Chris Cook: Naked Oil

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.

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  1. hondje

    ‘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.”

    Very good read and interesting idea. Would read again

    1. Susan the other

      Very interesting. But I’m confused: this quote from Chris Cook about the deal between the Saudis and the US which meets the price requirements of both sides sounds a lot like his proposed solution, to be presented in the next installment. Price stability at $50 a barrel? Because peak oil is so abundant? And so, why is world industry crashing? He doubts we will go to war with Iran because it isn’t worth it. So then why exactly are we war mongering? We want to control stable prices? In dollars? But Iran is dealing with Russia in rubles. And with China in yuan? Did all this commodity hedging and hoarding crash the world?

      1. charles sereno

        “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.”

        History is closer to blank verse. A reckless forecast diminishes the strength of this interesting report.

        1. Chris Cook

          charles sereno

          There are plenty of people in the market who have already taken 2012 positions at those levels using put options.

          To suggest, as I do, that the market will decline to those levels by Q2 2012 is hardly reckless.

          Saying it will happen in Q1 2012 might be a bit precipitate, I grant you.

          1. Maximilien

            Sorry, I agree with Charles. The ONLY time a prediction can be accurate is if you know something no one else knows or has not acted on that knowledge.

            This doesn’t seem to be the case here. You mention 2012 put options. I strongly doubt you are the only person who has this information. So why do you assume that many other investors don’t have it or that they haven’t yet acted on it?

            If what you say is correct, the markets would have responded and oil would ALREADY be at $50. Will it be at $50 in Q2? No one knows—including you.

            Predictions are tricky, especially when it comes to the future. The immortal Yogi Berra liked to say that. Keep it in mind.

  2. aet

    Ha ha ha!

    Page 5, paragraph (b), clause (iv) strikes again!

    (Seriously, though: this is a fine article, providing good grist for the mill. Thanks for sharing your expertise!)

  3. henry Leland

    I recently read in a blog whose name I can’t recall, that US is currently a net exporter of oil. If true, this should be widely noticed, esp. by politicos, but there has been no such reaction. Can anyone verify this or is it an unfounded rumor?

    1. Dan B

      The USA imports 60-66% of its oil. You read about “products” from petroleum, but that’s a story too long for a comment.

    2. Crazy Horse

      Excellent article, Chris:

      Henry, a country can be a net exporter of refinery products (think multi-weight lube oil or road diesel) while importing 60%-70% of our crude oil as we do. The variable is not national production levels, but refinery type and capacity. And bear in mind that all refineries are not created equal. It takes a different refinery design to process Venezuelan heavy crude than Libyan sweet, so you can’t suddenly change where you send your crude to be refined.

    3. rps

      USA Today 12/18/2011: Oil boomlet sweeps U.S. as exports and production rise

      he U.S. exported more oil-based fuels than it imported in the first nine months of this year, making it likely that 2011 will be the first time since 1949 that the nation is a net exporter of such goods, primarily diesel……U.S. is importing a smaller share — 49% in 2010, down from 60% in 2005 —………….American consumers benefit little from the U.S. oil boomlet, because their fuel prices depend heavily on a global oil market

      Perhaps the bigger impact is on American foreign policy. The U.S. oil boomlet has amplified concurrent shifts in the global oil market. Today, half of net U.S. petroleum imports come from the Western Hemisphere, and half of that (or a quarter of the total) comes from Canada. Only 12% came from Saudi Arabia last year, down from nearly 19% in 1993…………

      1. joecostello

        there are two big reasons for this. One in their wonderful way, the oil companies never built many refineries outside Europe and US, better to control things that way, this is particularly painful for the Iranians at this point. Most of the rise of US “net exports” has been refined products which has coincided with US demand drop due to recession.

        Also, as far as the Pax Americana is concerned, it doesnt matter how much the US gets from the Gulf, the key is providing plenty and stable price for rest of the world, which is getting harder every day.

  4. Lambert Strether

    The great state of Maine is more dependent on heating oil than any other state, and I don’t think there’s one person up here who doesn’t think the market’s manipulated.

    But how, exactly? It would be really helpful if the thesis of this post on manipulation (not the prediction part) could be stated in one sentence, suitable for sharing with a clerk at the convenience store.

    I’m guessing that the cap/collar thing is a Goldilocks scenario from the perspective of the gas producers…. And if I were a PR person for GS or BP, I might argue that if the price of heating oil is artificially high (whatever artificial means) that keeps the price of driving reasonably low. So it’s all a wise trade-off from our benevolent masters….

    1. bob

      Heating oil is very close to diesel. 2 factors-

      The ongoing fracking in the NE (completly fueled by diesel)

      The recent road route supply problems in Afghanistan (more JP needed).

      This is ON TOP of the oil market manipulation.

      1. citizendave

        Heating oil is very close to diesel. – bob

        Small point here. I worked in the trucking business for many years, and I own a house here in Wisconsin with an oil furnace. My understanding is that there is only one difference between #2 diesel fuel and home heating oil — the color of the dye injected. I’ve never heard a convincing rationale for why they want to keep the two markets separate, but I suspect it involves taxation. Our heating oil supplier sends a brochure every year that advises that if we run critically low on fuel in a cold snap and can’t get delivery soon enough to avoid running out, we should take a 5-gallon can to the local gas station, fill it with diesel fuel, and put that in the tank to tide us over until they can get a truck to our neighborhood. I’ve never seen any information to suggest there is a chemical difference, but if there is I would enjoy hearing about it.

