Boil in Oil $$$

[AnnaDub]

By Tim O’Shei

HOUSTON BUSINESS JOURNAL | Friday, Apr 8th 2011

Who controls the global oil prices?

Powerful banks? Massive hedge funds? Big Oil? OPEC?

There’s never been a straight answer to that question – until now.

Leah McGrath Goodman, a former special writer and editor for The Wall Street Journal and 1998 graduate of St. Bonaventure University, spent the last seven years writing a book that reveals where oil prices have been set for decades: the New York Mercantile Exchange. Or, as the title of Goodman’s book calls it, “The Asylum.”

Published this year by William Morrow/HarperCollins, “The Asylum” takes readers into the boardroom and onto the trading floor of Nymex. Goodman paints a warts-and-all portrait of the often rough-edged traders, for whom she claims making or losing millions in a day was as commonplace as fistfights, drugs and pornography.

By executing both their own deals for oil contracts and orders from big banks and hedge funds, the Nymex traders set the benchmark for global oil pricing. They still do, though Nymex is now part of a group that includes its former competitor, the Chicago Mercantile Exchange, and most of the trading action happens online rather than on the floor.

Business First Managing Editor Tim O’Shei, a classmate of Goodman’s at St. Bonaventure, recently talked to her about the book and about the oil market. Following is a truncated version of that conversation:

[apifxonm85]

What’s your overall take on Wall Street and the oil market’s effect on the country today?

Goodman: The underlying problem in the oil market and in the broader market in this country is that ordinary Americans are now seen as a resource to be exploited by those who are in power – the wealthy and those with political influence. We’re seeing Washington and Wall Street working so closely together that you really can’t tell the difference between them anymore. The figureheads of each like to go back and forth between both locations, picking jobs, then switching and going back again. The government officials we are trusting and paying to look out for Americans are using those positions to get really nice, high-paying jobs in private-sector places, including Wall Street, that are effectively being used as bribes. It’s a problem, and it is obvious that it’s a threat to the long-term prosperity of this nation.

Let me put it this way: If you can imagine a country where the rich and the influential have managed to take over pretty much every last power center, can you imagine a situation different than the one we see here in the U.S. today?

The Asylum has several examples of that, but what really stuck in my mind were some of the crazy things – the drugs, sex, gambling – that you describe happening on and near the Nymex trading floor. The charges are explosive. What kind of reaction have you been getting?

Goodman: There has been no denying of how bad things are in terms of the traders and their behavior. There has been a lot of incredulity over who controls the market for oil itself. I saw someone wrote on the Amazon page that Nymex wasn’t really the market that calls the shots on oil, anyway, that everyone knows oil prices are controlled by OPEC and the banks and the oil companies and the hedge funds. These guys just pushed the orders through and had no idea what was going on. While it’s true that banks, oil companies and hedge funds now dominate the market, the Nymex traders handled almost all the orders and traded right alongside them, generating huge volumes. The idea that they had no idea what was afoot is a perception a lot of people have been enjoying putting out there. Because if you’re going to accept that these people were running the show, then you have to have a conversation about how we can have politicians and important, key figures in the city of New York visit this trading floor, and nobody ever said, “Maybe we shouldn’t have people doing drugs and bringing strippers and drinking alcohol while trading the benchmark global oil contract.” People would actually have to assume responsibility for what took place. And that’s out of the question. It’s more, “Oh, they weren’t running it anyway.” But they were running it.

I can see where people get confused. The long-held belief is that oil and gas prices are controlled by Big Oil, OPEC, banks and hedge funds and the like. But you make it pretty clear that the traders, who were executing the deals for big clients, could also make their own bets on the floor – and time them around massive trades from big players.

Goodman: At the end of the day, it was the traders in the pit who decided how everything was going to go down. My book tells what, exactly, took place behind closed doors in the traders’ own words, as Americans struggled to come to grips with rising oil and gas prices. It is all true. The traders talk openly about how they could arrange things around [big trader orders] so they could benefit. That happened frequently. The traders would take big orders from big players and get the best of them as a way to profit.

What kinds of reactions have you gotten from people you wrote about in the book?

