naked capitalism

If my RSS reader is any guide, most of the press about shale gas has focused on two issues. First, shale gas is in considerable supply, cheap to produce, and burns far cleaner than other fossil fuels. Second, shale gas does not look so hot environmentally, all in. Fracking can pollute ground water (and potable water is our most scarce resource) and releases enough methane to make shale gas as detrimental as coal. Still, it has been treated as the Great Hope for America’s energy woes, a way to turn the US into an exporter, and maybe it will cure cancer too. Obama touted 100 years of shale gas reserves, and manufacturers envision an American revival based on cheap fuel.

The problem is that the good part of this story is largely wrong. Shale gas supplies are overestimated, and it is not as cheap as it has been touted to be. The big reason is that shale gas wells, unlike oil wells, peter out really quickly. The result is that the viability of shale gas as a solution to America’s high energy consumption level is only on an interim basis. Shale gas is more likely to be a stopgap, a 25 year solution rather than a 100 one.

As with the housing bubble, analysts and journalists who understand the economics are giving clear warnings, but they don’t seem to be getting much of an audience. For instance, Jeff Goodell in Rolling Stone wrote in March:

At the same time, scientists began to conclude that America’s reserves of natural gas have been overhyped. In January, the Energy Department cut its estimate of the amount of gas available in the Marcellus Shale by nearly 70 percent, and a group affiliated with the Colorado School of Mines warns that there may be only 23 years’ worth of economically recoverable gas left nationwide. Even worse, new studies suggest that because of fugitive emissions of methane from wellheads and pipelines, natural gas may actually be no better than coal when it comes to global warming.

In February, no doubt annoyed by Obama’s State of the Union claim of 100 years of shale gas, aeberman of The Oil Drum wrote a detailed post explaining in some detail what the supply side looks like. One key fact: the US is already at the point where it is drilling less productive wells:

In 2001, the U.S. natural gas decline rate was about 23% and the annual replacement requirement was 12 Bcf/d when total consumption was 54 Bcf/d. Today, the decline rate is estimated to be 32% and increased consumption of gas means that approximately 22 Bcf/d must be replaced each year.

And the broader implications:

The shale revolution did not begin because producing oil and gas from shale was a good idea but because more attractive opportunities were largely exhausted. Initial production rates from shale are high but expensive drilling and completion costs make economics challenging…

Shale plays have produced a land grab business model in which hundreds of thousands of acres are acquired by each company. Unprecedented lease costs have become the norm often based on limited information and science.

Operators have indulged in over-drilling these plays for many reasons but adding reserves, holding leases and company growth are among the main factors particularly with the low cost of capital. The inevitable result has been the collapse of prices as supply exceeded demand. Most analysts forecast that the future will be much like the present, and that natural gas will be abundant and cheap for decades to come. There are, however, strong and consistent indicators that natural gas supply may be less certain than most observers believe and require a higher price to be developed economically. Natural gas demand is growing as fuel switching for electric power generation continues, and will be increased by environmental regulation in the coming years. The U.S. will shift more of its future energy needs to natural gas in many sectors of the economy. The best justification, in fact, for the land grab and over-drilling spree is expectation of higher prices. Those companies that grabbed the land and held it by production will profit greatly once the true supply and cost of shale gas is recognized.

In March, Wolf Richter also explained why the super low shale gas prices ($2.28/MMBtu) were not a sign of a great new energy source, but lack of producer discipline:

Natural gas is dirt cheap, hovering at a 10-year low. In the US, that is. In other parts of the world, natural gas is four, five times more expensive—a rare discrepancy in a globalized economy…

But there is a problem: price. Natural gas is too cheap…drilling activity is collapsing. In 2008, the peak of the drilling bubble, there were at one point over 1,600 rigs drilling for natural gas in the US. During the financial crisis, the rig count fell off a cliff, then recovered a bit, but now is in free fall again. Last year at this time, there were 882 rigs drilling for gas. Two weeks ago, the count was down to 691. Last week it was down to 670 rigs (Baker Hughes).

Fracking has turned into a massacre for producers…at current prices, drilling activity will continue to shrink while production at wells drilled over the last two years is plunging. At some point, the massive amount of gas in storage will be drawn down below a normal level. But production can’t be cranked up from one week to the next. Perceived or real shortages will drive up the price, but not to an equilibrium where producers barely break even and consumers enjoy low-cost energy. It will be a spike. We’ve been through this before.

But why the comparison to subprime? The biggest producers are more land/lease speculators than energy companies, in terms of how they seek to make money. And they’ve been speculating in a highly leveraged manner. Per John Dizard of the Financial Times:

Even before the most recent gas price crash, the shale gas producers were spending two, three, four, and even five times their operating cash flow to fund their land, drilling, and completion programmes.

The widely accepted claims of huge volumes of cheaply produced energy did not square with this deficit financing…

Too much money was borrowed, on complex and demanding terms. Wall Street should have provided reality checks to the shale gas people; instead, they just provided cashier’s cheques with lots of zeroes at the end….Prices will have to adjust upwards, a lot, to cover not only past debts but realistic costs of production.

There is an echo of the late residential real estate financing bubble in the shale gas story. Consider the parallels.

Institutional investors sought to capture excess return while “hedging away”, or simply avoiding, classic sectoral risks (whole loan default risk, dry hole and gas price risk). The ultimate effect is their assumption of larger, less initially visible, and less manageable risks (securitisations backed by unenforceable foreclosures, very large, quickly-depleting, high cost shale operations).

The same institutional investors could not find enough “investment grade” risk to fill those baskets in their portfolios (triple A or double A operating company bond issuers, investment grade energy company equity). In the case of the energy industry, the rise of national oil companies reduced the opportunities for integrated majors or even conventional-prospect-oriented smaller public companies.

US national policy tilted the capital markets’ risk/reward calculation to a favoured set of investments (subprime/ “non-traditional” mortgages, gas substitution for coal, or gas-fired backup for renewables).

The promoters had a “story” for institutions (home mortgages have a low historic default rate/ shale gas fields have little, if any, dry hole risk, and are a way to ‘manufacture’ gas).

The lead companies in the industry devised complex structured products, often priced by OTC derivatives (tranched home equity asset-backed securities, impenetrable joint venture agreements and scantily disclosed hydrocarbon hedges).

The issuers’ apparent risk mitigation was validated by expert opinion (rating agencies/ sellside geology consultants).

The sad bit isn’t just that we seem to be playing the same tired scripts over and over, but that finance now seems to be based on deeply flawed incentives and risk sharing that encourage the manufacture of bad loans. I focused on current readings to contrast them with the hype, but consider: Dizard (not an energy expert, he’s only as good as his sources) was issuing warnings in 2010. As he points out, journalists, again in a parallel to the housing bubble, have been as remiss as the promoters.

By Les Leopold, the author of The Looting of America: How Wall Street’s Game of Fantasy Finance destroyed our Jobs, Pensions and Prosperity, and What We Can Do About It. Cross posted from Alternet

Gasoline prices have been falling in recent weeks, but they’re still close to their five-year high after climbing steeply for three years. For every penny increase at the pump, $1.4 billion per year leaves our collective pockets, creating a drag on the sluggish “recovery.” Where does it go and what caused the price explosion at the pump?

It’s a common belief that oil prices are set on the world market by supply and demand. Less supply and/or more demand causes prices to rise. Oil is getting harder to find; OPEC is holding back supply; China and India are guzzling it up; Iran is threatening to blow it up. And regulations are getting in the way of drill, baby, drill — end of story.

But this fixation on blind market forces ignores the fact that Wall Street is financializing the commodities markets – especially oil – as it seeks new ways to pick our pockets. The same greedy swindlers who puffed up the housing bubble and then milked it dry are now hard at work doing the same with gasoline.

What is financialization and why is it coming to the oil industry?

Here’s a chilling definition provided by economist Thomas I. Palley (PDF):

Financialization is a process whereby financial markets, financial institutions, and financial elites gain greater influence over economic policy and economic outcomes…..Its principal impacts are to (1) elevate the significance of the financial sector relative to the real sector, (2) transfer income from the real sector to the financial sector, and (3) increase income inequality and contribute to wage stagnation. 

In short, we’re talking about the spread and growing supremacy of financial gambling – the ability to bet on the prices of goods produced in the real economy without actually owning those goods.

The vital activities of manufacturing, resource extraction and agriculture are turned into financial instruments that can be rapidly bought and sold. More to the point, financialization allows financial gamblers to extract profits from the real economy to enrich themselves without producing any real economic value for our economy.

When markets are financialized, they offer a myriad of ways for Wall Street firms to bend or break laws to manipulate markets and haul in enormous profits. In effect, financialization extracts a hidden tax from the real economy which is then passed onto us in the form of higher prices, economic hardship and then government bailouts when it all comes crashing down.

The oil markets have become just another profitable Wall Street casino. Why? Because, as the infamous outlaw Willie Sutton said, “That’s where the money is.” Oil markets as well as other commodity markets require a certain number of speculators. Oil producers and end users go to these markets in order to lock in prices for the products they use or sell. From refiners to shippers to airlines, oil markets provide a way to obtain price certainty for a specified period of time. To make these markets function, speculators are needed to take the other side of those trades. For more than a century about 30 percent of these commodity markets involved speculators and 70 percent of the participants in terms of volume were real producers, distributors and users. That’s what a healthy commodities market looks like.

But once financialization metastasized, the proportions flipped. Now 70 percent of the action comes from speculators, while only 30 percent comes from those who really produce, distribute and use the actual commodities. The casino has taken over.

This speculative invasion is why gasoline prices are climbing rapidly. The only question remaining is how much of the price rise is due to excess speculation. Here’s what the experts say:

• The St. Louis Federal Reserve (not exactly a Marxist institution) claims that 15 percent of the rise in gasoline prices is due to Wall Street speculation (PDF).

• A report from the House Committee on Government Oversight claims that up to 30 percent of the rise may be due to speculators.

• Even experts at Goldman Sachs, of all places, say that “excessive speculation is causing oil prices to spike by up to 40%.”

• And Saudi Arabia, ”the largest exporter of oil in the world, told the Bush administration back in 2008, during the last major spike in oil prices, that speculation was responsible for about $40 of a barrel of oil.”

This flip in the balance of real economic activity and speculation is precisely what John Maynard Keynes warned us about more than 75 years ago:

"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism…."

Who are the speculators?

Senator Bernie Sanders released classified documents revealing the names of the largest speculators in the oil markets as of 2008.

A look at the top 20 speculators reveals that only five are actually involved in producing, shipping, refining and consuming oil (Vitol, CMA, ENA, Semgroup and Emirates Oil). The other 15 are banks and investment houses – a virtual who’s who of Wall Street firms that puffed up the housing bubble and took down the economy. Goldman Sachs, Morgan Stanley, JP Morgan Chase, Merrill Lynch, Citigroup — they all make the list.

A tale of two casinos

It’s stunning to compare the similarities between the housing bubble and the rise in oil prices. Just take a look at the two charts below. The first shows the price of a barrel of oil after eliminating the impact of inflation. You can see the price spike in the 1970s during the Iranian oil boycott, and then in the 1990s during the Persian Gulf War. Clearly, those significant geopolitical events disrupted supplies and had a real impact on the price of oil.

But look what happened when the Wall Street big boys jumped into the oil speculative business right around 2002-’03. The price of oil went bonkers. The gyrations were far more extreme than any of the previous geopolitical events. There is no rational supply-and-demand explanation that accounts for that dramatic rise. Sure, after the economy crashed in 2008 prices declined. That makes sense. But up again goes the price of oil even though we’re facing nothing like the supply and demand shifts caused by oil boycotts and wars. Then again, maybe it does indicate a new war – Wall Street versus the rest of us.

Now take a look at the housing bubble graph – similar shape, similar timing. And that’s no coincidence. When Wall Street turns a market into an enormous casino, prices skyrocket and the economy is threatened. Wall Street did it to housing and now they’re doing it again to commodities — especially oil.

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Wall Street oil speculators kill jobs

When Wall Street jacks up gasoline prices through its speculative activities, it has two job-killing impacts. First, it sucks money out of our pockets to pay for gasoline, which in turn means we have less money to spend on other goods and services in the real economy. It’s the equivalent of an anti-stimulus tax. As gasoline prices go up, economic demand falters and workers in the real economy are laid off.

