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Can the Oil Market Be Manipulated?

by | published May 27th, 2011

On Tuesday, May 24, the U.S. Commodity Futures Trading Commission (CFTC) sued two companies on charges they manipulated prices for crude oil and oil futures at the height of the recession.

The case – filed in Manhattan’s U.S. District Court – is called U.S. Commodity Futures Trading Commission v. Parnon Energy Inc.

It actually charges two related companies with manipulating the pricing in West Texas Intermediate (WTI) crude between the fourth quarter of 2007 and early in 2008. They are California-based oil logistics company Parnon Energy and London oil trader Arcadia Petroleum – both affiliates of the closely held Cypriot company Farahead Holdings Ltd.

(Remember, WTI is the benchmark crude traded on NYMEX in New York.)

The suit alleges that the companies acquired stockpiles of crude, issued call and put options on the long and short positions developed to mimic a market shortage, and profited enormously from what the CFTC says amounts to a fictitious, “artificial,” price increase.

And it is reviving the question of whether the price of crude oil can be manipulated.

The companies lost on the sale of the crude oil itself (the “wet” barrels of actual commodity) they had stockpiled. But, according to the filing, they gained more than $50 million in profits from the derivatives (the related “paper” barrels).

The alleged activity occurred during the early part of a run up to historically high oil prices of $147.27 a barrel (by the second week of July in 2008). The companies charged, however, were trading, and making profits, when the price for crude was well under $100.

The civil lawsuit further contends that the companies stopped the practice when they were apprised of a CFTC investigation.

Now, the Commission regards this alleged conduct as an unwarranted manipulation of pricing -for both a physical commodity and the derivatives based upon it.

The companies, of course, will claim that their actions amount to normal operations of supply and demand.

However, given a number of precedents, the respondents will have some difficulty in sustaining that position…

After all, several years ago, BP plc (NYSE:BP) tried to claim the same thing, when a couple of affiliated traders cornered the propane market and then began increasing prices. And although the oil major never admitted to any wrongdoing, it still paid a fine of almost $400 million.

The same result probably awaits Parnon/Arcadia/Farahead, along with two company officers also named in the civil suit.

The Real Question Is Whether Such Manipulation
Can Actually Determine Direction and Price

Taking a $50 million profit from paper transactions is one thing… but when compared to the daily trading in oil futures and options the amount is insignificant – it’s positively minute.

Certainly no one can suggest that amassing an oil stockpile like the one documented in this case could actually control the crude oil market. Even creating a bottleneck through artificial means (controlling access to transit volume at a strategically located port, for example) could not result in more than a temporary impact on market pricing.

Conspiracy theory buffs aside, this may be the way players manipulate for a short-term, localized profit.

Yet the sheer size of the suppressed inventory (on the one hand) and the avalanche of derivative paper (on the other) that it would take to control the market in this way renders such a strategy impossible. Even if a series of traders could pull it off, it makes for an unwieldy tool and a very obvious group of culprits.

Traders, speculators, shippers, and logistics providers cannot artificially manipulate the broader market this way. However, producers might…

A More Troubling Development

I have had an interest in tracking oil companies (for crude) and refineries (for oil products) trading in their own volume over the past 11 years.

As I noted last week (in “Oil Inventories, Speculation, and Hedging,” May 20), anecdotal evidence is already emerging that vertically integrated oil companies (VIOCs) – those controlling the upstream/downstream process from field to refinery through retail outlet – were unusually active recently in trading in near-month futures contracts in their own product.

This occurred both when crude oil and gasoline prices were rising (through close on April 29) and thereafter, as crude plummeted almost 15% and gasoline over 13% as of the end of trading on May 6.

Hedging is certainly required in such volatile periods. And the VIOCs will insist that is what they were doing.

Yet an even more troubling development may be brewing with the activities of the huge state-controlled producers in OPEC and Russia. These two sources alone account for almost 58% of all crude oil available in daily trading. That certainly accounts for the “wet barrel” side of the equation.

