ChrisJCook

Is Excessive Speculation in Oil and Commodities Markets Actually Occurring?

Nate Hagen's post re CFTC and futures position limits at the Oil Drum was good....

www.theoildrum.com/nod...

I made a long comment, from the perspective of someone who used to regulate energy markets for a living (I used to be Director of Compliance & Market Supervision at the IPE...now ICE Europe), and the CFTC part follows...


"....Secondly, I believe that the CFTC are barking up the wrong tree.

For a deliverable contract, the futures market converges on the spot market, and not vice versa, and while position limits are useful coming in to the spot month, they are not really necessary even there because any clearing member who goes in to a delivery month without ensuring that either he, or his clients, are in a position to make or take delivery in accordance with exchange rules is in deep shit.

In my view, and this was the tenor of my evidence to the UK Parliament Treasury Select Committee last year, the big problem lies in the (rightly named) Brent complex ("Brent" is of course now BFOE - Brent, Forties, Oseberg, Ekofisk).

The hugely traded ICE BFOE contract is of course cash settled and therefore can have no direct influence on the physical or "spot" market price any more than a bet between me and Nate.

It is settled against a price calculated against trading in respect of the BFOE 600,000 barrel forward contract, but even this price is not that against which most of the global oil price is calculated. It is the Platts assessment of "dated" BFOE contracts to which we must look for that, and the relationship between the ICE futures price, the forward price, and the dated price is what makes the Brent complex...well, complex. It is also a licence to print money for intermediaries at the expense of end user producers and sellers.

Moreover, although it may not be easy for US politicians to accept, WTI is, through the existence of massive arbitrage trading between BFOE and WTI, almost entirely irrelevant as a pricing benchmark other than in the US. The ICE BFOE tail wags the NYMEX WTI dog, and a great part of NYMEX trading continues to be locals feasting on order flow.

I have long believed that a good starting point - and indeed the basis of a new global energy architecture is a global trade repository.

www.theherald.co.uk/bu...

Such a registry, through an exclusive user group ("International Energy Trade Association"), gives both a mechanism for transparency, and also a tool for enforcing and maintaining agreed market standards - ie suspension or termination of membership of the user group, and hence of the right to register transactions.

I digress.

For as long as we have a financial system dominated by intermediaries intent on maximising profits - and moreover a system in which these profits are accounted not in Units of value but in Units consisting of claims over value asserted "ex nihilo" by credit institutions - then we are stuck on the current treadmill.

I believe that the key is to create a partnership-based framework within which end users transact directly, and where intermediaries transition to service providers. In fact we are already seeing this trend writ large in the way that producer NOCs are taking back ownership on reserves from NICs, and re-engaging with them as service providers.

As I outlined here, my proposal is essentially for the creation of simple but radical new asset classes, which are to all intents and purposes new currencies. In particular, these would be units redeemable in gas, electricity, and other carbon-based fuels but priced against a Unit of Measure or "Value Standard" consisting of a fixed amount of energy.

It is only by bringing to bear a full global market price of energy to bear on those nations profligate in its use that we will see a serious reduction, and through monetisation, we may compensate the citizens of these nations with Units redeemable in energy which have a global value in exchange.

Within a partnership framework it will be possible to address resource use, apply a carbon levy, and much else on the basis of sharing gain and pain.

My take on what has been going on these last 15 years in the oil market is that we have seen three periods:

Firstly, from the mid 90's to maybe 2002/3 we saw the dominance of investment banks and oil trading intermediaries who routinely and systemically created artificial levels of price volatility. They profited from this, and from information asymmetry at the expense of end user producers and consumers who were using the market for its intended primary purpose - ie hedging.

Secondly, from 2002/3 to last year was the era of the hedge funds, who began to lead market volatility, but the investment banks morphed seamlessly into making money from prime brokerage, and privileged knowledge of order flow and positions.

Finally, and more recently, we have seen the flow of money into "safer" ETFs and the likes of the GCSI.

Pillaging these big fund positions has been going on for years. I blew the whistle on it 9 years ago and lost everything I had - livelihood, home, family - as a result, but it has long since been accepted that such conduct is a fact of market life.

The FT's John Dizard wrote tellingly about "Goldman's magic commodity box" here...

www.gata.org/node/4787

Hell, if you make the rules, you can't break them can you?

Finally, and apologies for such a long post, I think that what is happening in the market is that funds such as GCSI are essentially being used to prop up the market price through long term manipulation of the BFOE complex.

I am reminded of the way in which the International Tin Council kept the tin price artificially high for years - until production ramped up, they ran out of money, and the price collapsed overnight in 1985 in the "Tin Crisis".

I am also reminded - and this is probably a closer analogy to current shenanigans - of Hamanaka's long term manipulation of the copper market which went on for 10 years, and for five years was undetected.

Of course, the producers who are coining in hundreds of billions aren't going to complain about a few billion to middlemen, and the consumers don't know that they are losing.

This brilliant article by Mike Riess is a must read in the context of

www.materialsmanagemen...

What is needed IMHO is a new global energy settlement at a Bretton Woods II where a new architecture, pricing mechanism, reserve currency denominated in energy and investment distribution allocation is made in respect of energy. "