Wednesday, May 25, 2011

...Seems like talked about this.

  • The Wall Street Journal

Traders Accused in Oil-Price Plot

Three years after launching a probe to determine whether the 2008 oil-market frenzy was fueled by excessive speculation, the U.S. alleged that two traders and their firms operated an international plot to manipulate prices.

In a federal-court lawsuit filed Tuesday, the Commodity Futures Trading Commission accused the traders of running a simple, but effective, scheme in early 2008 that reaped more than $50 million.

In one of the biggest cases ever pursued by the CFTC in the energy markets, the agency is seeking triple damages and disgorgement of gains, according to the complaint, which could amount to up to $200 million.

Getty Images

In the Nymex oil pit on Feb. 27, 2008, when crude hit $102.

The CFTC accuses the traders, Nicholas J. Wildgoose and James T. Dyer, who worked for Arcadia Petroleum Ltd., a Swiss commodity-trading firm, and its affiliates, of buying millions of barrels of oil, creating the illusion that supplies were critically low at the nation's central oil hub, Cushing, Okla. That drove up the value of derivatives contracts they already held, the agency says.

After pocketing the profits on those derivatives contracts, the complaint alleges, the traders then executed a similar scheme in reverse, dumping the physical oil they had purchased back onto the market and profiting in the derivatives market.

The traders continued their scheme from January until April 2008, the CFTC alleges in a civil suit filed in U.S. District Court in New York, ending only when they learned of a CFTC investigation into their conduct.

Phone messages left with Arcadia offices in Switzerland and London weren't immediately returned. Arcadia is owned by Farahead Holdings Ltd., a holding company headquartered in Cyprus and owned by Norwegian shipping magnate John Fredriksen. Parnon Energy Inc., an oil-trading firm affiliated with Arcadia that also executed trades in the alleged plan and was named in the lawsuit, as well as an attorney for the defendants, didn't respond to phone messages. Mr. Dyer, reached at his home in Brisbane, Australia, declined to comment. Mr. Wildgoose, of California, couldn't immediately be reached for comment.

IntercontinentalExchange and CME Group Inc., which operates the New York Mercantile Exchange, declined to comment.

The charges come three weeks after President Barack Obama set up a Justice Department task force designed to "root out any cases of fraud and manipulation in the oil markets," after oil prices soared above $100 a barrel. Oil prices rose 1.9% on Tuesday to close at $99.59 per barrel, and are up 9% this year.

The case also comes as the CFTC is considering a new rule aimed at curbing speculation in commodities, a goal of regulators since the 2008 spike that sent crude-oil prices to a record high of $147 a barrel in July.

There is still disagreement about what caused the 2008 price spike. Major oil consumers and some Washington lawmakers blame financial speculators for driving prices up, but many traders and analysts argue that supplies became perilously tight.

Early in 2008, supplies in Cushing hit their lowest level since 2004, around 15 million barrels, making them especially sensitive to signs of a shortage.

Cushing's storage tanks are key because they are the delivery point for the main oil-futures contract traded on the Nymex, the world's most heavily traded oil contract and the benchmark off which much of the world's oil is priced.

"The case will likely turn on whether there is enough here that you can infer the causal relationship" or whether the defendants can say there were "others things going on in the market," said attorney Paul Forrester, a partner in the energy practice of Mayer Brown in Chicago, who wasn't involved in the case.

In January 2008, Arcadia subsidiaries bought a majority of the West Texas Intermediate oil, the blend used to fulfill Nymex futures contracts, expected to reach Cushing in the following month, the CFTC said. They also placed large bets that February futures would trade at an expanding premium to the March contract. As other traders began to notice that Cushing was due to run low on oil, that bet paid off.

Mr. Dyer and Mr. Wildgoose then took positions that would profit on March futures trading at a growing discount to April futures, the CFTC said. When Arcadia began selling its oil, the rush of crude into Cushing deflated the value of the March contract. Arcadia repeated the trade two months later, but stopped when they became aware of the CFTC's investigation, according to the agency.

Betting on this gap, called the "calendar spread" or "time spread," is a common trade in the futures market. However, the CFTC alleged that Arcadia "wanted to lull market participants into believing that supply would remain tight; that they would not be selling their physical position."

As a result of the scheme, the complaint alleges, the spread between key oil contracts was "artificial" on 12 different dates in January and March of 2008.


