naked capitalism

James Bianco, a respected fixed income analyst at Arbor Research, was so kind as to pass along his observations about the retreat in oil prices from his morning research note. “Is This Why Crude Oil Is Getting Slammed?”:

The Financial Times – Oil trading company files for bankruptcy Access

SemGroup, the US physical oil trader, on Tuesday filed for bankruptcy as it acknowledged trading losses of more than $3.2bn in different energy markets after betting this year that crude oil prices would fall. Its collapse came as oil prices plunged to their lowest levels since early June. West Texas Intermediate crude oil fell to an intraday low of $125.63 a barrel, down $5 on the day. Traders sold oil futures as news emerged that tropical storm Dolly was set to miss oil and natural gas installations in the US Gulf of Mexico. Oil traders said SemGroup could have exacerbated the spike in oil prices this month, when the market experienced unprecedented swings of more than $10 a barrel, as the company was buying back some previous bets on lower prices. The bankruptcy of SemGroup, which describes itself as the fourteenth largest US private held company, affects approximately $3.1bn of debt, according to court filings. Oil company BP is the largest creditor, with almost $160m.

Reuters – Huge oil trading loss sinks energy trader SemGroup

SemGroup took a $2.4 billion loss on July 16 after it transferred its New York Mercantile Exchange oil futures trading account to Barclays Plc, converting what they called “loss contingencies” into an actual loss. Included in the NYMEX loss was $290 million owed to SemGroup by a trading company owned by co-founder and former chief executive Thomas Kivisto, who was placed on administrative leave on July 17. Securities legislation limits publicly traded company executives from extensive dealings with their firms, but experts said privately held companies have more flexibility. . . . SemGroup, ranked the No. 12 private U.S. company by Forbes.com in a 2007 article, also took $850 million in losses on July 17 when its over-the-counter hedging program was marked to market. It listed liabilities of $7.53 billion in its bankruptcy filing, including $3.1 billion of total debt $2 billion of secured debt and $594 million in unsecured notes. SemGroup’s financial difficulties were disclosed by its publicly traded affiliate SemGroup Energy Partners LP last week, when it warned that a liquidity crisis at its parent could lead to bankruptcy.

Comment – This story reminds us of the May 2006 parabolic rally and collapse in copper. Back then it was the short position held by China and Dwight Anderson’s Ospraie Management that was forced to cover and when they did, copper prices collapsed.

The Financial Times – (May 7, 2006) Bears seek cover as copper’s rise extends

China’s State Reserve Bureau and Ospraie Management, a $4bn commodities-focused hedge fund, both had large short positions that they covered within the past two months, are China’s State Reserve Bureau and Ospraie Management, the $4bn US commodities-focused hedge fund according to copper market participants familiar with the matter. When investors exit a short position, they repurchase stakes they previously borrowed and sold, and the repurchasing can add substantial upward pressure to the investment. For instance, China reportedly exited half of its large short copper position last autumn, fuelling a sharp price rise. Several market participants believe the SRB has closed out the remainder of its short position in the past few weeks. Ospraie, meanwhile, was believed to be short about 12,000 contracts of copper, or about 300,000 tonnes. “They have been covering that position in the last few weeks as the pain just became too much,” said one market participant. Another trader said Ospraie is believed to have closed out its short position at about $6,750 a tonne after being bearish on copper’s price starting around $3,000.

This time around, it is crude oil that rallied enough to force SemGroup to take a $3.2 billion loss. As the chart below shows, the current correction is approaching the biggest correction in crude oil since February.

It could be argued that $3.2 billion is not that much money in the cash crude oil market. That is true. But often these are not the only firms “caught.” But, it is often the case that stories like this that lead to market reversals often do not involve that much money relative to the size of the underlying market.

As we note in the next block, an ambiguous SEC-ruling designed to rein in the shorting of 19 financial stocks, all that were easy to borrow (see this comment), is at first blush just a tiny sliver of the U.S. domestic equity market. However, as S3 Matching says below, this rule caused almost all shorting to stop and was the catalyst for the sharp stock market rally last week.

Whether SemGroup’s forced cover is the catalyst for one of the biggest recent corrections in crude oil can be debated. But the fact that this correction started literally hours after SemGroup were forced to cover (July 16/17) seems to be more than mere coincidence.