The second impact is more complex but just as real to unemployed oil workers on the East Coast where several refineries in the Philadelphia area are being shut down even though the price of refined gasoline is rising.

Here’s where it gets tricky. The East Coast gets its oil primarily from the North Sea. That’s called Brent oil. The rest of the country gets most of its oil from the Gulf Coast. That’s called West Texas. The two kinds of oil are very similar in content and traditionally were similarly priced. Not any more.

As the chart below illustrates, a gap has emerged so that Brent oil is now significantly more expensive. This means that the oil coming into East Coast refineries is more costly to refine. But the increased cost can’t be passed on at the pump because the national prices are mostly set by the lower cost West Texas oil (and from European refineries that are dumping gasoline in the U.S. as Europe switches more and more to diesel). As a result, East Coast refinery profits are squeezed, which in turn leads to the shutdowns.

But what accounts for the split between the two prices of oil? Some experts say Brent oil is becoming more expensive because other oil supplies coming into Europe from the Middle East are more vulnerable and uncertain due to the Iranian situation and the Arab Spring. Maybe so. But speculation also is at work. Because oil speculation regulations are more lax in London, it is likely that Brent oil is the raw material for a more profitable casino. As Wall Street money pours in, up go the prices…and down go the refineries and thousands of refinery workers.

But wait, isn’t Wall Street helping the environment by driving up gasoline prices?

Without question the rise in gasoline prices moves the nation toward more fuel-efficient cars, which in turn will reduce greenhouse gas pollution. But relying on Wall Street to cause this dynamic is ridiculous, foolish and grossly unfair. First, because Wall Street speculators not only drive up prices they create price instability – rising prices followed by rapid crashes. If a recession follows, gas prices will crash and the incentive to purchase fuel-efficient cars will disappear. Second, rising gas prices without offsetting credits for low-income people are very regressive – meaning lower-income people pay a higher share of their income on fuel costs.

But more galling is the fact that Wall Street speculators are pocketing what amounts to a gas tax as if they were the duly-elected government of the United States (maybe they are the government, but not duly-elected).

If we want to tax carbon for the sake of the environment (and we should), then the government should do so and collect the revenues, not Wall Street. And if we think that Wall Street’s nefarious way is better than nothing at all, than heaven help us.

How do we rein in the speculation?

President Obama recently called for $58 million in order to put “more cops on the beat” at the regulatory agencies that police the commodities markets. Supposedly these extra cops would be able to prosecute more cases of price manipulation and other blatant violations of the rules and regulations that govern commodity trading.

This effort, while laudable, doesn’t go nearly far enough. The best way to check speculation may be through a financial transaction tax that makes it less profitable to speculate in commodity markets. A relatively small tax on all financial transactions would likely reduce the number of bogus speculators. That’s the only message they understand. Enforcement of weak rules matters little to those who spend all their waking hours playing and dreaming up new financial casino games. The only way forward is to take away their chips.

Unfortunately, the Obama administration opposes any and all financial taxes for fear they will upset financial markets. Well, this market is already upset by financial greed and corruption. Hopefully, the administration will learn before it’s too late that the American people are sick and tired of being fleeced by Wall Street.

In the meantime, next time you fill up your tank, remind yourself that something like $10 to $25 is going right from your pocket to Wall Street. Maybe that will get us to join the fight for a financial transaction tax. It’s long overdue.    

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange

Cui Bono from High Prices?

If there is one thing that the history of commodity markets tells us it is that if producers can support and manipulate prices in their favour, then they will.

As those who have read my previous two Naked Capitalism posts (here and here) will know, my analysis of the oil market in recent years is that investment banks have enabled oil producers to create not just one but two bubbles in the oil price. The first – a private sector bubble – was from 2005 to July 2008, and then – after a collapse in price from $147/barrel to $35.00/barrel in November 2008 – a public sector bubble was inflated in the first half of 2009 which remains to this day.

I firstly outlined how passive ‘inflation hedger’ investors in Exchange Traded Funds and Index Funds essentially lent dollars to oil producers, and were able to borrow oil in return. In doing so, they not only perversely caused the very inflation they aim to avoid, but also eroded the foundations of the crude oil derivative markets as a risk management mechanism.

Secondly, I explained how much of this flow of medium and long term risk averse investment which has financialized the oil market has used the very same Prepay technique which Enron used to defraud investors and creditors. By creating what is essentially Paper Oil the investment banks who come between the funds and the producers have been able to inflate and distort the market price of physical oil, and hence the derivative contracts based upon that price.

Note here that my view of the oil market in the long term is that the price of a finite resource can only go up.

Spikes and Speculation

I have mentioned already the role in inflating these oil price bubbles of passive and risk averse investors who aim to avoid loss and thereby to ‘hedge inflation’. But these risk averse investors are diametrically opposite in motive from the active risk-taking investors who buy and sell crude oil futures contracts (not necessarily in that order) in search of transaction profit.

The US population at large; press; politicians; regulators and the majority of economists all point the finger at greedy speculators, hoarders and price gougers operating on the futures markets such as NYMEX and ICE and blaming them for the sky-high US gasoline prices which result from inflated crude oil prices.

Recent market price moves, and CFTC ‘Managed Money’ market data in relation to the market participation of investors enable us to shine new light on the role of speculators and futures exchanges.

Reuters’ perceptive commodities analyst John Kemp recently suggested that the oil market might be about to repeat the dramatic correction it made in May 2011 when the current speculative ‘spike’ in prices ends.

FT Alphaville last week took up the running from Kemp and published a CFTC Commitment of Traders (COT) chart, which details current participation of ‘Managed Money’ in the US West Texas Intermediate (WTI) crude oil futures contract.

Managed Money is one CFTC category of market participant, the others being Swap Dealers (such as investment banks), oil producers; and ‘other reportables’ such as certain traders.

Managed Money

What this COT chart shows in respect of the MM category is not the absolute number of WTI contracts (the MM ‘open interest’) but the relationship between MM investors holding ‘long’ positions, through buying and holding contracts open, and those who are ‘short’ of the market having sold futures contracts.

The first point that leaps out from the chart is that the ratio of Managed Money is always greater than one. This illustrates the long term presence in the market of the passive investors who are off-loading dollar risk in favour of oil risk and who are thereby structurally ‘long’ in the market.

The second point is the way that inflows of active speculative money flows in and out of the market in short-lived speculative ‘spikes’. The first in March 2011 followed the Libya supply shock and collapsed very soon after in May of the same year. Kemp’s point, and mine, is that there is a similar – but even more pronounced – spike now taking place, and that such a spike is an accident waiting to happen.

But there are is another aspect which is very relevant to the relationship between WTI futures contracts and the underlying market which has long been the subject of debate by regulators and economists.

I think of this as the Curious Incident of the Speculators in the Springtime

The Curious Incident of the Dog in the Night-time

[Inspector Gregory] “Is there any point to which you would wish to draw my attention?”
[Sherlock Holmes] “To the curious incident of the dog in the night-time.”
[Inspector Gregory] “The dog did nothing in the night-time.”
[Sherlock Holmes] “That was the curious incident.”

As will be seen, the WTI price first crashed from $146/barrel in July 2008 to just over $30/barrel in December 2008. It then more than doubled (at a time of over-supply) to over $70/barrel in July 2009.

But throughout that period the Managed Money ratio is not exactly raising the roof, or come to that, disturbing the cellar. So whatever was driving the WTI price downwards and upwards it does not appear to have been either active nor passive investment by Managed Money in buying or selling WTI futures contracts.

In other words, the speculator dog did not bark: so what does that tell us?

As I have outlined previously, there was a wave of ‘inflation hedging’ dollars which poured into commodity markets generally and the oil market in particular in the first half of 2009. My case is that this wave of dollars flowed into the markets through Enron-style Prepay contracts entered into with certain oil producers by a couple of investment banks operating in the Brent/BFOE complex of contracts which sets the global market price in crude oil.

When this financial demand for physical crude oil (paper oil) is added to normal consumer demand the result is a rapid increase in the physical market price, and the nature of Enron-style sale and repurchase use of Prepay contracts is that demand for forward contracts is also increased, thereby creating what became a ‘Super Contango’ market.

Worse, these Prepay contracts – like those of Enron – were invisible to the market at large and they created a ‘Dark Inventory’ of crude oil. This oil was no longer in the beneficial ownership of the producers who had ‘lent’ the oil to the investment banks who acted as credit intermediaries but did not take market price risk. The outcome was that a false market was created in crude oil.

So, if greedy price-gouging hoarders and speculators weren’t responsible, then who was?

I have already written of the way that BP and Goldman were joined at the head for more than 15 years and the probability that a combination of astute marketing; hype and their mutual use of Prepay contracts was instrumental in the first bubble in oil prices.

In relation to the 2008 spike which burst that bubble, some sore losers at Semgroup blamed Goldman Sachs for a market coup of which they were the principal casualty:

What transpired at Semgroup was no less than a $500 billion fraud on the people of the world,” says John Catsimatidis, the billionaire grocer turned oil refiner who is attempting to reorganize Semgroup in bankruptcy court.

The $500 billion is how much the world would have overpaid for crude had a successful scam pushed up oil prices by $50 a barrel for 100 days.

But since 2009, the principal beneficiary – and likely facilitator – of the more recent bubble in prices appears to be J P Morgan Chase, who have had a long and fruitful relationship with the Saudis. Their hire from the wreckage of Lehman Brothers of the former Goldman Sachs oil trading star Jeffrey Frase appears to have been an inspired move which has been a major contributor to their phenomenal recent profits from oil trading.

But whatever the truth behind these murky oil market dealings, I agree with Kemp’s view that market conditions today are not dissimilar to the position in May 2011 when the WTI price fell dramatically in a matter of days, and that the market is similarly exposed today to a ‘flash crash’ like that on May 5th 2011.

I stand by my view that the underlying position of demand in the oil market is such that a flash crash may both wipe out the speculators and then continue, possibly to the extent of taking down the clearing houses which I believe are under-capitalised for the ‘fat tail’ risks they run.

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange

I outlined in a recent post my view that the oil market price has been inflated twice by passive (inflation hedgers) investors, albeit with short term speculative spikes from active (speculators) investors: once from 2005 to June 2008; and again from early 2009 to date. In attempting to ‘hedge inflation’ passive investors perversely ended up actually causing it, and allowed oil producers to manipulate and support the oil market price with fund money to the detriment of oil consumers.
.

But there has always been a missing link – precisely how has this manipulation been achieved?

A comment thread at the FT Alphaville blog a month ago shed light on the esoteric subject of collateralised commodity borrowing by BP, who with Goldman Sachs were the heroes of a January post.

While Izabella Kaminska’s Alphaville post was as interesting as usual, the real nugget on this occasion lay in the extremely well informed discussion which followed.

The protagonists were firstly, Patrick McGavock – a very clued up former banker whose blog rejoices in the name of the “Complete Banker”. The second commenter – whose nom de plume is “Free Again” – not only had technical mastery of a subject that has me reaching for an icepack for my head, but also displayed a comprehensive knowledge of Enron’s modus operandi.

Volumetric Production Payment (VPP) versus Prepay

The very name is enough to make the eyes glaze over, but in essence a VPP is a loan secured against a flow of production which remains in the ownership of the producer.

Prepay, on the other hand, is a forward sale of a commodity where the ownership rights to production pass to the financier.

The Alphaville dialogue is instructive as to the difference.

Free Again (to McGavock): Enron did two types of related transactions: Sales of Volumetric Production Payments (described below), which are being done today in much the same way, and Prepay transactions, which were round-trip trades (three parties involved) meant to create the appearance of Funds Flow From Operations, when it was actually funds flow from financing.

McGavock (to Free Again): Absolutely right. Although VPPs and prepays are essentially the same thing except for the ownership of mineral rights.

A day later came a response which I did not see until recently (my bold).

Free Again (replying to McGavock) Yes, I think we agree, but the most interesting distinction, and what may be relevant to the BP discussion, is the reason a company would choose a particular structure.

A VPP is a form of (acceptable) off-balance sheet financing. In most cases, reserve risk is transferred to the buyer (though the seller usually retains the operating risk).

A Prepay transaction is a little more insidious. It is a form of financing, but if structured as a commodity trade, can be made to look as if it is cash flow from operations.