        Chris, I enjoyed this article very much – it’s like a page-turner. I’m sharing it with friends. Looking forward to the next installment.

        1. Frank Speaking

          In another life I worked as a truck driver for Longreach Fuel and Marina in Bath Maine driving and delivering #2, kerosene and gasoline.

          The same #2 that went in home tanks for heating went into various contractors tanks for their diesel trucks. In the fall the diesel deliveries would call for a kerosene sweetener for those who could afford the additional cost.

        2. citizendave

          Here is an interesting discussion of fuel oil.


          “…Home Heating Fuel Oil #2 and Off Road and Agricultural Diesel #2 appear to be similar products. Home Heating Oil #2 refers to a specific product and specific formulation, which may be a very similar product in terms of composition and formulation to Off-Road Agricultural Grade Diesel #2. Home Heating Oil is a generic term covering a variety of potential fuel products, formulations, and compositions…”

          And check this: “Sometimes due to economic and shortage fuel distributors may sell other fuels, or combinations and blends of fuel oil to home owners, as Home Heating Fuel Oil. Fuels such as; Standard Road Diesel #2, Diesel #1, Kerosene, K-1, Jet Fuel, JP-1, Agricultural Diesel, Diesel #2, Home Heating Fuel Oil #4, or Home Heating Fuel Oil #6 can be shipped by fuel distribution companies and sold for use as home heating oil…”

          Lambert, maybe you Mainers are heating with jet fuel!

    2. Chris Cook


      As for Maine, it is certainly the case that fuel prices in the remoter part of Scotland, where I live, tend to be higher for logistical reasons of shifting the stuff around to inaccessible points. I don’t know what the refining and distribution system is like there.

      Generally, it’s the speculators wot gets the blame but the truth is that – whenever they are able – “It’s the Producers, Stupid!”

    3. F. Beard

      But how, exactly? Lambert Strether

      With so-called “credit” from the counterfeiting cartel, the banking system. How else does one buy on margin?

    1. jake chase

      I think this excellent post can be summarized to read: oil markets maintain artificially high prices because gullible investors flood into commodity funds and producers offload inventory into such funds while pretending to retain it. It has seemed to me for years that it was speculation and not physical demand that maintains the high price of oil. If the speculation is financed by borrowing (as speculation generally is), a withdrawal of credit will normally produce a crash. One should remember, however, that maintaining a high oil price is critically important to the banks, the oil industry and the oil producers, all of which are monopolists with the highest connections in government. My bet is that the monopolists will win out over the reality of physical demand. Of course I could be wrong.

      1. Chris Cook

        Jake Chase

        I think that it is a category error to conflate ‘inflation hedging’ (which is ‘long only’ and motivated by fear and aimed at loss avoidance in the medium/long term) with ‘speculation’, which aims at short term transaction profit and may involve either buying or selling first.

        These two activities are like chalk and cheese, in the same way that the market instruments used are completely different in nature, since ETFs etc are quasi-equity, or ownership/creditary claims, whereas derivatives and purchases on credit are debt claims.

        As I have said elsewhere, to inflate markets in this way is inherently unstable, leaving the markets open to supply and demand shocks.

        Note also, it is in the interests of trading intermediaries to destabilise markets.

        1. jake chase


          Stockpiling a commodity you will never use is speculation. When the stockpiling is justified it by a fear of inflation you characterize it as inflation hedging, but regardless of what you call the activity, you are betting the price will go up, and if it goes down you have a loss. Hedging means buying or selling in a futures market to protect against losses arising out of either future production or future consumption. Hedgers only lose by not hedging.

          My more important point concerns the powerful entities having a vital interest in maintaining an artificially high oil price.

          1. Chris Cook

            Jake Chase

            As I have said, I view speculation as risk taking with a view to profit.

            Stockpiling may be for a speculative motive, but only if done in the short term.

            Stockpiling with a view to storing value over time is with the motive of avoiding loss.

            I argue that to conflate the two as ‘speculation’ is category error, and leads to wrong conclusions in analysing market behaviour.

            This is precisely what we are seeing, and my understanding is that Kenneth Singleton eg here


            and one or two others are making a similar behavioural distinction.

            As for the motivation in keeping prices high, producers will always do so if they can fund such manipulation. In my view there is nothing – other than a major supply shock, which can now stop a price fall – and such a shock, by further damaging demand, will only make the subsequent collapse that much greater.

  5. nowhereman

    Brilliant! Thank-you.
    Equities, commodities, exchanges, markets, Capitalism?
    Time for a do over. Let’s scrap it all and start again.

  6. joecostello

    “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.”

    There was also a significant drop in global demand from the spring of 08 at oil’s high to the spring of 09 its low, US oil demand, the biggest pig on the block, is still down almost 10% — not a point that should be left out of this piece. And yes, the Feds money dumping helped bring the price of oil to 60 – 70 a barrel, as it raised all other commodity prices too.

    Oil from the days of Mr. Rockefeller has never been much of a “market,” how the price has been set, was always filled with a lot of bs, after all, what price oil?

    This is an informative piece to show another aspect of our financial system is complete shit, but lets not forget the important point the writer makes that North Sea Oil is in decline, along with a lot of big old fields, Cantarell, Mexico’s oil production is off almost 25% since 04,( ) or inshallah Ghawar for examples.

