The Fall of Semgroup and Its Impact on Oil Price

Anyone who follows the MLP sector is undoubtedly aware of the recent implosion of Semgroup Energy Partners (Nasdaq:SGLP). There have been several articles in the press that list this event as example #1 of why one should not be involved in the sector. I questioned that thought process in my previous article which can be found here.

Today, I thought I would briefly touch on the relationship between Semgroup’s demise and the decline in the price of oil. For those in need of a refresher, Semgroup Energy Partner's implosion was caused by the bankruptcy of Semgroup Energy Partner's general partner, Semgroup LP, which recently lost nearly $3 billion after positions in oil derivative contracts went against the firm. Prior to the bankruptcy filing, Semgroup LP provided over 90% of Semgroup Energy Parner's revenue.

Additionally, the market was expecting substantial asset dropdowns at Semgroup Energy Partners from the parent company over the next several years. Given the firm’s high level of customer concentration and the market's relatively large expectations for balance sheet growth, it was only natural to see the stock plummet after the news broke.

It was disclosed on Tuesday that Semgroup LP's massive losses were not caused by the firm’s hedge book.  It is typical of most companies in Semgroup’s industry to keep a hedge book filled with derivatives to mitigate their exposure to commodity prices. However, Semgroup LP's massive losses were due to substantial speculative bets in the oil market that far exceeded the firm’s hedging needs.

Semgroup LP's creditors had not authorized such speculative trading in oil futures, which is why Semgroup LP kept its activities secret until it was too late to rectify the situation. Semgroup LP disclosed it was facing a liquidity crunch during a conference call with creditors mere days before the crash in Semgroup Energy Partner's unit price. As you can see from the chart below, the unwinding of Semgroup LP's massive oil bets are correlated almost exactly with the fall in the price of oil. Is this a coincidence? I doubt it. First,  it is too coincidental, and secondly we have seen this phenomenon before.

Back in 2006, the collapse of the hedge fund Amaranth Advisors caused a similar reaction. Amaranth as you may remember collapsed due to massive speculative bets in natural gas futures that went against the firm. Amaranth Advisor’s notified creditors of its liquidity crunch in early September of 2006 and on September 20 2006, Amaranth Advisors gave up control of its portfolio to creditors who began the liquidation process. As you can see from the chart below, this event had a significant impact on the natural gas market. The chart during the month September is nearly identical to that of the one above.

I strongly believe that Semgroup LP's bankruptcy is one of the main contributing factors behind the recent decline in the price of oil. In the short term, speculators clearly determine the price of oil. However, I still believe that the longer-term fundamental factors reign supreme. The current high price of oil is in my opinion clearly justified by fundamental factors and while short term factors such as the Semgroup blow up are important they should not detract from the story behind the oil run up, which I detailed here.

Wednesday's bullish gasoline storage data further supports my idea that the recent decline in oil was due to the unwinding of Semgroup LP's leveraged oil bets instead of fundamental factors. The fact that gasoline and oil inventories continue to drop along with the price of oil can only be explained by disruptions in the energy market. The price of oil should continue to rise or at the very least remain steady until we reach a point in time where gasoline inventories stop dropping.

Disclosure: None

Comments

[Anony:]

Follow up question then . . . if SemGroup had been speculatively "shorting" oil with their hedges, explain to me how that causes a run-up in oil prices. Once those hedges were settled/novated/unwoun... and there was no longer a $MultiB short position out there, then why would spot prices go down?

Either my understanding of the dynamics is screwy, or your logic doesn't foot . . . food for thought.

2008 Aug 01 10:22 AM

[jjason:]

I believe we would all be better off if there were no hedge funds, no speculation in commodity futures, no naked short selling or short selling.

Gambling is not a sensible way to run a company, household or country.

We have been misinformed about the oil business and how oil prices are set.

If you want to help to bring down the price of oil, Go To:

www.stopoilspeculation.../

and sign the petition.

Also, tell your Congressman that you would like tax breaks for companies that produce electric power from solar, wind, natural gas and clean coal. And that these tax breaks should be for 30 years.

As for the fall of Semgroup...the executives screwed up. The people who screwed up should be made to compensate those folks who lost money trusting them.

2008 Aug 04 04:16 AM

[OctoberFaith:]

Report abuse, she toyed with my head.
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wires were already crossed. I told you I got wronged all the way around in two or three deals actually.

2008 Nov 01 06:52 AM

[OctoberFaith:]

you don't get it, eg/ie/eg, gold = oil = money = all of them, fund managers just got shorted left and right. then got to feel guilty for it too.

2008 Nov 01 06:58 AM