This is particularly important to companies that use mark-to-market accounting, as there usually exists a huge gap between earnings and cash recognition. In order to maintain credit metrics when using MTM, the companies will structure misleading FFFO transactions, as a key rating agencies focus is FFFO/Interest Expense.

Prepay

Prepay does not move the oil, which stays where it is in the ground or in tank. What prepay does is to create an ownership claim over oil which may be sold either temporarily (Enron-style) as an ‘oil loan’ to investors, or to refiners, who take delivery in due course of oil for which they have fixed the price by ‘paying forward’.

Investors prepay for physical oil which goes nowhere and stays in the custody of the producer, who has an agreement to buy the oil back from the investor, typically a month later in a forward contract that looks just like a futures contract. The outcome is that – facilitated by an investment bank intermediary – the producer lends oil to the investor, and the investor lends dollars to the producer.

The temporary ownership rights created and sold to investors via intermediaries such as Goldman Sachs essentially enable a producer to act as a private oil bank ‘printing oil’.

How does printing oil affect the market? First we’ll look at the printing process as dollars flow in to the market, and the Dark Inventory which it funds. Secondly, we’ll look at what happens when funds flow out and this paper oil is redeemed by the issuer.

Printing Oil

In early 2009, risk averse money poured into the commodity markets, and a large portion of it flowed in to passive funds such as Index Funds and Exchange Traded Funds investing wholly or partly in oil. Units in these funds are created, and some unit issuers then entered, via investment banks, into prepay agreements with producers.

Producers obtain dollars interest-free in exchange for transferring title to oil inventory to the investment bank, and what this means is that the producers do not need to sell as much physical oil to refiners, who must therefore raise their bid price to secure supply from producers, and this is why the price rose rapidly in early 2009 even though the market was not under-supplied.

The second effect was that the demand for forward contracts for the producer to buy the oil back again drove the forward price higher, and this created what is defined as a ‘contango’ market. In fact, it was so pronounced it was called a ‘super-contango’.

What happened as a result was that traders began to buy oil, and to sell it forward, since the contango difference in price enabled them to pay to insure and finance the oil; to lease tank storage, and even to charter the fleets of tankers which sat as floating storage off the UK coast through spring and summer 2009.

Passive investors, for their part, lose money in such a contango market, because the oil lease contracts are rolled over from month to month at a loss to them, since they would (say) sell June delivery oil contracts which they are in no position to perform, and have to buy July delivery oil contracts at a higher price.

It is this continuing loss to long term fund investors which funds the ‘contango trade’ of the arbitrageur traders who charter the tankers.

“De-Pay” – Fund liquidation

When risk-averse investors ask for their money back, what happens is that the oil leasing agreement comes to an end, the fund units are liquidated, and the dollars are returned to the fund investors.

So when the oil is repurchased by the producer from the investment bank, the position is no longer ‘rolled over’ and no further contract purchase is entered into in the next delivery month. This depresses the forward contract price relative to today’s price, a state of affairs which is known as a ‘backwardation’.

Moreover, the producer now has fewer dollars and more oil, and is exposed to a fall in the price of the inventory which he now owns once again. Of course, the producer could sell to refiners on a prepay basis, which a refiner would be happy to do at a suitably discounted price. Or alternatively, the producer could sell futures contracts to speculators who for some reason expect that prices will increase.

There have been two outflows of passive investment from the market, firstly in September 2011 when sentiment turned in favour of T-Bills as safe haven. The second was in December 2011, following the MF Global problem, which demonstrated that unit issuers come with a counter-party risk, since though the issuer may not be taking market risk themselves, they may nevertheless be playing games with the asset.

In each case we have seen the physical market go into backwardation, and in my view the record deliveries by the Saudis may be explained by an urgent desire to sell inventory returned to their ownership at high prices before the collapse they know is on the way.

But the exit of passive investors from the market has yet to have the effect it did in late 2008 when the price collapsed to $35/barrel from the high of $147/barrel. The reason is that the current noise and rhetoric re Iran has firstly attracted refiners, who have purchased oil forward, and possibly even prepaid, because they fear prices will rise.

This forced up the physical price of oil in the current ‘spike’ which will further kill off demand, while speculators have poured into the market to buy futures contracts, which producers have been only too happy to sell, in order to lock in high prices and insure against a collapse.

It is only a matter of time before this spike ends as the market turns, and at this point there is literally nothing holding the market up.

Inventories

Private inventories are at record lows, and this is mistakenly taken by commentators as a sign of demand. The reality is that traders will only store oil if they are able to afford to store it and sell it at a profit. The problem is firstly that many traders are being starved of credit by the banks, which will make it difficult for them to act as a ‘buffer’ through buying surplus oil

Secondly, the market is in fact in backwardation, which means that holding oil costs traders money, and if producers have cash flow problems, they too have an incentive to sell at a discount.

Refiners’ Demand for Oil

No investment bank with oil funds to sell you will ever come up with any reason why oil prices will ever go down, but their faulty economic logic can reach laughable proportions.

For instance, falling demand for products in the US and EU has seen massive closures of refineries, to the extent that some 2m barrels per day of US East Coast refining capacity has closed. This is of course good for the refineries left standing since it can create local shortages and opportunities for high margins and profits.

A very well respected investment bank analyst recently suggested in the FT that the resulting higher US gasoline prices would increase the demand for crude oil and hence – surprise, surprise – was bullish for oil prices. What he was ignoring was that all of the crude oil which used to go to the refineries which had shut will be looking for another home.

By way of example, Hovensa joint venture refinery at St. Croix in the US Virgin Island, which used to receive 350,000 barrels per day from the Venezuelan state oil company PDVSA which was one of the partners, has now closed. It is hardly likely that the PDVSA will now increase the price of their heavy crude oil when offering it to (say) the Chinese. The point being that oil refiners have been caught between the rock of a manipulated and inflated crude oil price and the hard place of cash-strapped consumers.

So in a nutshell, demand in the West is dropping like a stone. I do not believe for a minute that demand for consumption in the East will make up the slack. In my view much of that demand (if not wishful thinking and hand waving by analysts) is financial, being the building of strategic reserves and refinery stocks as a physical hedge.

It will be seen that the effect of Prepay on the oil market has been to create a parallel financial market in ‘paper oil’ which means that most participants are completely misled as to the true state of the market.

In summary, as I previously outlined, my analysis is that the oil market stands like an Oil-e-Coyote – running hard beyond the edge of a cliff, but not having yet looked down………

Window Dressing Enron

For those with short memories, Enron fraudulently concealed their financial position from investors and the rest of the world through a variety of sophisticated techniques. One of the most egregious was the use of prepay transactions with investment banks via a special purpose vehicle in a tripartite agreement which essentially misrepresented what was in reality a loan as a forward commodity purchase and sale.

In other words, Enron – facilitated by investment banks – was window dressing its balance sheet and fraudulently misleading investors and counter-parties alike.

Window Dressing the Oil Market

It appears to be the case that BP and Goldman Sachs have for many years been directly or indirectly enhancing BP’s balance sheet and cash flow through enabling BP to lend oil to passive inflation hedger investors and in return obtain interest free dollar funding and literally monetising oil.

Possible accounting legerdemain by BP is one thing, but the greater problem by far has been the effect of passive investors entering the market en masse via this route. As I explained, these transactions have eroded the foundations of the oil market, which have become entirely financialised and have lost touch with the reality of physical production, consumption and storage.

The fact that oil market inventory has been prepaid in this way creates a two tier physical market, where the tiny minority who have knowledge of the resulting ‘Dark Inventory’ of oil in temporary investor ownership have a massive advantage over the majority who do not and who enter into derivative contracts upon a completely false assumption as to physical supply and demand.

Whether or not this is illegal, and if so, in what country, is an interesting question. But as a former head of regulation of a global energy exchange I have no hesitation in saying that the result has been a complete perversion of the oil market, which has become, for maybe as long as ten years, in every sense a ‘False Market’.

The sheer scale of this oil market manipulation, and the staggering sums involved, make Yasuo Hamanaka’s ten year $ multi billion copper market manipulation for Sumitomo look like a car boot sale.

If my analysis of the oil market is correct, many if not all prepay transactions have been terminated in recent months as passive investors have pulled out and the market has become free again of Dark Inventory. However the oil price has been kept inflated by a massive wave of speculative buying attracted by rhetoric and noise about Iran.

With the market’s underpinnings eaten away by fulfilment of these pre-paid contracts (which will temporarily depress physical demand), a collapse in the oil price is inevitable once speculators exit. After this, perhaps steps may then be taken by producers and consumers collectively to free the oil market from the pernicious control of middlemen, and to completely reconfigure the market through a new settlement.

I’m not holding my breath, but I do live in hope.

Author’s Notes: Peak Oil

Before once again being assailed by Peak Oil proponents as a ‘denialist’, I am completely convinced of the proposition that crude oil is finite and that there is a maximum level of crude oil production, which we have either reached or approached.

The problem is that current markets are operated and manipulated by and on behalf of intermediaries with a vested interest in volatility and extraction of profit at the expense of producers and consumers.

The requirement is for a new and equitable dis-intermediated market architecture where carbon fuel prices are maintained at the level where demand destruction sets in, but where part of the surplus is reinvested in renewable energy and energy savings with a view to reducing future demand for carbon fuels)

By Washington’s Blog

Two Senators with Access to Classified Information Say Saudi Government Backed 9/11 Attack

Two former senators – one a 9/11 Commissioner, the other the co-chair of the joint Congressional inquiry into 9/11 – state in sworn declarations that the Saudi government backed the 9/11 attack.

The New York Times reports:

For more than a decade, questions have lingered about the possible role of the Saudi government in the attacks on Sept. 11, 2001, even as the royal kingdom has made itself a crucial counterterrorism partner in the eyes of American diplomats.

Now, in sworn statements that seem likely to reignite the debate, two former senators who were privy to top secret information on the Saudis’ activities say they believe that the Saudi government might have played a direct role in the terrorist attacks.

“I am convinced that there was a direct line between at least some of the terrorists who carried out the September 11th attacks and the government of Saudi Arabia,” former Senator Bob Graham, Democrat of Florida, said in an affidavit filed as part of a lawsuit brought against the Saudi government and dozens of institutions in the country by families of Sept. 11 victims and others. Mr. Graham led a joint 2002 Congressional inquiry into the attacks.

As we noted last year:

The Co-Chair of the Congressional Inquiry into 9/11 and former Head of the Senate Intelligence Committee, Bob Graham, previously stated that an FBI informant had hosted and rented a room to two hijackers in 2000 and that, when the Inquiry sought to interview the informant, the FBI refused outright, and then hid him in an unknown location, and that a high-level FBI official stated these blocking maneuvers were undertaken under orders from the White House (confirmed here).

Today, Graham called for a new 9/11 investigation. As Raw Story notes:

Graham on Monday called on the U.S. government to reopen its investigation into 9/11 after a report found that links between Saudi Arabia and the hijackers were never disclosed by the FBI to the 2002 joint Congressional intelligence committee investigating the attacks.

“In the final report of the congressional inquiry, there was a chapter related primarily to the Saudi role in 9/11 that was totally censored, every word of the chapter has been withheld from the public,” Graham said on MSNBC’s The Dylan Ratigan Show.

“Some of the other questions we ought to be asking are if we know that the Saudis who lived in San Diego and now apparently in Sarasota received substantial assistance, what about the Saudis who lived in Phoenix, Arizona? Or Arlington, Virginia? … What was happening in those places?”

“I believe these are questions for which there are definitive answers, but the American people and largely their elected representatives have been denied that information.”

The Times continues:

His former Senate colleague, Bob Kerrey of Nebraska, a Democrat who served on the separate 9/11 Commission, said in a sworn affidavit of his own in the case that “significant questions remain unanswered” about the role of Saudi institutions. “Evidence relating to the plausible involvement of possible Saudi government agents in the September 11th attacks has never been fully pursued,” Mr. Kerrey said.

Their affidavits, which were filed on Friday and have not previously been disclosed, are part of a multibillion-dollar lawsuit that has wound its way through federal courts since 2002. An appellate court, reversing an earlier decision, said in November that foreign nations were not immune to lawsuits under certain terrorism claims, clearing the way for parts of the Saudi case to be reheard in United States District Court in Manhattan.

***

The Saudis are seeking to have the case dismissed in part because they say American inquiries — including those in which Mr. Graham and Mr. Kerrey took part — have essentially exonerated them. A recent court filing by the Saudis prominently cited the 9/11 Commission’s “exhaustive” final report, which “found no evidence that the Saudi government as an institution or senior Saudi individuals funded” Al Qaeda.