Goodman: When you’re a trader who works in a place for decades where the inconceivable and outrageous is commonplace – and there is no one to tell it to who will believe you – there is a need by those subjected to the situation to talk about it in an almost confessional way. For many of the traders, market executives and government officials featured in the book, the telling of their personal stories was a cathartic experience. Some of them made huge fortunes while others were treated horribly. And the reasons for their respective fates didn’t always have much to do with whether or not they truly deserved them. Interviewing these people could be an emotional experience, for me and for them. It is no small thing to look someone in the eye, hear their story in their words and then go home, sit at your desk and render it as best you can. There is a lot of agonizing over the details and last-minute meetings and phone calls. You do not necessarily have an attachment to the person you are writing about – although you often do – but you feel a strong affinity for and loyalty to the integrity of his or her story. That said, the reactions have been a real mixed bag. Interestingly, I have heard from traders from the New York Stock Exchange and the American Stock Exchange who have told me, “This could have been a book about what we did in the stock market.” I’m not sure if that’s supposed to be reassuring, but it says a lot about the New York attitude toward running the markets. I have noticed the Amazon page for my book is essentially a lot of arguing among the readers and the oil traders. Some of it looks just terrible, but clearly this is an emotional subject for many. Some traders have called me to unload vitriol, while others have called to express their thanks. One pit trader wrote to me: “At last, someone who is not afraid to tell the truth.” Another trader, who I won’t name, rang me up throughout the entire writing of the book saying things like, “Am I going to have to wring your neck like a chicken?” I have fielded no few physical and legal threats. Thankfully, I live in a private, gated compound that is known for its surveillance and pit bulls.

Most trading now happens online. Can traders still time their trades in a way that benefits them personally?

Goodman: Can a trader still do that? Absolutely. It’s not considered to be legal within the rules of the market. If you’re caught doing things like that, you can be punished. The problem is technology has been moving so quickly – trading can be done now in milliseconds – that it’s pretty hard to catch people doing something.

If Washington were inclined to do something, what could be done?

Goodman: If members of Congress were of the mind to do something – and they’re not – they already know precisely what they can do. Traders are allowed to make very large bets with almost no money down. Right now in the oil market, for example, you can put about 5 to 10 percent down on a billion-dollar trade, which is going to have a huge effect on the price, and this is already a very fragile market. If there was a rule that said you have to put 30 or 40 percent down to do a trade, traders would think a lot harder before jumping in. The market would automatically reign itself in. People don’t like to put cash down for anything.

Wall Street has made it clear to Congress that having to put more money down to do trading is considered the nuclear option. That’s why it hasn’t happened yet.

What effect will the nuclear issue in Japan have on oil prices?

Goodman: All of these things are bad in terms of lessening our dependence on oil. As a child, I remember Chernobyl. I remember how that felt – this horrible dread toward the entire subject, and that never quite went away. This country has had a real aversion toward dipping our toe into the nuclear power pool, whereas France has given it a central role in its energy portfolio. Japan will only re-trigger all those fears about nuclear power that have been dormant in us for the past two decades. I don’t think that’s going to be good for nuclear development in this country, which means we’re going to need other things to offset it.

What about the unrest in Libya?

Goodman: Libya produces about 1.6 million barrels of oil a day, and oil fields have been threatened by the conflict. Yet in Libya they are paying 54 cents a gallon right now for gasoline. Which is very interesting. It shows oil countries are charging their own citizens much less than they are charging us. And it looks like Americans are okay with that. Or at least our nation’s key decision-makers are. In the U.S., we don’t have an oil shortage, but there’s a heightened fear that’s not going away, because oil demand is going up again on a global scale and the world doesn’t have the ability to ramp up production as quickly as demand is capable of spiking. Even though Libya itself is not really the bottom line, every last drop is seen as something that really counts -and everyone who is active in this market is busily counting it.

Both Japan and Libya are not good in terms of bringing down oil prices. It’s only going to make us more nervous, more obsessive about oil — how much we have, and how much more we’re going to get before it runs out.

[amopabila]

Thanks for sharing.

I've been saying the same thing for years on these very forums. The driver of ever increasing commodity costs, or specifically the volatility, is not so much emerging markets as the popular media wants you to believe, but instead it is leverage.

Wall St is addicted to leverage like it's crack cocaine. One need look no further than the record correlation in the equities market over the last couple years as Wall St tries to recapitalize after losing its shirt in 2008-09. Stocks no longer trade as representatives of individual companies. Instead stocks trade in baskets as representatives of an asset class. This is because the big boys, the hedge funds, the high frequency trading outfits, and Goldman and JPMorgan are trading equity index futures because of the leverage it allows them. Buying index futures is akin to buying proportionate shares in the underlying stocks which in turn explains the record correlation among individual stocks.

Problem is, before Wall St started almost exclusively using index futures for their equity trades they first feasted their eyes on commodity futures where a 100K dollar contract for crude oil can be purchased for less than 5,000 dollars (over 20:1 leverage). Crude oil is simply the vehicle of choice for the speculators because of the BRIC story being peddled to the public but this speculation and leverage has driven up the cost of everything from corn and wheat to lean hogs and soy beans.

The common denominator in all of these markets is leverage. Wall St loves its leverage. Buying a single stock or a handful of stocks with cash and buying and holding is a fools game for the common folk like you and me. We exist only to be fleeced in their eyes. These vultures are not investors but instead they are manipulators looking to scam the public in inelastic assets.

