July 20, 2012

Forget Libor-gate, Oil Market Manipulation Is Far Worse

By EconMatters

Since the Global Community all the sudden seems to be preoccupied with Market manipulation even though the authorities knew it was a problem for over 5 years with Libor Rate Fixing. It is high time authorities look at the Crude Oil market which has been manipulated for the last decade and all the sophisticated participants know it is rigged or artificially higher than the fundamentals of the economy dictate. Consumers are paying an easy $35 dollars per barrel over what they would otherwise dole out for a barrel of oil, if fund managers didn`t use the benchmark futures contracts as their own personal ATMs.

Just a month ago Crude Oil WTI was $78 a barrel and today it is $93. Do you think the fundamentals changed one bit to merit this price swing? Nope! Supply levels are all at record highs around the world. Is it Iran? Please!! It is all about the money flows, nobody takes delivery anymore. Assets have become one big correlated risk trade. Risk On, Risk Off. If the Dow is up a hundred, you can bet crude is up at least a dollar! It has nothing to do with fundamentals, inventory levels, supply disruptions, etc. It is all about fund flows.

Chart Source: FT.com, July 19, 2012

 So how this affects the average Joe is that if Wall Street is having a good day, i.e., fund flows are going in, then Average Joe is having a bad day and paying more for Gas. Yes, it is that simple. A good day for Wall Street is a bad day for consumers at the pump these days as Capital flows into one big Asset Trade: Risk On!

It should be separate in that equities respond to stock valuations, and energy responds to the market conditions of supply and demand. But that isn`t the case in the investing world today, it is all about Capital Flows in and out of Assets. The economy could be doing really poorly, Oil inventories can be extremely high, the economic data very bleak but Oil will go up and consumers will pay more at the pump just because some Fund Manager pours capital into a futures contract. The Fund Managers goals are in direct opposition to the consumers who actually uses the product. Funds flows and not supply and demand ultimately carry the day in the energy markets, and that needs to change!

The key is equities, crude oil (both Brent and WTI) are essentially equities for Fund Managers to trade in and out of and they make a fortune in these instruments. When I refer to Fund Managers this includes Hedge Funds, Oil Majors, Pension Funds, Investment Banks etc. This is part of the reason that the price of oil can be so varied in value within a 3 month span. WTI can literally be $110 one month and $80 the next because of pure funds going in or coming out of the futures contracts.

The volatility really is where they make their money, they have deep pockets and they make a fortune moving crude oil around like a puppet on a string. If you think in terms of each dollar price move in the commodity being equal to $1,000 and the size that these players employ on a monthly and quarterly basis you start to see the value of buying thousands and thousands of futures contracts and capitalizing on these huge moves in the commodity.

Start out a quarter at $80 a barrel , buy a bunch of futures contracts and put them in the portfolio along with your other holdings like Apple, IBM, and Johnson and Johnson and run them up just like any other asset class in the first quarter to hit your numbers. Use the media to hype Iran or any other potential supply disruption scenario and Voila you end the quarter at $110 and you have made far more gains in your Crude Oil asset class than lowly Apple by comparison. It’s the biggest game on Wall Street!

Notice how European equities are at 11 week highs and look at the Spike in the Brent contract. Fund managers pump money into these asset classes and once earnings are over, they will pull their money out so they are not left holding the bag when the damage to the economy ensues as consumers and the economy slows due to the burden of artificially high Oil prices on discretionary income.

The economic downturn has a lot of negative effects, and consumers should be benefitting from lower fuel costs as a result of slower economic conditions. However, Fund Managers will not let the Fundamental Oil Price take hold in the market place, their gain is consumer`s loss. Right now Oil prices should be at least $75 a barrel based on current supply levels, and the facts regarding near recessionary levels of unemployment, weak manufacturing, and constrained housing production taking place in the economic landscape. Gas prices are not matching the GDP numbers or the capacity utilization rate of business activity in the economy.