But Mr. Kerrey and Mr. Graham said that the findings should not be seen as an exoneration and that many important questions about the Saudis’ role had never been fully examined, partly because their panels simply did not have the time or resources given their wider scope.

Terry Strada of New Vernon, N.J., whose husband died in the World Trade Center, said it was “so absurd that it’s laughable” for the Saudis to claim that the federal inquiries had exonerated them.

Unanswered questions include the work of a number of Saudi-sponsored charities with financial links to Al Qaeda, as well as the role of a Saudi citizen living in San Diego at the time of the attacks, Omar al-Bayoumi, who had ties to two of the hijackers and to Saudi officials, Mr. Graham said in his affidavit.

Still, Washington has continued to stand behind Saudi Arabia publicly, with the Justice Department joining the kingdom in trying to have the lawsuits thrown out of court on the grounds that the Saudis are protected by international immunity.

As we’ve repeatedly noted:

9/11 Commissioner Bob Kerrey said that “There are ample reasons to suspect that there may be some alternative to what we outlined in our version . . . We didn’t have access . . . .” He also says that it might take “a permanent 9/11 commission” to end the remaining mysteries of September 11

Indeed, while everyone remembers the false allegations about Iraqi weapons of mass destruction, most forget that the other primary justification for the war was the false linkage between Iraq and 9/11.

The failure to really investigate 9/11 led us into a disastrous war … which has virtually bankrupted our country.

Unfortunately, the endless wars in the Middle East and North Africa are about oil, not national security (and see this).

So we have idiots like MSNBC talking head Joe Scarborough saying that – even if the Saudi government backed the 9/11 attacks – Saudi oil is too important to do anything about it:

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange. Cross posted from Asia Times

The end game is about to begin. On the one hand you have the noise and rhetoric. Greedy speculators gouging gasoline prices; mad mullahs preparing to wipe Israel off the map; bunker buster bombs and fleets being positioned; huge demand for oil from the BRIC countries; China’s insatiable thirst for oil; the oil price will head for $200 a barrel and will never again fall below $130 …

On the other hand you have the reality.

Oil Markets

The oil markets are completely manipulated and orchestrated, and the conductors of the orchestra have the benefit of having already held a rehearsal in 2008.

History never repeats itself, but it does rhyme. This time around it is not demand from the United States that is collapsing, but European Union and United Kingdom demand, as oil prices in euros and pounds sterling have never been higher. In the meantime, the US is awash in oil as domestic production quietly increases, flushed out by the high prices.

As I have outlined in previous articles, the culprit for the high oil prices between 2009 and 2012 – with the exception of the speculative “spike” between March 2011 and June 2011 driven by Fukushima and Libyan price shocks – has been passive investment by risk-averse investors, which enabled producers to support oil prices at high levels.

Much of this passive money underpinning the market and enabling producers to monetize inventory pulled out of the market in September 2011, and another wave pulled out in December 2011.

What is now happening is the end game: an orchestrated wave of noise that is drawing in speculative money. This is enabling the producers who are actually in the know to hedge by selling production forward during what they confidently expect will be a temporary – and pre-planned – managed fall in the oil price.

The Game Plan

The smartest kids on the block knows that gasoline prices much over US$4 per gallon will be both deflationary and lethal to President Barack Obama’s re-election chances. So that won’t happen other than briefly.

I am by no means the only commentator who has pointed out the complete counter-productivity of these oil sanctions. The smart kids are well aware that oil sanctions are completely useless, and simply enable China to fill its strategic reserves at a discount to the market price at the expense of Greece and Italy in particular.

But the US has been quite happy to let the EU – as useful idiots – take the economic hit. The high oil prices caused by all this noise and nonsense are actually a net benefit to Iran – which rattles its sabre loudly as elections approach.

The effect of a managed decline in oil prices to, and probably over-correcting well through, $60 a barrel – which is coming fairly soon – will be extremely beneficial to the US in two ways.

Firstly, it will be catastrophic in particular for Iran, Russia and Venezuela – not exactly on the White House party list – whose hugely oil-dependent revenues will collapse. The ensuing economic mayhem will open these countries up to regime change and to rescue plans which Wall Street will be dusting off.

Secondly, the US population will be laughing all the way to the gas station as gasoline prices fall – at least temporarily – below $2.50 a gallon and release purchasing power into the economy, thereby doing the president’s re-election chances no harm at all.

What will then happen is that members of the Organization for Petroleum Exporting Countries will panic and genuinely reduce their production. The Saudis/Gulf Cooperation Council will again orchestrate the inflation of the oil price – as they did in 2009 – comfortable in the knowledge that they have been able to hedge against this temporary fall in prices at the expense of the speculators currently pouring in to the market.

That’s the game plan as I see it of the smartest kids on the block. What could ever go wrong?

A Buyers’ Strike

Quite clearly, consumer nations, like everyone else, are in the dark in relation to what has been going on in the oil market and have swallowed the populist “greedy speculator” meme. They are simply unaware of the nature and cosmic scale of the oil market manipulation that has been taking place, and as a result have been happily overpaying for oil for years.

What happens if they simply refuse to pay these prices?

Possibly a “buyers’ strike” by China would be enough to crater the market. We’ve already seen the effect of that on Iran, which has clearly agreed new terms with China after the latter held back purchases earlier this year.

Or possibly speculative short selling of crude oil by hedge funds funded by Chinese investment? I pointed out at a rather spooky conference on “economic terrorism” a few years ago in Lausanne – which examined ways in which terrorists might make economic rather than physical attacks – that the only difference between an economic terrorist and a hedge fund is motive.

System Fragility

The markets in oil have never been so fragile and susceptible to shocks. Private inventories of oil are low. The investment banks interpret this – as they interpret everything – as a sign of physical demand and therefore as bullish for the oil price … oh, and by the way, here are some oil funds they have to sell you.

The reason inventories are low is that private intermediary buyers will only store oil if they can both finance it and lock in a higher forward sale price. Bank financing is scarce and getting scarcer, while forward prices are below current prices; the result is that inventories are low.

The systemic shortage of finance capital means that neither physical oil traders nor the remaining proprietary traders of banks can afford to take into storage much of the approaching flood of oil onto the market.

Also, derivative market risk has become concentrated – since intermediaries are no longer capitalized to take it – in centralized clearing houses, which have for commercial reasons become fragmented silos.

In my view, the steep decline which is planned could easily get out of hand in a not dissimilar way to the tin market in 1985 when the price collapsed – literally overnight – from $8,000 per tonne to $4,000 per tonne.

We will then see whether the clearing houses are “too big to fail” – and ask why, if so, such utilities are run for private profit?

When, Not If

In my analysis, absent a massive, and sustained, shortfall in oil supplies – which I cannot see occurring, since all involved have every interest in ensuring it does not occur – the oil price will, as I have already forecast, fall dramatically by the end of this year’s second quarter at the latest. It’s not a matter of if, but when it will happen.

Finally, as an interesting aside, I have credible reports that Marc Rich – who got on well with both the Shah of Iran and Imam Khomeini, and who sold oil from Iran to Israel for 20 years between 1973 and 1993 – has recently been seen again in Tehran. I doubt that this is for the night life, or because he prefers Tehran air to Swiss: but as a trusted third party there would be few better placed to act as a go-between.

Let’s hope so. Once the stultifying political uncertainties of elections in Iran and Russia are over, things could get interesting.

Yves here. This is a short post, but don’t underestimate the significance. The big picture is that Chinese government has been tightening credit to try to lower inflation, with some success, and various commentators have been calling a soft landing outcome. But residential real estate sales took a tumble in November, and electricity use fell in January (although that may be in part due to the Chinese New Year). This is another sign that just as American economists were unduly confident in their ability to fine tune the economy in the 1960s, so too may analysts be overly optimistic about the ability of Chinese leadership to control its economy.

Cross posted from MacroBusiness

A week ago Phat Dragon was oozing calm in relation to what the January credit figures would say about the economy. Either an even 1 trillion yuan would be disbursed (the consensus), which would been fine, or a larger number would print, which would mean that the turnaround in monetary policy, as expressed through bank lending, was unambiguously here. Having now seen the new lending figure – a genuine tiddler at just 738 billion – (if that were a hooked fish, you’d throw it back in disgust) that state of calm has rapidly evaporated. The last time that a January month produced a smaller nominal new lending flow was in 2007. The economy has expanded by 77% since that time. Unless new lending jumps sharply in February – and by sharply Phat Dragon means a lift beyond even the extravagances of 2009 – then an annual loan supply north of 8 trillion yuan (and thus a total social financing provision that keeps pace with nominal GDP) is under serious threat.

A huge problem with relying on that to happen is that February lending has exceeded January lending exactly … let me just count this on my talons , … exactly, … bear with me … – exactly never. If an appropriate credit supply is not forthcoming, downside risks to already decelerating aggregate demand will emerge swiftly. In sum, Phat Dragon will reconsider his baseline 2012 forecasts if February loans do not break all sorts of records in addition to the Sinitic laws of seasonal motion.

er20120215BullPhatdragon

By Philip Pilkington, a journalist and writer living in Dublin, Ireland

In 2008 profits in the US economy crashed out. But they soon bounced back. This bounce was largely due to the profits being reaped in the financial sector – which sickened many given that 2008 was in large measure caused by the financial sector. This always struck me as odd – not to mention unsustainable. If the ‘real’ economy is in the doldrums you can be sure that, in the medium to long run, the business class will go down with it.

In what follows I will draw on Chris Cook’s post on this site the other day to argue that, if he is correct (and I think he may be), judgment day is just around the corner for the profiteers. Soon they will have to learn that you cannot financial engineer your way to profitability forever, especially when the rest of the economy is withering. Who knows, this may even inspire what has come to be called the 1% to focus their attention on the problems that have arisen in the global economy in recent months – for they have been truly burying their heads in the sand for the past three years.

But first, let us look at this incredible post-2008 resurgence of profitability.

From Profit Bust to Profit Boom

When the world financial markets crashed out in 2008 profits hit the wall. Yet, they did not hit it quite as hard as one might expect. As the below graph shows profits did not even reach the levels they did during the 1983 recession as a percentage of GDP.

I think that the reasons for this have largely to do with the manner in which wealth has come to be distributed in the US. As the below chart shows a far greater proportion of national income now goes to profits than was the case in 1983 when labour compensation was at an all time high.

If we take this into account we can then appreciate that the hit that profits took in 2008 was quite substantial.

But then we saw a major kick back in profitability. Have a look at that first chart again. As a percentage of GDP profits soon nearly reached their pre-crash levels. Yes, a lower rate of GDP growth probably had an effect on this, but even if we simply look at the nominal level of corporate profits (below) we will see that they surpassed their previous height in 2008 despite the crisis.

We can safely say that, while unemployment soared and people found themselves completely drowning in debt, profitability essentially made a comeback. Many publications that were not known for their left-wing or redistributive credentials, noted this phenomenon. In 2010 The Economist magazine wrote:

One of the many oddities of the current joyless economic recovery is that this traditional enthusiasm is strikingly lacking. Corporate America has bounced back impressively. The quarterly results season that is now nearly over has revealed that profits are back within a whisker of the all-time highs achieved before the downturn in late 2008. By some calculations, the rate of recovery of profits from their trough is the strongest since the end of the Great Depression.

An oddity indeed. One can palpably sense in such pieces a suspicion that this bounce back in profitability might be too good to be true. Certainly, it does seem so. And when we look at the source of this new profitability our suspicions only mount. All this profitability was coming, as hinted at in the intro, from the financial sector. Just look at the graph below.

It was financial profits that made a roaring comeback, not profitability more generally. That graph only charts up until 2009, but if we look at the more recent data it correlates. Below is a graph charting the percentage of total domestic profits that is accounted for by financial sector profits.

The Wall Street Journal economics blog summarised the situation well:

Top-line, or pretax, operating profits economywide hit a record high at the end of 2010. All of the gain was in the financial sector…

Since [the crash in 2008], the sector has come roaring back. The GDP report shows finance profits jumped to $426.5 billion. While profits haven’t returned to their high levels of 2006, the gain in finance profits last quarter more than offset a drop in profits posted by nonfinancial domestic industries. (My emphasis)

This was simply carrying on a trend we’ve been seeing in the US economy – and probably much of the Anglo-Saxon economies – for some time now. Look at the below chart that shows how the different business sectors contribute to profitability.