    Theres a lot bigger problems with the global cheap oil economy than its historically fixed and scammed pricing system. If the price of oil goes back down to $45 a barrel in first half of 12, its going to have a lot more to do with a contracting global economy, than the machinations of finance.

  7. Jack M.Hoff

    Mr Cook, Thank you for your fine article, which provides insight into the mechanisms of commodity trading. I just can’t see producers and consumers agreeing on a middle of the road pricing on anything though. Those with a superior position will always rape the other repeatedly and forcefully. That’s the capitalistic way. What is needed is more transparency in all commodity markets so someone looking to protect themselves financially has the ability to do so without being an industry insider. Sure, some will say thats why you invest in funds, but really, are those funds managed for the investor or for the fund managers benefit?

  8. Mark

    I wonder how the Peak Oil camp will respond.

    Occam’s Razor does suggest, though, that the simpler solution is the right one. Peak production in the face of high demand would be a perfectly sufficient explanation to explain high oil prices. The complex scenario described above is … complex.

    Caveat: I have no idea how these markets work and I don’t profess to have an answer to anything.

    1. Chris Cook


      Re Peak Oil, I agree with the thesis that there is a peak level of production; that we have seen Peak Cheap Oil; and that in the long term the price can only go up.

      But the way I see it there are two boundary trend-lines (both up).

      There is an upper bound ‘seller’s market’ at which demand destruction sets in, and a lower bound ‘buyer’s market’ – at which production gets locked in.

      If leverage is available, sellers will always aim to maintain prices at the upper bound, but it is in the interests of intermediaries for the price to fluctuate between the two, as it is doing.

      For middlemen, price stability is Death.

      We have seen the over-supplied global natural gas market – which does not have the same market mechanisms enabling financialisation – at the lower bound, while the oil price was inflated/manipulated to the upper bound in April 2009, destroying the historic oil/gas relationship, and discomfiting Gazprom in particular who found customers no longer wishing to have oil-linked contracts.

      1. joecostello

        “demand destruction sets in”

        or as we know it in an economy dependent on cheap oil, the economy contracts.

      2. Mark

        I take your insight into the workings of the market at face value because I can’t really say otherwise. I wonder what I’ve ready regarding the higher prices required for unconventional oil sources.

        You’re saying sellers attempt to use leverage to keep prices high, and they would need to do that to make unconventional plays profitable. Without high prices, wouldn’t unconventional plays fold and reduce supply, thereby increasing prices again?

        Oil prices in the range you suggest would kill off shale plays and tar sands, or so I understand from what I’ve read elsewhere.

        Again, I don’t have an answer for anything. I’m a layman attempting to understand the implications of Peak Oil.

  9. Eclair

    Fascinating read!

    I don’t have one of those ” best financial brains that money can buy.” Farmers, growers of wheat or hogs, using the futures market to hedge against a fall in prices when their product is ready for market, makes sense to me. But the spiral into the stratosphere of derivatives seems like pandering to a taste for risk and gambling, the attraction of which eludes me.

    But the notion of “Dark Inventory” is mind-blowing. If I understand this correctly, this means we have no idea who owns what in the murky underworld of petroleum. Whooosh!

    But Lambert’s request is a good one: can the author summarize the whole manipulation scenario into a sentence or two that one could share with the clerk at the convenience store. Or with me.

    Reading this post is like diving into a John LeCarre novel. Nothing is as it seems.

    1. Frank Speaking

      relative to the idea of potential manipulations…if you want to put upward pressure on WTI price and reduce the glut of tar sands oil accumulating at Cushing, oh, I don’t know…how about we delay indefinitely activation of the Keystone….

      from Jeff Rubin on February 2nd, 2011

      “It is largely new crude from the Alberta oil sands piling up at Cushing these days, often coming in much faster than local refineries can process it. And within a couple of months, there is going to be another 150,000 barrels a day of Alberta crude coming down Transcanada Corp.’s newly completed arm of its Keystone Pipeline that will connect Cushing with the flow of oil sand crude from Hardisty, Alberta.

      “Until TransCanada can connect the ever-increasing flow of crude from the oil sands to refineries on the Gulf of Mexico (not likely before 2013), there is going to be a bigger and bigger disconnect between WTI and global crude demand as more oil piles up at Cushing.

      “As that happens, the oil industry and the investment community will look to Brent as the new benchmark for global oil prices. Soaring purchases of Brent crude contracts have already driven the European oil benchmark to the highest level in five months against NYMEX oil futures contracts as more investors bet it is a better indicator of global demand.”

      and just what are the armed bands in the Niger Delta up to making headlines about extorting Shell Oil when ever a price spike is called for?

      “Prior to 2003, the epicenter of regional violence was Warri. However, after the violent convergence of the largest military groups in the region, the Niger Delta People’s Volunteer Force (NDPVF) led by Mujahid Dokubo-Asari and the Niger Delta Vigilante (NDV) led by Ateke Tom (both of which are primarily made up of Ijaws), conflict became focused on Port Harcourt and outlying towns. The two groups dwarf a plethora of smaller militias supposedly numbering more than one hundred. The Nigerian government classifies these groups as “cults”, many of which began as local university fraternities. The groups have adopted names largely based on Western culture, some of which include Icelanders, Greenlanders, KKK, and Vultures. All of the groups are constituted mostly by disaffected young men from Warri, Port Harcourt, and their sub-urban areas. Although the smaller groups are autonomous from within, they have formed alliances with and are largely controlled from above by either Asari and his NDPDF or Tom’s NDV who provided military support and instruction.

      the intrigue and potential of manipulation is legend in the oil fields. as is often the case historical fiction comes closer to truth than straight history—”There Will Be Blood”; “Reilly: Ace of Spies”; “The Seven Sisters” as in oil not womens’ colleges.

