The Backwards Robin Hood Effect in Crude Oil Trading

Includes: GS, ICE, MS, NMX, OIL
by: Bob van der Valk

You have heard of Goldman Sachs (NYSE:GS) but may not know that it is the owner of the biggest casino in the world through its commodities-trading subsidiary J. Aron and Company. No, it does not own an actual casino but it is merely the stomping grounds for high dollar bettors in the world of commodities.

There are no slot machines or other gaming devices anywhere around its sumptuous offices at 85 Broad Street in New York before you start planning to make reservations to fly in on your private plane, be met by a private limousine with a chauffeur, check into your luxury suite and hit the tables. Better yet, it is set up and is connected to every major commodities exchange around the world.

For some background on this subject, the Commodities Futures Trading Commission in the U.S. has established speculative position limits on trading contracts. These limits are intended to prevent market imbalances that would result in failures for the ultimate settlement of the futures contracts.

J. Aron & Company is exempt from those limits under the Commodity Exchange Act. The reason behind the CFTC decision was that U.S. investment brokers could otherwise do their trades on other world commodity exchanges without any volume restrictions, thereby preventing the New York Mercantile Exchange from gaining its rightful share of the action. They are the world's largest physical commodity futures exchange and want to keep it that way.

However, that exemption became a license to rob from the poor and give to the rich with Goldman Sachs becoming the owner of the world’s biggest commodities betting parlor, taking its share from the top no matter whether the prices of crude oil went up or down. The Goldman Sachs Commodity Index tracks the prices of 25 major commodities and is weighted heavily toward crude oil.

Index speculators, who are mostly “long” bettors, seldom take short positions and thereby are betting on prices to rise, but they eventually spiral back down. This instability forces prices for crude oil up at times for no other reason than too many paper barrels are chasing the “wet” physical barrels. The balloon eventually bursts when the real value of the crude oil barrel kicks in. That cost is equivalent to the cost of getting crude oil out of the ground and shipping it to the refineries.

In order to break up this monopoly, the CFTC will have to eliminate the exemption from the limits on those trades. Just recently, some examples of gross violations happened when PVM Oil Futures, trading on the London Intercontinental Exchange (ICE) in Brent crude oil contracts, caused the global crude oil prices to spike to its highest level in eight months last week Tuesday.

PVM, which is the London-based division of the world’s biggest broker of over-the-counter derivatives, eventually lost almost $10 million in those early morning trades on Tuesday.

Steve Perkins, a senior and long-standing trader, apparently unhappy with his first-half year bonus, brokered those contracts and has now been suspended from his post by PVM. It is a privately held company owned by its employees with offices in Vienna, Singapore, New Jersey and Houston.

Mr. Perkins’ actions were hard to explain at the time by traders on the ICE and other commodity exchanges. He could have done it by intercepting the exchange confirmations thereby hiding the open position or the trades were simply booked as hedges where no corresponding physical position actually existed.

Any disciplinary action by the United Kingdom’s Financial Service Authority regulators, the equivalent to the CFTC in the U.S., against PVM and Mr. Perkins will be too little too late. Steve Perkins will eventually be found not “fit and proper” to work in London and banned from trading. But catching him now is too little and too late after the horse has already escaped the barn.

In May 2009, the FSA had taken its third regulatory action against Morgan Stanley (NYSE:MS) this year when it fined Nilesh Shroff, an executive director at the firm, who deliberately disadvantaged clients while conducting their trades. He had traded for the firm’s benefit before making the requested trades from his clients. In addition to a £140,000 fine, Mr. Shroff was banned by the regulators from trading. He was the third Morgan Stanley trader to be fined this year with Morgan Stanley having to paying substantial fines for the other two violations.

What may be good for investors is terrible for the ordinary Joe and Jill trying to fill up their fuel tank at the local gas station while looking for some stability in prices.

Alas, what cannot be cured must be endured.

Disclosure: The writer has no investments in any stocks or commodities. Any views expressed in this newsletter are those of the writer, except where the writer specifically states them to be the views of the 4Refuel group of companies.