That graph, of course, shows the rise of the bubble economy of the 1990s and the 2000s like no other. It also leads one to suspect that the resurgence of profitability after 2008 was, to some extent at least, due to the inflating of yet another bubble.

Instinctively many of us feel this. It seems so obvious. The economy is doing horribly and yet, for all their complaining, Wall Street does not seem to be doing so badly. Frankly, that stinks; not just morally, but logically and economically. The financial community are supposed to channel funds into productive activity, thereby turning a profit while increasing investment and economic growth. If they’re not doing that and they’re still making money – well, chances are that they’re blowing more bubbles.

The article run on this site the other day by Chris Cook may point in what direction this remarkable resurgence in profits came from. Let us briefly run through Cook’s argument before we go any further.

Big Oil, Big Finance, Big Trouble!

Chris Cook argues that financial investors have fled into commodities and inflated a bubble which they are using to keep their margins up. While one is tempted to reach for the gun shouting “speculation!” one should be more careful. According to Cook, this is not the cynical, greed-fuelled speculation that led to the pre-2008 housing bubble. No, this something altogether different. This is a bubble mainly based on fear. But such makes it no less ominous.

First a run through of the structure of the modern oil market as Cook portrays it.

Basically what has occurred in the oil markets in the past few years is that oil has begun to be traded as an inflation hedge. Investors trade dollars for oil to ensure that, in the event that the value of the dollar is eroded by inflation, they possess something that holds its value. It’s a bit like the strategy of the gold bug. Fearing inflation they give away their dollars that they think to be declining in value for something ‘tangible’ that they believe will hold its value or appreciate.

On top of this Cook tells us how Big Oil and Big Finance have locked arms in this regard. Each has something the other wants: Big Finance has access to dollar loans that can be used to ensure that, should oil decline in value, Big Oil has ample amounts of dollar liquidity lying around. Meanwhile, Big Oil has plenty of barrels of crude lying around that can be exchanged for dollars, thus allowing Big Finance to hedge against any inflation that may take place.

Such an institutional arrangement has given rise to a highly opaque and unstable market that few can see into. Indeed, no one really knows just how much oil is being ‘held’ as an inflation hedge by Big Finance. These stockpiles have even gained themselves an ominous name within the industry (recently christened by Izabella Kaminska over at FT Alphaville who has been doing some of the best work on this): Dark Inventory.

Looking at recent market trends Cook raises concerns that we could be seeing the beginnings of the end of a bubble that began to inflate in the oil market after the crash of the previous bubble in 2008. This bubble, Cook argues, was inflated due to inflation fears after the QE programs undertaken by the Federal Reserve and the Bank of England. With the markets awash with dollar and sterling liquidity, banks and investors piled into commodities to escape what they saw to be a looming inflation.

In recent months Cook focuses on the move of the market from a position of ‘contango’ to a position of ‘backwardation’ – which he sees as evidence of a bubble deflating. While some investors read in this that the short-run demand for oil has risen, Cook points out that with the global recession grinding along there is no fundamental reason that this should be occurring. Instead Cook sees in this move a sign that the long-run demand for oil is falling as the current bubble begins to burst.

Cook thinks that the price collapse is going to be very painful – falling possibly as low as $45-$55 a barrel. In response to this OPEC will try to ramp up prices by cutting production and, most importantly for our purposes, a financial crisis of sorts will occur as inflation hedged investors see their net worth cut to pieces.

If this is as Cook says – if this is a bubble of fear and it bursts – the financial sector is going to see a huge wiping out of the profits they have been reaping from it. We have no way of knowing how much profitability is tied up in these dodgy markets – but my thinking is: a lot.

And Then… Depression?

One could speculate for hours on what happens to the economy next. Certainly lower oil prices will mean higher effective demand for other goods and services. On the other hand, the rich will undoubtedly be licking their wounds in the case of such a collapse and will retract spending (think: the ‘capitalist consumption’ part of the Kalecki profit equation). Pension funds and the like will also likely see red ink ooze from their balance sheets.

However, there is something else to consider – something alluded to at the start of this piece. For the first time the rich may see no tangible way to regain their lost income. In short, they may not see any other potential bubbles to inflate.

In the past few decades the real economy has become increasingly financialised. And so, as shown in the first half of this piece, nonfinancial companies have been able to maintain their profitability through their financial arms despite the real economy of production, distribution and consumption stagnating. If financial profits fall off a cliff they’ll have little left to hold onto. They’ll be in the ditch with their financial buddies.

Certainly this could push our elites to take real action and expand fiscal policy and with it the real economy. We all know Big Finance’s lobbying power and if they began to really see their profitability tied up with the real economy we might see our ignorant and shameful governments getting off their asses and actually doing something about our economic problems.

So, perhaps this will be a positive development in the long run. But in the short run this will be anything but. With their profitability squeezed, businesses are likely to turn on their workers and attempt to cut their wages and living standards. At this point we could well see a true depression taking shape in which businesses cut workers and wages to increase profitability, all the while profitability continues to fall as the unemployed and underpaid buy less and less stuff.

What can I say? I hope I’m wrong. I really do.

By Chris Cook, former compliance and market supervision director of the International Petroleum Exchange

All is not as it appears in the global oil markets, which in my view have become entirely dysfunctional and no longer fit for its purpose. I believe that the market price is about to collapse as it did in 2008 and that this will mark the end of an era in which the market has been run by and on behalf of trading and financial intermediaries.

In this post I forecast the imminent death of the crude oil market, and I identify the killers; the re-birth of the global market in crude oil in new form will be the subject of another post.

Global Oil Pricing
The “Brent Complex” is aptly named, being an increasingly baroque collection of contracts relating to North Sea crude oil, originally based upon the Shell “Brent” quality crude oil contract which originated in the 1980s.

It now consists of physical and forward BFOE (the Brent, Forties, Oseberg and Ekofisk fields) contracts in North Sea crude oil; and the key ICE Europe BFOE futures contract which is not a deliverable contract and is purely a financial bet based upon the price in the BFOE forward market.

There is also a whole plethora of other ‘over the counter’ (OTC) contracts involving not only BFOE, but also a huge transatlantic “arbitrage” market between the BFOE contract and the US West Texas Intermediate (WTI) contract originated by NYMEX, but cloned by ICE Europe.
North Sea crude oil production has been in secular decline for many years, and even though the North Sea crude oil benchmark contract was extended from the Brent quality to become BFOE, there are now only about 60 cargoes of BFOE quality crude oil (and as low as 50 when maintenance is under way), each of 600,000 barrels, delivered out of the North Sea each month, worth at current prices about $4 billion.

It is the ‘Dated’ or spot price of these cargoes – as reported by the oil price reporting service Platts in the ‘Platts Window’– which is the benchmark for global oil prices either directly (about 60%) or indirectly, through BFOE/WTI arbitrage for most of the rest.
It will be seen that traders of the scale of the oil majors and sovereign oil companies do not really have to put much money at risk by their standards in order to acquire enough cargoes to move or support the global market price via the BFOE market.

Indeed, the evolution of the BFOE market has been a response to declining production and the fact that traders could not resist manipulating the market by buying up contracts and “squeezing” those who had sold forward oil they did not have and causing them very substantial losses. The fewer cargoes produced; the easier the underlying market is to manipulate.

As a very knowledgeable insider puts it….

The Platts window is the most abused market mechanism in the world.

But since all of this short term ‘micro’ manipulation or trading (choose your language) has been going on among consenting adults in a wholesale market inaccessible to the man in the street. It is pretty much a zero sum game, and for many years the UK regulators responsible for it – ie the Financial Services Authority and its predecessor – have essentially ignored it, with a “light touch” wholesale market regime.

If the history of commodity markets shows us anything it is that if producers can manipulate or support prices then they will, and there are many examples of which the classic cases are the 1985 tin crisis, and Yasuo Hamanaka’s 10 year manipulation of the copper market on behalf of Sumitomo Corporation.

When I gave evidence to the UK Parliament’s Treasury Select Committee three years ago at the time of the last crude oil bubble I recommended a major transatlantic regulatory investigation into the operation of the Brent Complex and in particular in respect of the relationship between financial investors and producers, and the role of intermediaries in that relationship.

I also proposed root and branch reform of global energy market architecture, which in my view can only come from producer nations and consumer nations collectively, because intermediary turkeys will not vote for Christmas.

A Meme is Born

In the early 1990′s Goldman Sachs created a new way of investing in commodities. The Goldman Sachs Commodity Index (GSCI) enabled investment in a basket of commodities – of which oil and oil products was the greatest component – and the new GSCI fund invested by buying futures contracts in the relevant commodity markets which were ‘rolled over’ from month to month.

The genius dash of marketing fairy dust which was sprinkled on this concept was to call investment in the fund a ‘hedge against inflation’. Investors in the fund were able to offload the perceived risk of holding dollars and instead take on the risk of holding commodities.

The smartest kids on the block were not slow to realise that the GSCI – which was structurally ‘long’ of commodity markets – was taking a long term position which was precisely the opposite of a commodity producer who is structurally ‘short’ of commodities because they routinely sell futures contracts in order to insure themselves against a fall in the dollar price. ie commodity producers are offloading the risk of owning commodities, and taking on the risk of holding dollars.

So in 1995 a marriage was arranged.

BP and Goldman Sachs get Married

From 1995 to 2007 BP and Goldman Sachs were joined at the head, having the same chairman – the Irish former head of the World Trade Organisation, Peter Sutherland. From 1999, until he fell from grace in 2007 through revelations about his private life, BP’s CEO Lord Browne was also on the Goldman Sachs board.

The outcome of the relationship was that BP were in a position, if they were so minded, to obtain interest-free funding via Goldman Sachs, from GSCI investors through the simple expedient of a sale and repurchase agreement: ie BP could sell title to oil with an agreement to buy back the oil later at an agreed price.

The outcome would be a financial ‘lease’ of oil by BP to GSCI investors and the monetisation of part of BP’s oil inventory. Such agreements in relation to bilateral physical oil transactions are typically concluded privately, and are invisible to the organised markets. However, any risk management contracts which an intermediary such as Goldman Sachs may enter into as a counter-party to both a fund and a producer are visible on the futures exchanges.

Due to the invisibility of the change of ownership of inventory ‘information asymmetry’ is created where some market participants are in possession of key market information which others do not have. This ownership by investors of inventory in the custody of a producer has been termed ‘Dark Inventory’

I must make quite clear at this point that only BP and Goldman Sachs know whether they actually did create Dark Inventory by leasing oil in this way, and readers must make up their own minds on that. But I do know that in their shoes, I would have done, particularly bearing in mind that such commodity leasing is a perfectly legitimate financing stratagem which has been in routine use in the precious metals and base metal markets for a very long time indeed.

Planet Hype

The ‘inflation hedging’ meme gradually gained traction and a new breed of Exchange Traded Funds (ETFs) and structured investment products were created to invest in commodities. In 2005 Shell entered quite transparently into a relationship with ETF Securities which enabled them to cut out as middlemen both investment banks and the futures market casinos, and with them the substantial rent both collect.

Other investment banks also started to offer similar products and a bandwagon began to roll. From 2005 to 2008 we therefore saw an increasing flood of dollars into the oil market, and this was accompanied by the most shameless, and often completely misleading hype, and led to a bubble in the price.

There was (and still is) no piece of news which cannot be interpreted as a reason to buy crude oil. The classic case was US environmental restrictions on oil products, which led to restricted supply, and to price increases in oil products. Now, anyone would think that reduced refinery throughput will reduce the demand for crude oil and should logically lead to a fall in crude oil prices.

But on Planet Hype faulty economic logic – the view that higher product prices are necessarily associated with higher crude oil prices – was instead used as justification for the higher crude oil prices which resulted from the financial buying of crude oil attracted by the hype.

You couldn’t make it up: but unfortunately, they could, and they did.

More worrying than mere hype was that a very significant amount of oil inventory had actually changed hands from producers to investors. Only those directly involved were aware that below the visible part of the oil market iceberg lurked massive unseen ‘Dark Inventory’.

Greedy Speculators and Hoarding

The pervasive narrative among people and politicians, and which is spread by a campaigning press, is of ‘greedy speculators’ who are ‘hoarding’ commodities and ‘gouging’ consumers in search of a transaction profit.