Okay, here is the scenario: let's say the hottest, new hip-hop/rock trio, Backyard BBQ, announces a Third Coast concert tour, shortly after the release of its ground-breaking album. On the schedule, the trio is slated for a show at the recently-constructed Diamondhead Amphitheater, along the Mississippi Gulf Coast. This is touted as "one of the best shows in ages", with DJ Rowdy kicking things off as the opening act, and so you and your friends have decided to experience the excitement for yourselves. With tickets going on sale in two weeks, you've also volunteered to go online at the first hour of availability and get the best possible spot in the 2,500-seat venue for you and your troupe. It's all quite simple, right? You plan to click through the official ticket provider's website, select the appropriate seats, and plug in a credit card number to complete the transaction. You estimate that the entire affair will be done within five minutes or so. Unfortunately, you are wrong.

In the minutes before midnight, when the tickets go on sale, you are sitting in front of your computer, repeatedly refreshing the website of the ticket provider. In fact, though this should be quite boring, you are actually a bit upbeat. That's because you are now on a mission to get great seats for this concert, and when commerce does open on the website, you go on the hunt. Understandably, the website reacts a bit slowly to your prompts, given all of the traffic coursing through its pages. But, when you finally make it to your destination, you notice that, within the few seconds since they became available, those great seats have been gobbled up. In fact, all the great seats are gone! It would appear that, somewhere across the vast digital landscape, another group of buyers is using advanced software systems capable of sequencing the same purchasing techniques in nanoseconds, and they move quickly to acquire nearly all best seats for the same concert, potentially making it an instant sell out.

Though you are a bit disappointed, you know that there is still a ray of hope. Those sophisticated buyers who grabbed all of the good seats, you quickly realize, have absolutely no intention of attending the Backyard BBQ concert. In fact, some of those buyers are nearly a continent away. They weren't buying tickets with expectations to see a clever performance; they were buying with the hope of making a profit. Knowing this, you now quickly leave the original ticket provider's website, and you head for others like EBay and little-known secondary ticket exchanges. And there, at any one of them, you find those great seats with a bit of a twist: whereas those seats were originally priced at, say, $59 per ticket, the new holders of the tickets are offering them up for roughly $100 per ticket. It is a painful decision, but you elect to accept the new price, anyway, realizing that, if you don't, you run the certain risk of watching that same price even rise later.

For most of us, though aforementioned scenario is facetious, it is one to which we can easily relate. We've often blasted scalpers for manipulating the prices of everything from concert tickets to football tickets. Their efforts to run up the prices of great seats leave us either poorer or stuck in the back of the arena. And what's worse, their market manipulation knows no limit. Tickets for Hannah Montana performances during her 50-plus city tour, in 2007, rose to as much as several thousand dollars, from a maximum face value of nearly $70. Indeed, event-goers across the country seem to have justification for their outrage.

However, while we do rail against these scalpers, and even legally constrain the manner in which they can resell their tickets, we have to acknowledge that, from an honest perspective, theirs is a practice as natural and as old as the free market, itself. These enterprising folks identify an opportunity--in this case, the desire by some to participate in a great experience. They developthe tools to seize upon that opportunity--in this case, the software that speeds up their purchasing capabilities. And then they execute their strategies. Granted, they may be gouging prices in most cases, by limiting access to the most desirable seats, but the consumers help those scalpers to skew the reality of the market, by accepting their higher prices, and creating increasing artificial supply pressure. (There is even more pressure on the demand side, when additional consumers eventually join the market and take the prices even higher.)

We must also acknowledge that, just by their function, these scalpers have a whole lot in common with those individuals who trade for profit in our financial, commodities, and stock markets. Like scalpers, their desire is neither to hold bonds and other debt through their maturity periods, nor to own and grow industries over the long term--or even to take possession of commodities for later use. Rather, they see an opportunity to make a buck. And that reason, alone, though grossly oversimplified, resides at the heart of what really drives today's markets. While we are apt to believe that fundamental shifts in demand and supply have caused the subsequent shifts in the prices of, well, everything, we have to accept that fundamentals may have little to do with it. Instead, timing, speculation, and--yeh--greed play a far more significant role.

In no place is that more certain than in today's commodities markets, and in no one sector is the speculator's anthem being song more than in oil markets. Indeed, as Light Sweet Crude prices closed at $119.37 per barrel today, marking the third day of record highs, for some overzealous traders around the globe, this has to be a remarkable moment. (Even London Brent Crude is trading north of $116 per barrel.)