And for the “paper barrel” side?

Take a look at where more of the investments are directed these days… from these countries’ sovereign wealth funds.

That combination dwarfs anything that might come out of a courtroom in Manhattan.

Sincerely,

Kent

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  1. Dean Patelis
    May 27th, 2011 at 09:55 | #1

    I do agree oil, silver, corn, wheat anything can be manipulated if there are enough players with enough money and strategy working together using futures/options can control specific sectors at specific times, it’s done all the time with small float companies and little volume. these hedge funds play both sides of the bid/ask. Pathetic. My question is what do we do and how to play it. Thank you.

  2. jack gordon
    May 27th, 2011 at 12:52 | #2

    arcadia may have skimmed off some $ on oil manipulation, but they are/were small time operators compared to goldman sachs, who cheerled the price up to 147 & tried to get it to 200 but couldn’t make it.
    trouble is GS is too big to be prosecuted & too well connected in DC.

    some yrs ago there was manipulation in potato futures but those are no longer available.
    > jack

  3. Bob
    May 27th, 2011 at 13:52 | #3

    The extremes of plenty and disaster or drought make it virtually impossible to trade on commodity products with any predictability. Thus the whole concept of the futures market is but a tool to mitigate those extremes. Using hedge to defray the risk is paramount to any type of success with commodities. It’s simply the nature of the beast. I don’t claim special knowledge of future or option trading but it seems to me the above is basic to 101 understanding before any other conclusions.

    Then when we attempt to use option chains to measure overall human market sentiment I start to get lost. Where the market wants to go,”trend bias”, by observing the open interest of puts or calls buying or selling either, I start to get a little suspicious of who is manipulating what.
    Perhaps someone here might bestow on us the correct discernment of put and call open interest as to tool for determining sentiment. I, for one, get very confused as to the cause and effects of these option chains open interest.

    Personally I’m very skeptical of those ascribing conspiracy to manipulate. Its just to easy to throw up our hands and cry fowl when most of us don’t really understand the system. Perhaps its because I’m so easily confused of such things. LOL

  4. Crystal
    May 27th, 2011 at 15:49 | #4

    The minute diesel became more expensive that gasoline, everyone should have run for the exits…

    The markets, retail, wholesale, stock, have been openly manipulated since that time. They probably have been manipulated before that, however, in a more subtle way.

    There is no logical reason for such a fundimental change in pricing.
    When this started, all cause and effect scenarios could be thrown out the window.

    I don’t have issue with someone have the ability to own or supervise a products handling for the ‘craddle to the grave’ so to speak, as long as in the world of free interprise, the little guy can come along and become a force to recon with.

    This is no longer possible, therefore, the ‘free market’ no long exhists.

    The fundlementals of cause and effect, free markets and of ethical capitalism can no longer be seen at work in our country and maybe not even in the world…the little guy either gets bought out, cus don’t you know every one has a price, or he is eliminated one way or other.

    That is not a conspiracy, it is fact.

    There are mom and pop companys to feed the industry giant(contracts to supply food, parts, items needed for daily basis on site, etc), but not to compete wWITH the industry giant within the same industry.

  5. May 30th, 2011 at 10:52 | #5

    Then when we attempt to use option chains to measure overall human market sentiment I start to get lost. Where the market wants to go,”trend bias”, by observing the open interest of puts or calls buying or selling either, I start to get a little suspicious of who is manipulating what.Perhaps someone here might bestow on us the correct discernment of put and call open interest as to tool for determining sentiment. I, for one, get very confused as to the cause and effects of these option chains open interest.
    +1

  6. Grover Graves
    May 30th, 2011 at 16:11 | #6

    Ted Butler has been talking about the same thing in the Silver markets for 25 years(Go to “investmentrarities.com”to find his current and archived work. Or he can be reached at info @butlerresearch.com. You will be interested in http://www.thedailybell.com as well. It’s good to be with you. G

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