There is no better example of this meme than the UK’s Daily Mail scoop on 20th November 2009.

Here we saw pictures of shoals of some 54 shark-like tankers loaded with oil lurking off the UK coast with millions of barrels of ‘hoarded’ crude oil, some of them having been there since April 2009. The Mail’s story was that these tankers were full of hoarded oil whose greedy owners were waiting for prices to rise before gouging the public.

The reality was rather different.

The motivation of the investors involved was not greed but fear. The Fed had been busily printing another trillion in QE dollars to buy securities and the sellers, and other investors aimed not to make a dollar profit but rather to avoid a dollar loss.

So they poured $ billions into oil index funds and similar products and the oil leases/loans which accommodated these funds’ financial purchases of oil had the effect of raising forward prices and of depressing the spot price, thereby creating what is known as a market ‘in contango’.

When the forward price is high enough in a contango market what happens is that traders will borrow money to buy crude oil now, and sell the oil at the higher price in the future. Provided the contango is high enough, they will cover interest costs, and the cost of chartering and insuring the vessel and its cargo, and lock in a profit for the trader at the end.

This is exactly what traders did through the summer of 2009, until the winter demand by refineries for crude oil and a reduction in the flow of QE dollars into the market combined to see the stored oil gradually delivered to refineries and the sharks depart the UK shores.

The point is that the widely held perception of high oil prices being the fault of hoarders and greedy speculators is – apart from very short term ‘spikes’ in the price, entirely misconceived. And even when speculators do dabble in oil markets, they are almost always pillaged by traders and investment banks with much better market information, which is probably what is happening right now.

The Bubble Bursts

In 2008 there was an influx of genuine speculators in search of short term transaction profit. The motivation of inflation hedgers, on the other hand, is the avoidance of loss, which leads to different market behaviour and the perverse outcome that they have been responsible for causing the very inflation they sought to avoid.

The price eventually reached levels at which demand for products began to be affected and shrewd market observers began to position themselves for the inevitable bursting of the obvious bubble. But those market traders and speculators who correctly diagnosed that the price would collapse were unaware of the existence of the Dark Inventory of pre-sold oil sitting invisibly like an iceberg under the water.

Traders who had sold off-exchange Brent/BFOE contracts or deliverable WTI contracts found themselves ‘squeezed’ because title to the crude oil which they thought would be available at a cheaper price to fulfil their contractual commitment had been ‘pre-sold’ to financial investors. This meant that they had to scramble to buy oil at a higher price than they had expected.

The price spiked to $147 per barrel and then declined over several months all the way to $35 per barrel or so as many of the index fund investors pulled their money out of the market in late 2008 and joined a stampede to the safety of US Treasury Bills. What was happening here was that the Dark Inventory which had been created flooded back into the market, and overwhelmed the market’s capacity to absorb it.

Convergence and Futures Pricing

The oil market price is – by definition – the price at which title to dollars is exchanged for title to crude oil.

But there is very considerable debate among economists about the effect of derivative contracts on this spot market price, and whether it is the case that the futures market converges on the physical market price or vice versa.

Now, in the case of a deliverable exchange futures contract, a price is set for delivery of a standardised quantity of a particular specification of a commodity at a particular location within a specified period of time. If that contract is held open until the expiry date and time then there will indeed be a spot delivery and payment against documents at the original price. in accordance with the exchange’s contractual terms.

But the key point is that this futures contract will not be held open to the expiry date at the original price unless the physical market price – which is set by physical supply and demand – is actually at that price at that specific point in time. If the physical price is lower or higher, then the futures contract will be closed out through a matching purchase or sale and a profit or loss will be taken.

I managed the International Petroleum Exchange’s Gas Oil contract for six years, which was deliverable in North West Europe, and the final minutes of trading before contract expiry were Europe’s greatest game of ‘chicken’.

Moreover, no IPE broker in his right mind would dream (because the broker was responsible to the London Clearing House for defaults) of letting a financial investor with no capability of making or taking delivery hold a position into the last month before delivery. And if a broker was not in his right mind, it was my job to act under the exchange rules to ensure such positions were liquidated.

In other markets, the ability to own physical commodities – eg through ownership of warehouse warrants – is much more straightforward for investors. But the logistics of oil and oil products are such that financial investors are simply incapable of participating in the physical market. In my view the use of position limits for financial investors in crude oil and oil products is of little or no use if the clearing house, exchange and brokers are doing their job.

Finally, now that the US WTI contract is just the tail on the Brent/BFOE physical market dog, this discussion has moved on, since the ICE Brent/BFOE futures contract is in fact settled in cash against an index based on trading in the BFOE forward market, with no physical delivery. It is simply a straightforward financial bet in relation to the routinely manipulated underlying BFOE physical market price. ie the question of convergence does not arise.

Anything but Dollars

With interest rates at zero per cent, and with the Federal Reserve Bank printing dollars through QE, a tidal wave of money flowed into equity and commodity markets purely as an alternative to the dollar, and they did so through a proliferation of funds set up by banks.

Note here that the beauty of such funds for the banks is that it is the investors who take the market risk, not the banks, and the marketing and operation of funds has become a very profitable use of scarce bank capital.

So a flood of financial purchasers of oil were looking for producers willing and able to sell or lease oil to them.

Producers in Pain

Producing nations who had massively expanded their spending in line with a perceived ‘sellers’ market’ paradigm where they had the whip hand, were badly hurt by the 2008 price collapse and OPEC took action to restrict production.

But might some OPEC members or other producing nations have gone further than this?

What is clear is that the price rose swiftly in 2009 and then remained roughly in a range between $70 and $90 per barrel until early 2011 when twin shocks hit the oil market. Firstly, there was the supply shock in Libya which saw 1.5m bbl per day of top quality crude oil leave the market, and secondly, the demand shock of Fukushima, which saw a dramatic switch from nuclear to carbon-fuelled energy.

My thesis is that Shell, directly, and others indirectly were not the only ones leasing oil to funds. I believe that it is probable that the US and Saudis/GCC reached – with the help of the best financial brains money can rent – a geo-political understanding with the aim that the oil price is firstly, capped at an upper level which does not lead to politically embarrassing high US gasoline prices ; and secondly, collared at a level which provides a satisfactory level of Saudi/GCC oil revenues.

The QE Pump Stops

In June 2011 the QE pump which had been keeping commodity and equity markets inflated and correlated stopped, and price levels began to decline. Consumer demand – as opposed to financial demand – for commodities had also been affected not only by high prices, but by reduced demand from developed nations for finished goods. In September 2011 more than $9bn of index fund money pulled out of the markets for the safe haven of T-bills.

What happened as a result was that the regular rolling over of oil leases, and the free dollar funding for producers of their oil inventory ceased. So the leased oil returned to the ownership of the producers, while the dollars returned to the ownership of the funds.

Since the ‘repurchases’ were no longer occurring, the forward oil price fell below the current price, and this ‘backwardation’ was misinterpreted by market traders and speculators . They believed that the backwardation was – as it usually is – a sign that current demand was high and increasing relative to forward demand, whereas in this false market the current demand is unchanged but the forward demand is decreasing.

As in 2008, speculators and traders were again suckered too soon into the market, and this led to profits at their expense to those with asymmetric information, and a ‘pop’ upwards in the price as they were forced to close speculative short positions. My information is that a major oil market trader was successfully able to ‘squeeze’ the Brent/BFOE market on at least two occasions in late 2011 precisely because they were aware of the true situation of inventory ownership, and the rest of the market was not.

As an insider puts it……

You can’t have proper price discovery when half of the inventory is being sold elsewhere at a different price. On exchange physical doesn’t even exist. Futures are converging to physical, but only the physical which is visible for Platts assessment.

….pointing out that transactions in respect of physical ownership of oil do not take place on an exchange, and that there is effectively a ‘two tier’ market. Only a proportion of spot or physical Brent/BFOE transactions therefore actually form the basis of the Platts assessment of the global benchmark oil price.

Enter Iran

In my view there is little or no chance of military action against Iran, and having been to Iran five times in recent years, and as recently as two months ago, there is much I could write on this subject.

While financial sanctions have been pretty smart, and increasingly effective so far, the medium and long term effect of the proposed EU oil embargo – which will in fact affect only a pretty minimal and easily accommodated amount of demand which is evaporating anyway – is more apparent than real.

While there would undoubtedly be a short term price rise – cheered on by the usual suspects – in the medium and long term the embargo will act to reduce oil prices. This is because Iran will necessarily have to sell oil at below market price to China and others, and since the market is over-supplied, particularly in Europe, this will undercut market prices generally.

Mexico has routinely hedged oil production for years, and Qatar – who are very shrewd operators – began to do the same in November 2011 since they expect the price to fall this year. In the short term the Iran ‘crisis’ is in my view being hyped for all it is worth to entice yet more unwary speculators into the oil market so that other producers may sell their production forward at high prices while they last before the inevitable and imminent collapse.

Current Position

If you believe the investment banks – who all have oil funds to sell to the credulous – Far Eastern demand is holding up, supplies are tight, and stocks are low, so prices are set to rise to maybe $120 or above in 2012, even in the absence of fisticuffs involving Iran.

I take a different view. I see real demand – as opposed to financial demand and stock-piling, such as in the copper market – declining in 2012 as the financial crisis continues at best, and deepens at worst, particularly in the EU. Stocks are low because bank financing of stock is disappearing as banks retrench, and it makes no sense for traders to hold stocks if forward prices are lower than today’s price.

As for supplies, US crude oil production is probably higher, and consumption lower, than widely appreciated. Elsewhere, there is plenty of oil available now that much of the Dark Inventory has been liquidated, and this liquidation was probably why in November 2011 we saw the highest Saudi monthly deliveries in 30 years.

Finally, we see North Sea oil being shipped – for the first time since 2008 – half way around the world to find Far East buyers. We also see Petroplus, a major independent Swiss refiner, crippled by inflated crude oil prices, and shutting down three refineries because demand for its products has disappeared, and it can no longer finance crude oil purchases now that banks have pulled its credit lines.

In my world, refineries closed due to reduced demand for their products imply a reduction in demand for crude oil: but not, apparently, on the Planet Hype of investment banks with funds to sell.

History does not repeat itself, but it does rhyme, and my forecast is that the crude oil price will fall dramatically during the first half of 2012, possibly as low as $45 to $55 per barrel.

Then What?

As the price collapses we will see producer nations generally and OPEC in particular once again going into panic mode, and genuinely cutting production. We will also see the next great regulatory scandal where a legion of risk-averse retail investors who have lost most or all of their investment will not be pleased to hear that they were warned on Page 5, paragraph (b); clause (iv) of their customer agreement that markets could go down as well as up.

At this point, I hope and expect that consumer and producer nations might finally get their heads together and agree that whereas the former seeks a stable low price, and the latter a stable high price, they actually have an interest – even if intermediaries do not – in agreeing a formula for a stable fair price.

We can’t solve 21st century problems with 20th century solutions and I shall address the subject of a resilient global energy market architecture in my next post.

Wow, this bit of news is amazing, in both a good and bad way. Just to mention one fracking contaminant, benzene is a particularly nasty carcinogen (not that this Bloomberg article mentions it, but it is the sort of thing that too often gets into water tables thanks to fracking). The fact that fracking is seen as a big enough public health risk to rally the normally apolitical medical profession (at least as far as measures ex health care reform are concerned) to call for intervention is striking.

From Bloomberg:

The U.S. should declare a moratorium on hydraulic fracturing for natural gas in populated areas until the health effects are better understood, doctors said at a conference on the drilling process.

Gas producers should set up a foundation to finance studies on fracking and independent research is also needed, said Jerome Paulson, a pediatrician at George Washington University School of Medicine in Washington…

“We’ve got to push the pause button, and maybe we’ve got to push the stop button,” said Adam Law, an endocrinologist at Weill Cornell Medical College in New York, in an interview at a conference in Arlington, Virginia that’s the first to examine criteria for studying the process…

A moratorium on fracking pending more research “would be reasonable,” said Paulson, who heads the Mid-Atlantic Center for Children’s Health and the Environment in Washington, in an interview.

A top scientist at the U.S. Center for Disease Control and Prevention said last week that fluids used in hydraulic fracturing contain “potentially hazardous chemical classes.” The compounds include petroleum distillates, volatile organic compounds and glycol ethers, said Christopher Portier, director of the CDC’s National Center for Environmental Health.