However, the impact of these higher prices are not necessarily celebrated by all. In fact, thespike in energy costs have been very painful for many individuals, for many families, and for many businesses, all the same. As an example, higher fuel costs have only served to augment the run-up in food prices, which are also bolstered by the overall commodity boom, and we have certainly noticed these jumps every time we buy a loaf of bread, a gallon of milk, and even those red slabs of yellowfin tuna steaks. But the situation is more dire, beyond our borders, in places like Jakarta and Johannesburg, where food price increases are so high people have taken to the streets, and in Port-au-Prince, where an angry populace has toppled yet another Haitian government.

Higher oil prices have also moved quickly into the fuel markets. Using the 1-to-0.03 ratio, whereas every one dollar in the price of oil translates to 3 cents in a gallon of gas, fundamental petrol prices would now stand at $3.5811 per gallon, notably before taxes and the minor markup at the pump. (It will be a few working days before those price actually hit retail consumers.) From a linear projection, barring any geopolitical or weather-related incidents, gasoline prices will arrive at $5.00 per gallon by the middle of September. Strikingly enough, though, diesel prices are already north of $4.00 per gallon, and this has posed a challenge to many logistics businesses, from independent truckers to giants like UPS. Even the airline industry has taken its share of critical blows, following the spike in the price of jet fuel, and now bankruptcies and consolidations are the order of the day in an industry fighting to recoup from the impact of 9/11.

Indeed, the consequences of higher energy prices have been profound, even life-changing, but it is high time that we focus less on the troubles we are facing and more on the solutions needed to reign in this sector of our fragile global economy. Put simply, the question is, at this point, how do we curtail the speculator in the commodities markets, before more damage is done? How do we keep these profit-motivated capitalists from running the wheels right off of the very economy system that made them?

First of all, let me say two things. First, though I disdain the profuse speculative actions of many of these professional traders, I acknowledge that we are all among them. After all, when we all invest our money, we do so for the same reason--to make a profit. That said, it is outside of my nature to bash the free-market system or the desire to make profits, because it is from the creation of wealth that the abundance of our world has been derived. But profits at any cost, at the risk of chaos and insurrection, is not, and should never be, allowed. When children starve, when fear and uncertainty make people desperate, and when too much is amassed by too few--the order of the day must be corrected, and equilibrium restored.

Secondly, I concede that there is a notable distinction difference between the ticket scalper and the man sitting behind the trading desk at some investment bank. The latter can buy on margin. Now just imagine the outrage you would have, if you lost Backyard BBQ tickets to a bidder who only has to front, say, $47.20 of the $59 face value, but then resold it to you for $100. You might want to avoid a bunch of concerts after that. And yet, this is actually what happens with the commodities markets. Virtually no one trading in commodities buy a contract at its full value. In fact, margin requirements for commodity futures contracts typically range from 3% to approximately 20% of current market values, while margins for trading stocks happen to be 50%. This enables the trades in commodities to provide speculators with larger profits, or even more staggering losses.

This might also be the one area where non-intrusive action can make a serious difference. As 2007 reached its end, Fadel Gheit, an oil analyst from the venerable Oppenheimer & Co., told members of the U.S. Congress that, because speculation (and not current or projected fundamentals) was driving prices, it was only appropriate to curtail that behavior in the market. "A family of four is going to have to cut corners to benefit a Wall Street trader who makes $20 million a year," he said, adding that this was tantamount to a crime. And with that, Gheit proposed a series of strategies that would tame markets: raising the margin requirement to 50% on each trade; constricting the number of futures contracts traded daily by an given account; and even establishing a minimum holding period for buyers of contracts. Any of Gheit's strategies, though likely to be unpopular with Wall Street America, would do a lot to slow the speculative urges of traders and bring prices back to sane levels, simply by compelling those traders to look elsewhere for profits. It is just unfortunate, however, that our leaders in Washington, D.C., did not have the foresight or courage to take heed.

As commodities markets continue to run amuck, I am reminded of statement made by the infamous, and albeit fictional, corporate raid Gordon Gecko, from the movie Wall Street. Though every financier on the planet can easily recall his monologue, proclaiming "greed is good", I remember another statement on valuations. "The illusion has become real, and the more real it becomes, the more desperate they want it," Gecko explained to his protege. And he was absolutely right. Indeed, with any asset, whether it is a concert ticket or a barrel of oil, we can manufacture a general belief in its importance and grandiosity, or even conjure up a collective fear in its scarcity, and from these illusions, we can drive their preceived value beyond what is rational or justified. For scalpers and speculators, alike, building such illusion of greater value have always been rather easy. The hard part is left for those trying to steer the course back to reality without wrecking the markets.

God, please be with us all.


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