The answer is simple and the article above states it as have I in the past. The CFTC and the exchanges themselves have clearly shown they have no interest in fixing the problem so we must all urge Congress to act. What I'm referring to is eliminating the leverage appeal. These markets should be reduced to a 50% cash deposit (2:1 leverage) just like exists when you buy equities on margin. This will eliminate the comparitive appeal of these markets and the vultures and the Giant Squid known as Goldman Sachs will be forced to enter into the common stock market like the rest of us.

If you don't believe me this would fix the issue, I have evidence leverage is the culprit. You may recall there was much chatter about speculation being the cause of oil's meteoric rise in the Summer of 2008. The chatter rose to a feaver pitch to the point the CFTC actually held a discussion/investigation into the cause of oil's rise in late May 2008. You're guess is as good as mine as to what actually transpired at the meeting and behind closed doors but there was a rumor circulated on the street and purveyed by the financial news outlets including CNBC and Bloomberg that they were considering forcing the exchanges to raise margins. I think oil was somewhere around $125/bl when the investigation was launched and during the investigation the steep increasing trend in oil prices saw a pause and traded sideways. The investigation lasted a couple days at which its end they announced they saw no illegal activity and would not raise margins. This was basically waving the green flag for the speculators and immediately after the announcement that it was "game on" once again oil saw its largest one-day gain in history at the time* of over $10/bl ($10.75/bl or 8.41% to be exact).

There was no macro economic event on this day nor was there a geopolitical event. All that occured is the CFTC basically said they weren't going to prosecute or penalize anyone and speculators rejoiced and loaded up with leverage pushing oil ever closer to its nominal high of $147/bl later that Summer.

The answer is simple - raise margins for all non-bonafide hedgers (any market participant that is not a producer or end user) to 50% cash which is at parity with equities. This will abolish to appeal of commodity futures for speculators and the speculative money will come out of these markets and prices will tumble. The question is does Congress have the backbone to get the job done or are they in on it too as the article above implies?

[AntonioVem]

Fascinating discussion here. I think I also agree that commodities should not be leveraged simply because these are everyday consumables. If speculators artificially drive up prices, then this just hurts the average consumer for no good reason.

Keep the leverage to stocks, derivatives, forex, etc., and out of items whose price can directly affect the economy. I don't know about you, but I'm tired paying the kind of prices were are at the pump, and the last thing we need if for foodstuff to become too expensive to purchase.

[arogonoluhi]

Here's a Bloomberg article regarding the oil situation with Iran that details how China is definitely not our friend. I, for one, sure wish our politicians would recognize this. Or, maybe they do but they're so dependent on them to buy our debt for pork stimulus bills and entitlement spending on Social Security and Medicare that there's nothing we can do about it.


Bloomberg News said:
By Indira A.R. Lakshmanan and Gopal Ratnam
Jan. 12 (Bloomberg) -- China stands to be the biggest beneficiary of U.S. and European plans for sanctions on Iran’s oil sales in an effort to pressure the regime to abandon its nuclear program.
As European Union members negotiate an Iranian oil embargo and the U.S. begins work on imposing sanctions to complicate global payments for Iranian oil, Chinese refiners already may be taking advantage of the mounting pressure. China is demanding discounts and better terms on Iranian crude, oil analysts and sanctions advocates said in interviews.
“The sanctions against Iran strengthen the Chinese hand at the negotiating table,” Michael Wittner, head of oil-market research for Societe Generale SA in New York, said in a phone interview. Chinese refiners are likely to win discounts on Iranian crude contracts as buyers from other nations halt or reduce their purchases of Iranian oil to avoid being penalized by U.S. and European sanctions, he said.
At the same time, the U.S. is bearing most of the cost of air and sea patrols and surveillance in the Strait of Hormuz, through which transit 17 million barrels a day of crude, or 20 percent of world supplies. China, the No. 2 importer of oil after the U.S., enjoys protection for the shipping lanes without paying a cent, retired Admiral Dennis Blair, a former U.S.
Director of National Intelligence, said in an interview.

U.S. Patrols

“Policing the region imposes a cost on us, and benefits the Chinese,” Blair said in an interview. A few Iranian officials recently have threatened to shut the passage if the U.S. and Europe enforce tough oil sanctions.
The U.S. military is flying 24-hour drone missions every three days in the Strait and the Persian Gulf and 12-hour sorties by Lockheed Martin Corp. manned P-3 surveillance aircraft, according to Chief of Naval Operations Admiral Jonathan Greenert and Navy Captain Jim Hoke.
The U.S. gets 18 percent of its crude and petroleum products from the Persian Gulf, according to the U.S. Energy Information Administration. China imported 5.09 million barrel a day of oil in the first eleven months last year, of which 51 percent came from the Middle East. Imports from Iran rose 5.3 percent in the period from a year earlier to 25.32 million metric tons, accounting for 11 percent of China’s total, according to Chinese customs data.
As the world’s second-largest economy after the U.S., China often gets to be an economic free rider “even absent the current tensions in the Persian Gulf,” said Erica Downs, a China and energy specialist at the Brookings Institution, a research group in Washington.