Yves here. We cross posted a piece by Mark Ames on a massacre of Kazakh oil workers striking against KazMunaiGaz, a company “owned” by the son-in-law of the Kazakh president for life. Its American JV partners are led by Chevron.

The story got a surprising amount of pushback here and on Ames’ site, and some of reaction did not look organic. That led Ames to do further digging, and the resulting piece below gives a window into how big corporations go about neutralizing embarrassing news coverage. The more the public knows about the modus operandi of people like Foust, the faster they will be forced to seek more honorable lines of employment.

In this blogger’s humble opinion, this piece is a gold standard takedown of a truly deserving target.

By Mark Ames, the author of Going Postal: Rage, Murder and Rebellion from Reagan’s Workplaces to Clinton’s Columbine. Cross posted from http://exiledonline.com/the-massacre-everyone-ignored-70-striking-oil-workers-killed-in-kazakhstan-by-us-supported-dictator/“>The eXiled

Last week, some troll named Joshua Foust attacked my article about the massacre in Kazakhstan on December 16. I really had no idea who Foust was until I started getting emails from readers telling me “some guy with a goatee is having a meltdown on Twitter.” What upset Foust so much about my article was that I dared to report a death toll number, “up to 70,” that differed from the official figure of 15 that the regime in Kazakhstan wanted the outside world to believe. Why did Foust take on the role of massacre-denier for Kazakhstan’s notoriously brutal, corrupt regime? Read the rest of this entry »

By Richard Smith

Validated Carbon Credits is a trading name of Baron Traders Limited, a company operated by an expatriate British scammer called James Richards. I wrote about him here; when he popped up in the post’s comments threatening litigation, I snarled at him a little. Now I have a few minor updates.

Finding that there were no hits for “Baron Traders Limited” in Opencorporates, an international corporate registry, and usually a reliable free source on corporate registrations, I had written about his company:

Um, I think that means there’s no company called “Baron Traders Limited”, Number 105368, in Gibraltar.

But now, the Gibraltar regulator, whom I contacted, by way of backup, confirms that James Richards’ company Baron Traders Limited is registered in Gibraltar. So my conclusion was wrong, and I unreservedly retract my claim that Baron Traders Limited doesn’t exist.

This makes no difference to the main points of the original post, and it emphasizes some new oddities.

For a start, “Validated Carbon Credits” really is just a name, not a company, though “Ellie Richards” told the FT that she was a director of it. That just isn’t right.

The Gibraltar regulator did confirm my claim that Baron Traders Limited (and another company that I inquired about) are unregulated:

The activities which both companies purport to conduct, namely trading in emissions or carbon credits are not ones which require either company to seek authorisation from the this Commission, as these are not considered regulated activities under the Financial Services (Investment and Fiduciary Services) Act, the Financial Services (Markets in Financial Instruments) Act 2007 or other Supervisory Acts.

There are circumstances where companies carrying on such activities may be required to comply with the provisions of activities defined under Schedule 1 ‘List Of Services and Activities and Financial Instruments’ http://www.gibraltarlaws.gov.gi/articles/2006-32o.pdf (see Section C Financial Instruments on page 68) of the Financial Services (Markets in Financial Instruments) Act 2007.

This leads to another question for Mr Richards. Given that the FSC doesn’t regulate trading in carbon credits, and Baron Traders Limited isn’t registered with the FSC, this part of Richards’ comment to our original post makes no sense:

In Gibraltar we are under the watchful eye of the FSC (similar to the FSA in the UK) and so it would not be in our interest to mislead clients in any way.

Why does he mention the FSC? Baron Traders Limited’ transactions are covered by ordinary Gibraltar law, nothing more. The FSC do not supervise Baron Traders Limited. They would become involved if Baron Traders Limited operated some kind of collective investment scheme; or if it traded certain instruments and securities for certain types of clients.

We also repeat our observation on Vogue Estates, his now defunct real estate company:

…Vogue Estates started in 2000, grew to a size of 1,000 employees in multinational locations, and yet didn’t bother with a web site until 2007. And some time shortly after that, it vanished, leaving only its wayback machine traces. Remarkable.

We continue to question the way he promotes his trading services via bulletin boards and the like, wonder what his target market is, and now ask whether any of his activities on behalf of clients, if there are any, would fall under the FSC’s purview. We note that he claims a 300%+ return on $100,000 in three weeks and implies that he can repeat it (now that’s too good to be true!).

We again ask why, and to whom, he is promoting his company’s trading activities, at this venue, cheek by jowl with upfront fee scammers.

There is one more thing. Readers are invited to consider this series of postings, where Richards promotes a Private Placement Program,

“PPP starting at 10K, 75K, 1Million & 1Billion plus! (CIS); SHOW ME WHAT YOU HAVE (POF); LET ME KNOW WHAT YOU NEED (LOI)”.

A Billion, eh? Here is more on Prime Bank Fraud (“Private Placement Program” is picked out as a “red flag” phrase) from the US Treasury. The New York Fed has this to say about Private Placement Programs:

Targets are told that in order to participate they must provide the scam artist with verification of large (usually multi-million dollar) deposits in a personal bank account… Scam artists give “guarantees,” frequently in writing, that the money will remain in the target’s account, under her sole control, throughout the term of the program.

The purpose of these schemes is to obtain enough information about the target to allow the scam artist to impersonate the target and take the money from the designated account.

Note also Richards’ abuse of the sceptical commenters. I hope that will explain my uncivil response to his threats, and my reluctance to provide any contact details to him.

Note also his habit of misdirection: as to his location, which was Spain in 2009 and is still Spain now: not the UK, and not Gibraltar; and as to his affiliations: his postings were made in 2009 and give Vogue Estates’ UK “main office” address (actually, it’s just an accommodation address), while his LinkedIn profile, copied here, says his involvement with Vogue Estates ceased in 2008.

We still do not expect to hear from Mr Richards’ lawyers, and will have some more fun, if we do.

By Richard Smith

I posted this a few days ago, about the screechingly obvious fake Gibraltar company Validated Carbon Credits, a trading name of Baron Traders Ltd and its lying “CEO” James Richards. Two comments to the post have caught my eye:

It´s obvious your posting is not only slanderous but based on pure conjecture without any circumstantial evidence whatsoever. Why is it you don´t have a “contact us” link? Did you even bother contacting the company / individuals to try and establish some facts?

This was purportedly by a lady called Karen Johnson, who guilelessly provides an email address, bubblybosun@gmail.com, which, a quick Google reveals, is a handle used by none other than James Richards, the aforementioned lying CEO. Rather than dwell on that, or on the fact that “she” evidently doesn’t understand the meanings of the words “circumstantial evidence” and “slanderous”, I responded as follows:

Hello Karen,

Since I know that James Richards is a liar, and Ellie Johnson is a liar, why on earth would I go out of my way to contact them? I’d just get told more lies.

I don’t think my post is the least bit slanderous.

Produce some evidence that I am wrong.

Evidence was not forthcoming. But you will have guessed that, dear readers. Instead, James Richards freaked out a bit and took his web site down for a few hours, as reported here, and then realised that doing that gave completely the wrong impression, and put it back up again. Twerp.

There is more: today James Richards has followed up again in the comments, using his usual name. His comment has the same IP address as the Karen Johnson comment already quoted, confirming my belief a) that he can’t be relied on to give his own gender correctly, never mind his name or his business, and b) that he is startlingly stupid. So now he’s even on record on this blog, lying about who he is. But heck, we knew he did that already.

I can’t fix his IQ, but I do wish he would decide what he’s called, and whether he’s a boy or a girl. There is quite enough gender confusion at this blog already.

I will respond in-line to his latest ungrammatical rant.

We are writing in response to some poisonous, but more importantly, completely incorrect diatribe you have written about our company. We do not know who you are or what your motives are but what you have published is completely without substance, has no evidence to back up your wild allegations and is ultimately libellous and defamatory.

You will find all the evidence that’s needed if you read the post again, James. For reference: ignoring what you’ve been told already is another very well-known sign of bad faith, just like faking your name. There is a simple way to rebut the claim that your company does not exist. Provide a URL to a register of Gibraltar companies that shows your company. You haven’t done that very simple thing. It is fairly obvious why that is. By the way, our motives are perfectly irrelevant, (and would be unintelligible to the personality-disordered anyway, so it may be doubly a waste of time talking about them, to you).

Our company is registered in Gibraltar…

No it isn’t. Read the post again. We covered that already. For reference: ignoring what you’ve been told already is another very well-known sign of bad faith, just like faking your name.

…and our Articles of Incorporation can be provided to anyone on request.

Any fool can fake a set of Articles.

We are a VeriSign trusted company and we are contactable by phone and e-mail.

You have a secure money transfer link and you have an email address and a telephone. So what? And if you don’t handle client money, as you claim later, why are you even mentioning Verisign?

However, since you are clearly not capable of finding the truth you have failed to find us registered (how much do you know about Gibraltar registered companies anyway when you are located in Canada?)

Dear readers, there would of course be an easy way to put a very minor dent my post, namely, to provide a link to the Gibraltar registry or to OpenCorporates that shows Baron Traders Limited. And yet, somehow, this simple expedient doesn’t occur to James Richards; or much more likely, it has occurred to him, but he can’t deliver. The bit about Canada is comedy genius, of course. And anyway, nothing is going to prop up his other fakery from the post – Vogue Estates, his spam about the trader who can make $300K in three months, and so on.

and you have never made any contact with us direct. Is there a reason for this?

There is indeed. Since I know that James Richards is a liar, and Ellie Johnson is a liar, and Karen Richards doesn’t exist, why on earth would I go out of my way to contact any of them? I’d just get told more lies. That, by the way, is the gist of my response to your fake alter ego “Karen Richards”, which you will have already read before writing your latest comment, James. For reference: in this kind of conversation, ignoring what you’ve been told already is a very well-known sign of bad faith, just like faking your name.

Usually when someone has a grievance with a company or individual, the first port of call is to try to address the situation direct.

I don’t have a grievance with your company. I think you are a liar and a scammer, that’s all.

If you have the courage of your convictions why are you hiding behind the internet with no way of anyone communicating with you?

You somehow haven’t noticed, but you do seem to be communicating with me, do you not, (if lies count as communication)? Just…not in private. You may wish to abuse me privately, but that ain’t gonna happen. It is precisely because I am convinced that you are a scammer, and thus, an abuser, that I am not interested in opening a private channel to you.

We, therefore request that you provide this information so that our lawyers can contact you direct to address this situation you have created.

Try yves@nakedcapitalism.com, you pompous, inarticulate jackass.

We will be pursuing you aggressively through the proper legal channels…

No you won’t.

…and expect a full and public apology and punitive damages.

No you don’t.

We are completely above board,…

No you aren’t.

…do not handle any client funds and work with a highly credible, long established UK company who have been active in the global carbon markets for a number of years.

Who’s that then? You mention them here and at your web site, but you never say who they are. By now, readers can guess why that is.

We introduce clients to them should they wish to invest or offset in carbon. Nothing more, nothing less. We would be most interested to know where you have evidence that we have scammed anyone.

I would be most interested to see whether you have any clients at all. It may be that you are such an incompetent scammer that you haven’t managed to scam anybody. The intent, however, is blindingly obvious.

In Gibraltar we are under the watchful eye of the FSC (similar to the FSA in the UK) and so it would not be in our interest to mislead clients in any way.

Rubbish: the FSC, (which proclaims itself to be a lot less fearsome than the FSA, actually),  has never heard of you. We covered that already. Read the post again. For reference: in this kind of conversation, ignoring what you’ve been told already is a very well-known sign of bad faith, just like faking your name. Perhaps I mentioned that already. Provide a URL to an FSC register that shows your company. You haven’t done that very simple thing yet. That tells onlookers quite a lot. Oh, and you are not “in” Gibraltar, either!

In fact, given the number of rogue companies selling carbon credits out there, it is most likely that we have lost sales through telling it like it is and not making it up in order to get a quick sale.

This is your usual threadbare, obvious, hypocritical patter. It may convince FTAdvisers but it doesn’t wash with amateurs like me.

Perhaps, given the situation you have brought about, we should also consider contacting all the entities who advertise on your site and explain that you are now at the centre of legal proceedings due to the entirely unfounded, libellous and defamatory garbage that you have published.