But Fund managers are laughing all the way to their Hamptons and Connecticut mansions while average “Joe Blow Consumer” has to pawn household items or charge up their credit cards to fill up their gas tanks each week. This Oil manipulation is really putting a crimp on consumers and makes it extremely difficult to get this recovery off the ground because just as the economy starts recovering fund managers slap it back down with their run up of oil prices. This leads to growth being constrained and even sputtering, consumers start reeling, and the entire supply chain is negatively affected because of these artificially high energy prices. The fund managers then dump their holdings and short the market, and the entire cycle starts over every three to six months or so. The volatility is great for them, but really hurts economic stability.

Also, this is one major reason why a QE3 program will neverwork because it just adds fuel to this process. And any benefits to the economy are quickly offset by even more inflated energy prices. The Fed giveth on one hand, and the Economy suffers on the other hand. A no win situation which Ben Bernanke is well aware of from the last failed attempt in QE2 which just plays right in line with the ideal Fund Manager strategy of manipulating price by creating artificial demand through paper trading of markets. The last thing they need is more paper to artificially accumulate positions and distort market prices to an even greater extent.  

Hopefully, Ben Bernanke and crew have learned their lesson is this regard, which it is hard to target a QE Program without artificially inflating all assets, even those that are essential to everyday living, and end up hurting the very people that you are trying to help. In this case, Fed Policy would be a contributing factor towards the same Market Price Distortion of Fund Managers that ultimately needs to be fixed. 

So what is the solution to all this madness? Everybody in the market knows the culprits, so why doesn`t this practice ever get addressed? The same reason Libor manipulation went on for so long, all the watchdogs are completely incompetent or lobbied to death on these financial matters. Obama tried to squash the fund managers with the SPR release, but even then word got out long before the actual lever was pulled, and it took 2 months to coordinate. Can you say too little too late? Consumers were already paying $4 gas for months before any action was carried out.

Day Trading isn`t even the problem here it is the buy and holders who accumulate large positions for swing trading that ultimately do the real damage and price distortion in the Oil Markets. Legitimate regulation on Fund Managers who accumulate and hold these large positions in the form of enforcing delivery obligations would clear up this malfeasance real fast. I guarantee you if it was a requirement for any Fund Participant to take delivery of any Futures contract held more than 3 days that there would be a significant re-pricing in the Oil market, as well as adding price stability as true market conditions would dictate price.

And based upon actual inventory levels over the last 5 years, this suggests price should have been very stable as inventories have not fluctuated much during this era. Even with all the turbulence here and there, actual supply has never been an issue with inventory levels all near the highs of the 5 year range for this period.

Day Traders can continue to practice their craft in the Oil markets because it can be argued that they don`t move price significantly, and actually create better pricing by adding liquidity to the market for participants if they actually did need to hedge production or set up physical delivery of the commodity. An example would be an Airline getting a fair price when they enter the market to hedge price due to an active Day Trading market.

So the next time you fill up your gas tank, just realize that this price is an artificially high fixed, manipulated price due to the Position Trading of the Fund Managers. Libor Gate pales in comparison to the actual pass through effects of price manipulation in the Oil Markets. If you think Consumers are being screwed by artificially fixed Libor Rates, and Politicians have finally stepped forward after years of abuse and neglect, then you should really be outraged by the Oil Price Manipulation.

Consumers have been paying on average for the last five years by conservative estimates a good 35% over fair market prices for Oil related products due to this Manipulation on behalf of Position Traders. Again, I label the group with the catch all term “Fund Managers” defined earlier in this piece, but I am not referring to just the standard definition of Fund Manger. Any Market participant who accumulates a large position and holds over time which results in the distortion of market mechanism price discovery due to not actually taking physical delivery of the commodity is inclusive of this label “Fund Manager” and part of the problem that needs to be addressed.

So how long will it take politicians and the CFTC to address this manipulative practice that is a decade in the making in the Oil Markets?  My guess is it will just continue as usual because regulators and politicians are either corrupt or incompetent to address the issue and consumers are too busy working their ass off to even have the time or energy to revolt against this practice.

There isn`t a “Gotcha” moment like Libor Gate, rather just a slow steady business practice that drains consumers of their resources like just another societal Tax on their consumption.  A repugnant tax I am calling attention to: the “Gotcha Bells” should start resonating in policy holders’ ears, and they should finally start addressing this seedy Oil Market and its blatant Market Manipulation of Price.


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