      Much of what is in play in Afghanistan is about oil as much as it is anything else. As are the multiple intrigues ongoing in Eurasia. Stop by Jamestown Foundation’s “Eurasia Daily Monitor” site once a week and you will quickly see when it come to oil we are well and truly down the rabbit hole.

  10. BigBadBank

    Terrific piece – well done Chris (so much more interesting than the ‘What is money’ debate!) I hope you do give us a fuller rundown on Iran.

      1. LeonovaBalletRusse

        Frank, gotta say it again: “You’re good, you’re awful good” (To Have and Have Not” – Bogie-Bacall).

  11. Brick

    Well I don’t have the expertise to really comment on this article so I had a quick prowse of the IEA OMR derivatives report which confirms much of the criticisms outlined here. I have also seen sporadic critisms of the functions of WTI and Brent elsewhere and how they can be manipulated. The problem is that I think this article sees things purely through the eyes of the financial markets in oil and there are other bigger manipulators of oil prices which are coming rather unstuck at the same time.

    A couple of reports have come out through Platts recently of diesel shortages in Pakistan, India and China. Namely that trains are not running in Pakistan due to a diesel shortage, trucks being parked up in China due to diesel being unavailable. The problem is that these countries put a cap on the price of fuel such that when it becomes unproductive for refiners to produce they shut down creating a shortage. The problem is that we have seen this movie before in India and the end result is a rise in prices by the governments trying to cap prices. This alters the demand price floor for oil world wide. Its not unrelated to the arguments here but suggests to me the sustained financial manipulation of oil has permanently changed the oil price floor through governmental manipulation such that the size of any collapse must be limited and prices when economic recovery does take a hold could go to nose bleed levels. All the more reason to restructure the oil markets as you suggest now.

  12. Vernon Bush

    Two years ago I was on a vessel killng time off of Hurd Bank in the Med. The area was full of tankers just sitting full of oil at anchor. Every day we would see offloading onto smaller transports from one tanker and loading onto another. It was clear there was alot of shifting of oil going on but no tanker was moving to market. This went on for months till we left and as far as I know is still going on today


  13. bob

    Great read chris. Any truth in my reply to Lambert above? Something I have been watching for a while now.

    The reports out of platts of shortages of diesel in India and Pakistan also add some weight.

    Thanks again for the great summary.

  14. Jib

    Lots of good info but dont forget that there is a true physical market. A market of 85+ million barrels a day feeding refineries that produce refined product on a continuous basis that is distributed daily. The price the refiners pay for oil, that is the true price of oil.

    Good luck finding out what it is.

    I have been looking at this for a while and from what I see, most oil is sold on contract for delivery in the future at a set time for set price. I am not talking about a futures contract or anything you would see on a financial market. This is a true contract signed by a producer and a refiner. This oil never sees the financial market.

    Refineries are multi-million even billion $ factories that need a constant supply of raw material. No manager would ever let his refinery get in a bind for needing oil. They will not buy it on the open market, they will contract it out to insure delivery. The oil they get today at the refinery was agreed upon and contracted for months ago

    The oil companies do use the financial markets to try and make some more money but it is at the margins. So you do hear about a tanker of oil trading hands multiple times but it is all financial fluff. In the end, no matter what happens in the markets, tanker A will deliver its load to refinery B as was contracted about 6 months or so ago.

    The financial markets influence price but the coupling is looser than most people realize. The market price is almost totally about financial instruments, which is what this article is saying. If the global oil market represented by WTI and Brent was to evaporate tomorrow the result would be….a lot of financial companies going bankrupt. Oil would still flow, you would still have gas at the pump. Prices would…..

    That is the hard part, markets establish price visibility. This article and my research says that there is not a viable market for oil. So what is the true price of oil? Something close to the marginal cost is the best guest. That varies all over the place and with peak cheap oil, it is higher than it ever has been.

    And what is marginal cost to a nationalized oil company that uses its revenue to subsidize large chunks of govt spending? It is truly the cost of pumping or it is the cost pumping plus the cost of all the new stuff the govt is buying? Are you sure you know how the oil minister will answer that question?

    I dont think we will ever have a viable market for oil. As long as national oil companies consider the actual contract price they get for oil to be a state secret, there will be too much oil sold for undisclosed prices to determine the true price of oil.

    1. joecostello

      These are all really excellent points in understanding how “oil markets” work. The opacity of almost every aspect of the industry makes Wall Street look like a Public Citizen project. For example, how much of the market is traded as opposed to long term contracts?

      Its all well and good Wall Street found a big pile of money they didn’t have much of a hand in, but in fixing and manipulating prices they’re still pikers compared to the long experience of Mr. Rockefeller’s industry.

    2. Chris Cook


      Yes and no.