Go ahead, numbskull, draw even more attention to your lies. If you wish to write to some of our payday loan advertisers in that vein, that would be particularly wonderful. Just like everything else about Baron Trading Limited, we’ll believe we’re at the “at the centre of legal proceedings” when we get some independent evidence that these “legal proceedings” exist. We are agog.

Please note that Yves Smith, or Susan Webber, whatever she prefers to be called, as the Principal of Aurora Advisors, Inc. will also be receiving this e-mail.

Well, that bit is true, at last; in fact, you brightened Ms Webber’s day. In, um, “Canada”.

Clients of James Richards, if there are any, whether at Vogue Estates Limited,  Baron Traders Limited, or Validated Carbon Credits, are invited to pipe up in the comments about their experiences. If they are too embarrassed by their past association with this ludicrous deadbeat, they may wish instead to email yves@nakedcapitalism.com in strictest confidence. Testimonials from satisfied customers or business partners are also of great interest.

By Richard Smith

My last post about the scam carbon credits company, Validated Carbon Credits, was carefully sown with typographical elephant traps, now tidied away again (I hope!), and a load of miscellaneous needle, which is still there. All self-indulgent stuff.

First into the elephant trap was a commenter. I was trying to lure the scammer, but he can’t spell anyway, so perhaps that was never going to work. Misfire.

Next, not unexpectedly, the professionals at FTAdviser, who want me to spell their name that way and stick to it, which I am very happy to do. There is a limit to how much tail twisting one should inflict on a hard working hack. It was a cheap hit, but illustrative of a certain mindset. As long as I am permitted to keep checking the correspondence between their perfectly spelled stories and any kind of objective reality, I am content. Perhaps FTAdviser will have something more substantive to say about carbon credit scams once their blood pressure has subsided a little.

But the miscellaneous needle did its job, eliciting an angry comment from Karen Johnson, who is a sockpuppet of James Richards, the scammer who was the main subject of the post. Bullseye.

Mind you, I can see why the gender-confused Mr Richards is irritated: at posting time, if you clicked on his sites www.validatedcarboncredits.com or www.barontrading.com (which redirects to validatedcarboncredits), you got a ‘site suspended’ message. He’s not really building the case that he has nothing to hide, by doing that. Perhaps that’ll occur to him.

In the mean time, good riddance, although I expect Richards will be back very soon, in some guise or other.

UPDATE 11/11: yup, he’s back.

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By Richard Smith

“Carbon credit company hits out at ‘scammers’”, announces FTAdviser, unfortunately neglecting to consider the possibility that the very company doing the hitting out might itself be a scam.

Since this entire FTAdviser piece is, in fact, a transcription of a scammer’s schtick, and I really doubt that the FT wishes to enforce their copyright on that (while sort of hoping they try it), I’ll quote it in full:

After IFAs sounded the alert over a potential carbon credit boiler room operated by Carbon Trace Solutions, another carbon credit company has admitted to problems in its sector.

Validated Carbon Credits said it wanted to warn IFAs about the misrepresentations surrounding carbon credit investments.

The carbon credit company said IFAs needed to ensure credits were visible on a public registry and payment was made direct to the provider or seller of the credits and not to a third party or escrow agent.

It also advised asking about the exit strategy and how and when the credits were going to be sold as there were costs associated with this and it may be necessary to do some work to find someone to sell on the clients behalf or the client may need to open a trading account and manage themself unless a genuine alternative is available.

Validated Carbon Credits warned against any promise of returns as it claimed carbon credits were spot trades and so there were no fixed or guaranteed returns.

Ellie Richards, director of Validated Carbon Credits, said the company had come across other potential carbon credit boiler rooms.

She said: “We applaud your efforts in exposing the scammers who are destroying the industry and ripping off innocent victims with their clever sales patter.

“As a genuine company we have come across these and more. If it sounds too good to be true it usually is.”

So there we are: Validated Carbon Credits has wangled its little mention in the FT. The self-description (“genuine company”) goes unchallenged.

Let’s carry out a spot of due diligence, shall we? It’ll take just a few minutes. First, take a quick look at the Validated Carbon Credits web site, whose very design emits an unmistakable and unpleasing aroma; of rat. Validated Carbon Credits turns out to have a proxy domain name registration; there’ll be no quick discovery of the underlying owner’s identity, then. It’s an odd way for a “genuine company” to register.

Next it turns out that Validated Carbon Credits is a trading name of Baron Traders Limited. Down at the bottom of the web page, we read the dread words:

Baron Traders Limited is a Gibraltar registered company, Number 105368. Registered Office: Don House, 30 – 38 Main Street, Gibraltar. Baron Traders is VeriSign Trusted. The identity of BARON TRADERS has been confirmed using official records.

For American readers, here are a few Gibraltar stories plucked from, well, I’ll be damned, FTAdviser. You can get the gist from the headlines:

UK-based firms shut down by High Court for aiding share dealing boiler rooms (Two UK-based firms, Chesteroak Limited (Chesteroak) and Bingen Investments Limited (Bingen), incorporated in Gibraltar, have been placed into compulsory liquidation by the High Court for assisting share boiler rooms, the FSA said in a statement.)

Tax havens named and shamed

Diary: Don’t fear Gibraltar’s watchdog

Next, we look for Baron Traders Limited at Opencorporates. We get no hits at all for Gibraltar companies (there’s a UK company that was set up in 1995 and dissolved in 1997, so that doesn’t match either), so we look instead for every Gibraltar company with “Baron” in its name. This is what we get:

We’re five minutes in and the FT Adviser story is holed below the waterline. The bit’s between this blogger’s teeth now, so it’s on to Google. For leads, we’ve got Baron Traders Limited and we’ve got Ellie Richards. Via Baron Traders Limited we turn up another person, James Richards, on LinkedIn. Here’s a rough and ready paste of the highlights of his resumé:

James Richards’s Experience

Green and Ethical Investments. Carbon Credits – Purchase & Sales

Baron Traders. LazyBoy Investment. Green Investment (Sole Proprietorship)

Sole Proprietorship; 1-10 employees; Financial Services industry

January 2008 – Present (3 years 11 months)

Managing Director

Baron Traders (Sole Proprietorship)

Sole Proprietorship; 1-10 employees; Financial Services industry

March 1993 – Present (18 years 9 months)

Welcome to Baron Traders.

Negotiable Financial Instruments:

Type of Instruments

Commercial Paper

Bonds

Corporate Debt Securities

Commercial Paper Outstandings Federal Reserve

Bankers Acceptances

Guarantees

Bank Guarantees for officially supported exports

Zero-Coupon Instruments

Zero Coupons and STRIPS

Fixed Income – Zero Coupon Instruments

Advantages of Convertible Securities

Treasury Bills

Treasury Bills: How Marketable Treasury Securities Really Work

Treasury Bills, Notes &Bonds

Treasury Bills: U.S. Treasury Securities

Certificates of Deposit: Large Negotiable Certificates of Deposit

Certificates of Deposit: Advantages of certificates of deposit (CDs)

Certificates of Deposit Offerings

Certificates of Deposit: Utilizing foreign fixed deposits (CD’s) for credit lines

Eurodollar

About Corporate Medium-Term Notes

Repurchase and Reverse Repurchase Agreements

Alternative investments: Managed futures and hedge funds

We are regularly Selling: mtn’s, t-strips, bg’s, investment programs, currency exchange.

We are regularly Buying: MTN’S, T-Strips, BG’s.

Director

Baron Traders Limited (Sole Proprietorship)

Sole Proprietorship; 1-10 employees; Financial Services industry

February 1993 – Present (18 years 10 months)

Managing Director

Vogue Estates

1993 – 2008 (15 years)

Offering Real Estate investments in 17 countries.

That imposing list of securities traded by the nonexistent Baron Trading Limited, with the help of just 1-10 nonexistent employees,  looks exactly like a typical up-front-fee scammer’s mumbo-jumbo. I wonder if anyone fell for it.

Next, let’s check out the new companies this guy claims to be involved with. LazyBoy Investments gives no clear hits. Green Investments gives, of course, an unfilterably vast number of hits. Which leaves Vogue Estates. There’s no sign of a live site called “www.vogueestates.com”, but the wayback machine has this: apparently the first time the Wayback machine ever found it was in June 2007, and it does appear to be the relevant site. Odd, that, since we read elsewhere that:

Founded in 2000, Vogue Estates Ltd includes senior management with over 50 years experience in the Overseas Property sector, with the focus on providing investment properties to clients throughout the UK and Worldwide. The company is based in Strand, Trafalgar Square (London).

Vogue Estates

The overseas property specialists.

Buying a new home is always a big decision, but buying overseas can feel even more daunting.

Vogue Estates has built its business and reputation upon helping every client to find client’s perfect homes abroad and then completing the purchase as quickly and easily as possible. Vogue Estates is a family owned and operated business based in Marbella, Spain. Since Vogue Estates are entirely independent of any builders, bankers or brokers, Clients can always rely on Vogue Estates for completely impartial advice.

The company is managed by James Richards who has been involved in the Overseas Property business for many years. James Richards is well trained to look after the company, having previously worked for a large Blue Chip Company.

With a staff body of 1000 fully qualified employees, Vogue Estates Ltd has a growing team, qualified to an extremely high standard. With state of the art facilities and fully qualified staff, the company delivers a professional real estate to an International level. The service is designed to be relaxing and enjoyable, helping clients to find the right Investment / Lifestyle property.

So Vogue Estates started in 2000, grew to a size of 1,000 employees in multinational locations, and yet didn’t bother with a web site until 2007. And some time shortly after that, it vanished, leaving only its wayback machine traces. Remarkable.

Time to go to Opencorporates again to check on Vogue Estates, methinks, where we find five companies with some connection to that name, none of which was established in 2000 and none of which specialises in overseas property sales.

I think Vogue Estates is a figment of Mr James Richards’ fertile imagination.

The final exhibit is the result of Googling the string “On February 19th 2008, he started a trading account with $100,000″, in which we find James Richards spamming numerous message boards, etcetera, with minor variations of the following text:

Let me know if your interested in an introduction to this trader?

Why trade the markets yourself when there´s a world class trader ready to do it for you?

Having personally invested with this trader (and made handsome profits) I would like to introduce you to another type of investment, aside from real estate, which will greatly enhance any portfolio.

He trades the worlds financial markets for himself, and a handful of private clients.

On February 19th 2008, he started a trading account with $100,000.

On March 6th, at 6.15pm just 3 weeks later…. He closed it at $422,952.98

That fund is closed.

He is now accepting clients for his next trading period.

Full documentation with audited facts and figures can be provided upon request

For more information on how he could trade your account for you – call or email me today.

James Richards
Managing Director
Vogue Estates
james.richards@vogueestates.com

So much for James Richards.

What of Ellie Richards, who has the chutzpah to call the FT and spin them that indignant story about scammers? Two half-sightings hint at a possible modus operandi. First, here she is apparently dropping another bunch of scammers in it by ratting them out to Ripoff Report. It reads as if some sort of score is being settled. Second, here is a complaint about her activities by some other indignant anonymous person (who gets her husband’s name wrong):

Has anyone ever had this person working for them ?. Unfortunately, we discovered this information after our company database was manually copied by this person whom then went onto try and sell undervalued poor quality products to unsuspecting clients. This posting is to only prevent other companies in the future suffering a similar experience and prevent members of the public from losing their hard earned cash. How does she do it ? Having been unlucky enough to have employed her in the past, and having discovered both to my misfortune and that of other companies, that she has a history of joining telesales based companies both in the UK and Spain, then over a period of several months copying their client database before moving on. After leaving this company, this person in conjunction with her husband then calls the clients and offers them similar products to which the client was originally interested in.

I suppose the purloined mailing list is now being put to work on a Carbon Credit scam. With, of course, the inadvertent assistance of the FT’s publicity for Validated Carbon Credits. Perhaps the FT shouldn’t feel so bad: the specialist news agency Point Carbon News fell for Ellie Richards too, in the course of reporting on fraud concerns expressed by MarkIt, who have a role in running a big Carbon Credits registry. I do hope MarkIt have denied registry access to Validated Carbon Credits, or Baron Trading Limited, since they’re both utterly bogus. I suspect that the FT will want to follow up their original story, too.

Update 11/11/11: Followup from FTAdviser. They point out that I have been misspelling their name.