental Exchange) cash settled ‘BFO contract’ as it technically now is, and the re-jigged ‘BFO’ market itself. Brent/WTI (West Texas Intermediate), the physically deliverable WTI itself has become increasing irrelevant and during the last few years has essentially become an adjunct to Brent through a massive trading mechanism known as the Brent/WTI Arbitrage… Brent/WTI Arbitrage (in) 2001 and things have moved massively against Nymex since then, as a large part of WTI trading migrated to ICEFutures in London, following the ‘London exemption’ to CFTC (Commodity Futures Trading Commission, US) speculative position limits.”

After reading this dizzying gist, 2 things emerge--the migration of trading to the ICEFutures which had obtained exemption from CFTC regulation.

We fast forward to Cook’s narration of an actual case of manipulation: “The BP (British Petroleum)/Goldman (finance) complex…joined at the hip, both in governance terms--which is a matter of record (i.e. same Chairman, common Directors etc)--and in economic terms, both have made massive profits from energy trading… Structurally, BP (has) always…‘hedged’ (its) Forties (from an oil field of the same name) and…production using the IPE/ICEFutures contracts… Goldman, on the other hand, has long…invested in funds which are ‘invested’ in Brent and WTI contracts and ‘rolled over’ every month. Goldman’s trading arm J Aron has routinely ‘Date Raped’ these positions as they roll over…

“Date rape…Evolution of Manipulation - From Micro to Macro?… BP and Goldman’s ‘matched’ long/short Brent/BFO position has allowed them to act jointly as something of a fulcrum for manipulation. So that when one of them ‘bids up’ the market--the other will make matching profits…(and they) ‘wash trades’ (i.e. laundering trades) ‘off exchange.’ Both parties would then benefit from the fact that this artificially induced volatility made them profits on their ‘off-exchange’ dealings, e.g., they could sell options at overpriced premiums because the volatility was artificially high… In the early 2000’s we saw the entry of hedge funds--speculative money--into the market… What happened is that they (BP/Goldman) now make vast profits as counterparties for these hedge funds, utilizing sharing of superior market knowledge, and the positions held by speculators…”

How do we stop these oil market speculators? An article by Charles Biderman suggests the following: 1) regulate, the way the US Congress is now looking into tightening its oversight on oil trading; 2) raise margin requirements for oil futures traders to 25 percent from the current 7.5 percent, where they can put $10,000 to control $150,000 of oil; 3) require traders to disclose their total positions on all kinds of crude to know who is going long (expecting to profit in the long run through “shorting” the market in a big way); 4) for oil consuming nations like Japan, China, India and the US to make a concerted effort to burn the speculators by buying at the exchanges to deny them. The U.S. can temporarily cease its 70,000 barrels-daily increase (two million barrels monthly) to its strategic oil reserves, but that’s what I mean by “corrupt high level politicians” conniving with speculators--Bush is on their side!

...Our next column: How the Philippines can fight back

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