      There is indeed a considerable amount of financial pornography in terms of market data which is never disclosed, but you need to understand the producer/refinery relationship better.

      Exxon has long been ‘vertically integrated’ and works within long term supply relationships with producers to refine and distribute product. They do not trade on the derivatives markets to manage price risk, because it’s all internalised.

      BP is at the other end of the spectrum, and much of their oil tended to go to other people’s refineries, while they fulfilled their own refineries’ needs by buying oil from other producers. So BP trade oil more than any other major.

      Shell were somewhere in between, and in any case have made the very shrewd move to get into gas.

      How it works for those refiners who have not locked in price and crude oil supply internally, like Exxon, is that they make long term supply deals with producers – eg 10 million barrels/month, with some tolerance above or below.

      They then have a pricing formula which sets the price for specific cargoes – eg ‘Dated Brent Price plus $1.50 – and when the cargo is loaded that price is fixed, so that if the Platts Dated Brent price is $110/bbl the buyer pays the seller $111.50/bbl.

      You will see that the pricing has been separated from the supply. The futures market enabled this by allowing both producers and refiners to manage the risk, and to ‘lock in’ prices.

      So a producer like BP would be selling futures contracts in order to lock in the price and to protect themselves against falls: while the refiner for their part would buy futures to protect themselves against price rises.

      The producer and refiner will lose money on the futures contracts if the price rises and falls respectively: but that loss will be offset by the fact that they will be making/saving money on the physical market by way of compensation.

      1. joecostello


        The problem with your piece is that you leave out the whole demand drop part of the equation, because that would muddle the thesis on how much “financial” manipulation is involved in the oil bubble of 07 and 08, which I think you accurately show and many knew there was.

        But just look at the responses to this piece on how many Americans want to believe they can have they’re cheap gas still, if only Wall Street was brought under control. That just ain’t so.

        When you look at an industry, that has been intricately entwined with the military for the past century, and where in the last several decades the US has spent trillions “securing” the remaining large global conventional reserves around the Gulf, its difficult to talk about “markets” in any sense.


        1. Chris Cook


          Demand? Bloody hell, it was 4,000 words as it is!

          Some people are never satisfied ;-)

          You have a point, though.

          What happens on the demand side is extremely muddy, particularly once you throw in more complex refineries which are able to process the heavy fuel oil which simpler refineries sell off cheaply.

          You only need to read about the Petroplus saga to see how complex it gets.

          And yes, cheap gasoline has gone for good.

          1. Jb

            Mr. Cook, Thank you for a terrific article. In the comments above, ‘Mark’ asks about the effects of demand destruction on ‘shale plays and tar sands.’ I would expand on this and include financing of future exploration since the IEA has stated that significant investments are required to meet anticipated demand. Would you be so kind as to expand on this in your next article?

      2. Pwelder

        During the later John Browne years, BP in its investor presentations used to brag about what a great profit center their trading desk was.

  15. kayjay


    A somewhat distorted picture of a 3-dimensional puzzle. No question that the demand in U.S. and Western Europe has declined and somewhat precariously in Europe. Incomes just don’t match up with gasoline prices; yet, prices of gasoline have gone up on the East Coast, maybe, just maybe, because of closure of 3 refineries which indicates lower demand. But prices in California are quite high despite abundant supply from Canada and Tesoro (major refinery) which has suffered losses because of the low spread. Oligopolistic conduct by the majors is only part of the answer. But substantial demand is still there.

    Question: Why are the Canadians so hyper about the 2nd copy of the Alberta pipeline? That oil is not all going to Mexico and Brazil via Valero( major refinery) on the Gulf Coast. Part of it is going to stay in the U.S. despite large production in North Dakota, Montana, etc.

    I myself have been puzzled why the price of oil remains stubbornly high while discounting the Fed effect, reduced consumption and high prices. Oligopolistic behavior has something to do with it, the banks like JP Morgan, Morgan Stanley, Goldman, etc., the Swiss thieves, of course. But there seems more to it than meets the eye and the thesis elaborated here.

  16. Lune

    Mr. Cook,

    Terrific article! I’ve tried to wrap my head around the craziness of the oil market for a long time (how can a physically delivered contract stay so high when a global recession is dramatically reducing demand?), and your article does much to explain it. A few thoughts though:

    1) This may be a dumb question, but with respect to dark inventory, does inventory leased in this manner still show up on the US weekly inventory report? IOW, does the weekly inventory report underestimate true inventories by not counting the D.I. held by financial intermediaries, or does it overestimate by counting D.I. that isn’t immediately deliverable?

    2) While I agree with your conviction that prices are headed for a crash this year from an economics standpoint, don’t underestimate the political consensus to keep it high.

    Ten years ago, any sitting President would have had nightmares and visions of Mad-Max like armageddon sweeping the country if gas was allowed to reach $4/gal. Since that hasn’t happened and life on the streets has continued without so much as a protest from the sheeple, I think the pressure on the government to keep gas prices low has substantially reduced.

    OTOH, the immense profits that financial intermediaries have now found through their market manipulation and attracting funds to ETFs, etc. means there’s a new powerful player with a vested interest in keeping prices high (and volatile). Stack up the U.S. govt (wholly bought by the finance industry, with a minor interest purchased by Saudi and other Middle East sheiks), Wall St., the Middle East, and the oil industry, against the common person or silly industries that actually *use* oil, and it’s clear who’ll win this battle.