Iran’s Oil Income

In Afghanistan, China benefited economically from the U.S.- led war to oust the Taliban, Downs said. In 2007, Metallurgical Corp. of China won the right to develop Afghanistan’s largest copper deposit, even as U.S. forces were fighting and dying in the country, she said.
Oil is Iran’s main source of income, yielding the country
$73 billion in 2010 and supplying more than 50 percent of the national budget, according to the U.S. Energy Department and the International Monetary Fund. The second-largest producer in the Organization of Petroleum Exporting Countries after Saudi Arabia, Iran exported an average of 2.58 million barrels a day in 2010, according to OPEC.
Oil fell yesterday as U.S. crude and fuel supplies climbed more than analysts estimated. West Texas Intermediate futures for February delivery declined $1.37 to settle at $100.87 on the New York Mercantile Exchange. Prices rebounded as much as 0.6 percent today to $101.49 on concern that a strike in Nigeria will curb petroleum supplies and Japan will cut purchases of Iranian crude. Oil is up 2.6 percent this year.
The U.S. and Europe say they are targeting Iran’s oil earnings to force the regime to abandon a suspected nuclear weapons program. Iran says that its nuclear program is for peaceful civilian energy and medical research.

Four Rounds

While China has voted for four rounds of United Nations sanctions on Iran, China’s leaders have criticized efforts to expand U.S. and European sanctions unilaterally. Chinese Vice Foreign Minister Zhai Jun said a congressional measure signed into law by President Barack Obama on Dec. 31 to penalize Iran’s central bank and block payments for its petroleum exports elevates U.S. law above international norms.
China is the biggest refiner of Iranian crude, buying 22 percent of Iran’s oil exports, according to the U.S. Energy Information Administration.
“Iran is one of China’s biggest petroleum suppliers,”
Zhai said at a Jan. 11 briefing in Beijing. “China hopes that petroleum imports won’t be affected, as petroleum is needed for China’s development and for ensuring the needs of its people.”
China is seeking to diversify its Middle East oil sources.
Chinese Premier Wen Jiabao embarks Jan. 14 on a six-day trip to the Middle East, including Saudi Arabia, Qatar and the United Arab Emirates.

Hedging Its Bets

During Wen’s visit, China Petroleum & Chemical Corp., known as Sinopec, and Saudi Arabian Oil Co. will sign an agreement for a proposed refinery at Yanbu on Saudi Arabia’s Red Sea coast, the Saudi state-oil company said in an e-mailed statement Jan.
8. Sinopec has agreed to a 37.5 percent stake in Aramco’s planned 400,000 barrel-a-day fuel-processing plant.
Even if it diversifies sources of oil, China is unlikely to sever commercial ties to Iran, said Willy Wo-Lap Lam, an adjunct professor of history at the Chinese University in Hong Kong.
“It has been a long-standing policy of Beijing’s to undermine U.S. influence in the Middle East even as the Obama administration is shifting its diplomatic and military pivot to the Asia-Pacific,” Lam said in an e-mail. “There is no possibility that Beijing will curtail its oil imports from Iran, which is seen by Beijing as a major ally.”
Instead, China’s oil executives are expected to demand lower prices for Iranian crude, said Mark Dubowitz, director of the Iran Energy Project at the Foundation for Defense of Democracies, an advocacy group in Washington.

Reducing Purchases

Dubowitz estimates that if China were the only remaining buyer of Iranian crude, it might command as much as 40 percent discounts. Among the other major refiners of Iranian oil, India has increased orders from Saudi Arabia, and Japanese and South Korean officials say they are gradually reducing their dependence on Iran, Dubowitz said.
The European Union, which is collectively the No. 2 buyer of Iranian crude, taking 18 percent of Iran’s exports, has agreed in principle to an embargo of Iranian oil. The 27 EU foreign ministers are expected to approve the embargo at a Jan.
23 meeting in Brussels.
Discussion of the EU embargo “is already setting off a cascade of oil-market behavior,” as the Chinese try to exploit Iran’s weakness by demanding price cuts, Dubowitz said.

Forcing Discounts

The Chinese “are forcing the Iranians to offer these price discounts to compensate for added political and legal risk,”
said Dubowitz, who has been advising Congress and the Obama administration.
Sanctions work in part by leveraging the greed of buyers willing to flout sanctions, he said. Even those buyers will hurt Iran’s bottom line by cutting their oil revenue, Dubowitz said.
Dubowitz agrees with Lam that there’s little evidence that “Beijing and Tehran are breaking up.” Rather, a shrinking circle of refiners will be able to “ruthlessly drive for discounts,” he said.
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