    IMHO, while what you say is economically inevitable, it may not come to pass any time soon given the remarkable array of interests working against your conclusion. To anyone who wishes to bet against oil this year, I’m reminded of Keynes’ famous quote, “the market can remain irrational longer than you can remain solvent.”

    1. MB

      The other maxim is: Don’t fight the Fed. That counts, too. I guess we know who is in charge? It ain’t the market!

    2. Chris Cook


      First point, the inventory figures are available: but it’s impossible to tell who has an ownership claim over what’s in tank, pipeline or even still in the ground.

      Secondly, I agree that there is some tolerance now to higher prices, which is why I suspect there is a tacit agreement with the Saudi’s/GCC to attempt to maintain a floor under the price.

      Conversely, there is definitely a level – not sure what that is (you tell me) – where US gasoline prices become an issue affecting re-election chances.

      The other leg of the tacit deal will be to keep a cap on crude oil prices.

      But the market is much bigger, and storage far too limited, for such an agreement to tolerate anything more than a medium shock.

      In my view, the producers involved in leasing oil have given up on this iteration of the cycle, and are quite cynically selling as many futures as possible to speculative buyers so that they will be able to lock in the price for as long as possible while the price collapses and until they can pump it back up again.

      Except, this time pumping it back up again may be a little more difficult.

  17. mmckinl

    Whip Saw …

    We are seeing it in all the markets. The players are using dark pools for stocks and other commodities as well.

    Investors have been fleeing/ bankrupted out of the markets for some time now … they finally see the score.

    We see this in market trading volumes. They continue to fall. Now we see the big boys cannibalizing themselves (MF Global).

    We see “bank runs” by other banks using derivatives. The whole financial system is imploding …

      1. mmckinl

        If only … Yves next piece deals directly with this …

        Bill Black: More Proof of Obama Policy of Covering Up for Elite Financial Criminals –

        Most likely no charges for the financial criminals … a few fines for far less than their booty, if that.

        1. Frank Speaking

          the purpose of the “slow walk” is to give as much time as possible for intervention from a higher power—god, shiva, governor, president, army general— to forestall the inevitable.

          these shenanigans, it could be said, are all part of the get away plan from the bank hiest

  18. MB

    “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.”


    On a daily basis from 2007 on, I watched CNBC: daytime trading commentary as well as Fast Money. Fast Money was all about “playing” the contango. Much laughing and enjoyment on that show about the “plays”. These types of traders are basically “hedge” funds – those that “hedge” their bets, so they cannot or rarely lose. That is all about options (making money off high and low rumor and expectations), call spreads, futures and yes, if you put it so charitably, fear. Fear of not making money, or shall we say, finding a strategy of making money whether greed or fear is in charge. They are both about grabbing for one’s self, regardless if that is good or bad for the community, world or the environment. To clarify, the “fear” you are describing, is “fear” or recognition that as inflationary actions are applied (like money printing), you go where your assets are best preserved. So while you are talking about putting money in commodities (real tangible bets), we know that in the future, anyone can charge anything they want for it, when the need for survival is at stake. That is the rationale for “preserving money. It actually *is* greed, because it’s about keeping one’s money (and making more of it).

    Other parts of the market, say, HFT – high frequency trading, as expressed by buying and selling around minute incremental price fluctuations, is what another segment (high powered, Goldman types) arena. The average person cannot compete there either, because their computers are the best, co-located closest so their orders beat yours, and they play shadow automated games by placing orders, then yanking them, when greater fools (such as you or I) come in, believing price “discovery” is real. They are mirages, yet HFTs get to “invest” and make money. Those movements are dictated by computer momentum (daily news, rumors, supply/demand reports, speculation).

    The last type of market is the retail market, such as the common person might “invest”, banking on any sort of rationale – fundamentals, cyclical rotation or perhaps a dividend. We are the red meat for the above groups.

    It is not so hard to correctly diagnose what will happen in the future. If you watch Fast Money carefully (and in aggregate with daytime market shows and even Mad Money) you will eventually see a coherent picture of what is going to happen.

  19. MB

    What I think has also happened, which actually is great, is the broad participation, meaning, all the long term funds and investors (those who believe the buy and hold BS) have withdrawn, leaving the traders “naked”, so to speak. This is called “thinly traded market. The “greater fools are standing back, letting the greed cannibalize itself to implosion. The dark pools are revealed. The victims have woken up to their victimhood. Everyone is pulling their money (the last step of musical chairs. The largest players are now unable to find a chair and that exposes the leveraged risk of the others.

  20. Frank Speaking

    “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.”

    that is always the BIG “if” isn’t it?

    if the rating agencies had been doing their job…

    if the bank’s risk assessment departments had been doing their jobs…

    if the FED had been doing its job…

    then there are those who would say the aforementioned WERE doing their jobs—which is always to look the other way in deference to quarterly profit reports.

    1. Chris Cook

      Frank Speaking

      Let me unpack that a bit.

      My opinion on position limits in the exchange traded futures markets is that they are as much use as a chocolate teapot EXCEPT in the delivery month of a deliverable contract.

      And then only to make mandatory what a well run exchange and clearing house does already.

      IPE did not have position limits, and no-one ever seriously suggested they should.

      It’s what goes on off exchange which is crucial, and my recommendation to the UK Parliament’s Treasury Select Committee was that a global transaction registry is necessary – a subject to which I will return.

      At the end of the day, sunshine is the best disinfectant.

      1. Frank Speaking

        indeed, bring on the sunshine!

        in the case of oil though we will need that sunshine amped up through a solar collector like those used in electrical generating stations if there is any hope of gaining clarity.

        thanks for very interesting and informative piece and further expansion in your replies.

        looking forward to more

      2. LeonovaBalletRusse

        Chris, “the chocolate teapot” — “Tha’s what I like” say the skimmers. No evidence.

  21. Frank Speaking

    “We can’t solve 21st century problems with 20th century solutions…”

    all I can say is pray (animal sacrifice) for us here in the US where we have a growing political movement to take us back to 18th century solutions for 21st century problems

    oy vey!

  22. Frank Speaking

    “For middlemen, price stability is Death.”

    this is the cornerstone of capitalism’s boom and bust cycle where for capitalism equilibrium is death—as in unprofitable

    1. LeonovaBalletRusse

      Great insight, Frank. This may be the very crux of the matter, the pivot on which the whole rotten world of “I’ve got mine” turns.

  23. Hugh

    Great article, thanks. Not sure about the primacy of spot prices except at specific points, otherwise I think it is the futures which dominate. Also inflation hedging always just seemed an excuse to me for a different kind of speculation. Look for instance at the problems in Europe which have been going on for two years but especially hot and heavy since September-October. There’s been no problem selling Treasuries because of the flight to safety but oil prices have been moving up anyway.

    Re heating oil, I think it is a small and localized enough market that it can be physically hoarded. In the past, I think Morgan Stanley was a big player in this.

    I don’t see an accord between producers and users in the offing because as pointed out in the post, there already is an under the table agreement and it is falling apart. I think we have gotten to a point in kleptocracy where things are getting too unstable for such an agreement to work anyway.

  24. LeonovaBalletRusse

    “not a deliverable contract” — This is the tragic flaw, and the TELL of the INTENT to corrupt/ruin the fundamental, original purpose of any commodities exchange.

    This moves in common cause with the removal of Glass Steagall. Do not all such measures reveal the rank collusion for private profit through wreaking havoc in “free markets” in the U.S.A. and throughout the world?

    The Goldman-Sachs Greece FIX was the LOGICAL outcome of the above.

    “O what a tangled web we weave
    When first we practice to deceive.”
    (Alexander Pope?)

  25. Banner

    Regarding the actual price of oil delivered, I know smaller oil producing companies (LINE, EPD) who hedge their future production to guarantee stable dividends, sometimes put in their annual reports what was the average price they got for the past year and/or what their hedged price for the coming year will be.

  26. Fiver

    Very interesting piece. A couple of thoughts:

    1) I don’t think there’s any question of an understanding already in place between consumer nations (obviously US in particular in terms of raw power)and producer nations, and not just Saudi Arabia/GCC. There are simply too many important countries that rely on oil as a major, or even sole, revenue generator to let prices go much below $70 for any extended period absent a total demand collapse. And even within the US, not only would shale oil development be stopped in its tracks, but all existing conventional producing States, which still produce very large quantities of oil, would receive a severe shock.

    2) Re this statement: “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.” I just don’t buy that inflation-hedging in a deflationary environment was the motive here, as opposed to instant efforts to gun the price for all it was worth using free Fed money from the minute both QE moves were (first leaked, then..) announced. In the analysis laid out “fear” of inflation operates on both sides of the fence (holders of dollars AND holders of oil) even as prices rocket. An oddly lucrative “fear” from my perch. I smell greed. But either way, that instant commodity and equity spikes are about all that is accomplished by “easing” with nickels and dimes and pathetic service “jobs” trickling down to the peasants ought by now to be obvious to all.

    3) Given that ECB, China, Japan, and the Fed are all engaged in “easing” of one sort or another already, and will undoubtedly do more on cue from Mr. Market, I just don’t see where the unwind comes in unless it is European money liquidating assets circa key decision points in Europe (March Merkosy deadline, French election, ongoing debt auctions, etc.) – which would happen in any event as “investors” in general flee to “safety”. It’s a lot of fear to halve the current price.

    4) Who would actually benefit from a short-term (H1) collapse in oil prices?

    a) Consumers would receive a several hundred billion dollar infusion – which producers would not receive, and therefore not be buying goods from goods producers. Something of a saw-off there.

    b) HOWEVER, it would be great for Obama’s election chances given Americans’ clear identification with gas prices as proxy for assessing better/worse economic direction; and

    c) Provide a golden window for any move on Iran, with the virtually assured major spike taking off from a much lower base. While I’m sure plenty of shills of various sorts are hyping Iran for all its worth, it nevertheless is already the object of what amounts to a war (measures against oil and Central Bank; sabotage of missile sites; assassinating scientists; much more)and the dangers of a policy error, be it an Israeli/US attack, or Iranian to defend itself is huge. The threat of real crisis is anything but trivial.

    5) Whether oil prices are manipulated only by oil companies and some big financial players, or also the favorite of intense speculative activity, the lack of transparency and information renders the idea of a “market” a total joke. Nonetheless, it’s evident that major new capacity exists in Saudi Arabia (added since 2008), Libya was a non-event but in any case is now pumping away, and Iraq is going to be the new Saudi Arabia inside a few short years. Taken together with uncoventional oil (Canada, shale, deepwater, etc.) there is an actual glut of real oil supply in the cards for several years, to be followed very quickly by supply constraints and far higher prices based solely on demand – what the oil majors, GS, and “investors” tack onto that (I’d say at least 20% currently)will still be there, as I don’t expect any action of any kind to change the existing, rotted-out system.

  27. Chris Cook


    Concerning markets and information, the whole point of mentioning ‘Dark Inventory’ is that with the exception of a few people in the know virtually the entire market is blithely unaware of its existence and is therefore making investment decisions on the base of erroneous assumptions.

    I believe – for the reasons given – that I have identified a bubble currently in the process of deflating.

    My forecast is based upon the analysis outlined above. I have access to the same information as other players: my assumptions are different.

    So, with respect, I may be wrong, but hardly ‘reckless’.

    We’ll see if I’m right soon enough.

    1. Pwelder

      Yves and Chris: Thanks for this post/thread. It’s one of the most important items to go up on NC in quite a while. And that’s saying a lot.

      Chris Cook knows a lot about his subject. More important, he’s aware of and candid about the present limits on his knowledge, due to the opacity engineered by the good folks at BP/Goldman.

      While we’re talking forecasts, let’s note for the record:


      Published: Jan 09, 2012

      LONDON (Dow Jones)–Oil has the strongest fundamental picture of all the globally traded commodities this year due to resilient Chinese demand for oil and substantial shock risks to crude oil supply, said the head of commodities research at Goldman Sachs Group Inc. (GS) Monday.

      “Into 2012, you argue that the risks change. There’s more upside risk to demand and upside risk to supply,” Jeff Currie told a conference in London.

      He said strong demand from China and steep backwardation in the crude oil market shows an underlying squeeze in supply.

      Goldman maintained its price forecast of $120 a barrel for Brent in 2012.

      Currie was speaking at a Goldman Sachs conference on global strategy.

    2. charles sereno

      I regret using the term “reckless’ (because of its emotive implication) to describe Chris Cook’s forecast of possible $50 Oil in Q2. His analysis, however, is solid and he says — “We’ll see if I’m right soon enough.” I’ll be anxiously looking forward to his follow-up post and I’d like to join other readers in thanking NC for this very useful dialogue.

  28. billwilson

    The price of spot may fall, but the long term uptrend will remain.

    If oil prices fall, exploration drops off and supply falls (decline rates now are quite high for new wells, and exploration costs high), leading to the next bigger spike a few years on.

    One big problem with oil is that the various producers can have widely differing production costs of an essentially (yeah I know sweet crude vs sour etc) similar product. This always make the pricing dynamic interesting.

  29. MikeR

    These opaque markets need to be opened; however, it won’t happen anytime soon. The markets are now being controlled by the Fed and Central Banks through the big banks (Goldman, etc.). Central Banks will NOT let the price of oil collapse simply because it will/would undermine their attempts to minimize deflation. Since almost everything made and services provided have oil as a major cost input, lowering oil would greatly increase price deflation; something they will not allow to happen.

  30. Mark Chembrovich

    This can not happen. The Saudi Gvt needs oil at $92/bbl to sustain their economic commitments to the citizens of their country. They do not borrow money to finance their economy and their currency is backed by gold. You may reduce the amount country’s can afford, but you can not bring the price of oil below that amount because the valves get closed and the commodity is stored until the asking price is met.

  31. TomOfTheNorth

    If the forecast crude oil price collapse will supposedly be result of the failure of sinister cabals to perpetuate their dastardly manipulations, are we to infer it was a similar failure which caused the break in 2008? I think not.

    Mr. Cook offers insight into all manner of technical market operations in support of his prediction yet I am left with the conclusion that this is still just a fat tail ‘flyer’ that excludes any discussion of FX, economic conditions, geopolitical developments, etc., which is ok but not particularly convincing.

    A side note, futures exchanges do not see private contracts between parties.

  32. Gerry

    Mr. Cook is undoubtedly correct is his assessment of the financial side of the market. I am sure Brent and some other prices can be manipulated.

    However as many posters have mentioned, he is light on any analysis of the physical side. The story mentions lower demand in the developed nations several times. Higher demand in Asia doesn’t appear to be worthy of mention. The story mentions that Saudi pumped record amount of oil in November, why are they doing that into an over-supplied market, don’t they understand supply and demand?

    Over the summer the developed nations released 60 million barrels of oil and yet inventories are down. Yes Libya played a role in that but there are no signs of excess supply in the market.

    Anything can happen over a few weeks, the hedge funds have stampeded in an out of many markets over the last three years, but if your view is long term, I don’t see oil at $50 for more than a few weeks, if at all.

  33. TomTom

    I think this is an interesting article but it is missing the elephant in the room which is the rise Asia middle class, no need for convoluted financial conspiracy theory here. Of course traders can increase volatility but one player alone is not enough to move the entire market in one direction given the sheer size of this market. Regarding the recent Saudi Arabia production hike, it is perfectly consistent with a decline in OECD inventories and an increase in domestic consumption.

  34. Nathanael

    Seems reasonable, it meshes with the DB report, except that this is actually a *cycle*. In response to high prices, demand will drop, then the speculators will pull out, the price will crash, production will be tightened, the price will start rising, a new round of speculators will go back in…. on and on until total demand destruction.

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