February 13, 2013

The Brent Oil Contract is a Sham!

By EconMatters  


Oil Benchmark 

It is a sad state of affairs that the entire world of energy, and consumer energy prices are all based upon a fraud of an energy contract masquerading as the Industry`s Benchmark, setting the price for all other grades. 

Monthly Rollover Ramp

Here is an idea of how manipulated the Brent Oil contract that trades mainly on the ICE exchange is we are at rollover time once again in the Brent oil contract and sure enough as day, the contract is moved up substantially right before expiration. 

This happens almost every rollover, and is impossible to do in a non-deliverable market without precise market manipulation. 

Always Positive Rollover Carry

The other common feature of the Brent contract is the expiring month is always higher by a dollar, dollar and a half, than the contract for the next month without fail. Again this happens every single rollover without fail, and again very hard to “naturally occur”. 

It might be reasonable in the old days, or in a market that was partly physical deliverable that you would have times that exhibit Contango features that would account for this price differential. 

No Physical Delivery 

But this happens every time, and the old rules of Contango and Backwardation don`t apply to purely paper markets as there is no need from one month versus the next for “stronger demand” as nobody ever takes delivery of a Brent contract of oil. There is no demand for near term oil contracts due to supply shortages in the oil market.

The only reason for this price differential which always occurs and is heavily manipulated is to ensure for a positive rollover effect for the big players in the market.

No Rollover Risk equals much easier to invest capital in the market

Why lose money if in basically an unregulated space you can just move up the front month at expiration so that when you sell to close out the position on the front month at a higher price, and buy the next month to reestablish a position at a lower price you have a positive built in rollover. 

Makes the risk of investing in oil with an always positive carry much less. It is a scam of major proportions when you factor in how many years this has been going on in the ICE market.

Not fully credentialed to be a Benchmark for anything

However, that isn`t the only thing that doesn`t pass the smell test with the Brent contract. The main problem is the Brent contract is illegitimate and should not serve as a founding basis for any price discovery.

It trades on essentially an unregulated market with little or no accountability in regards to transparency. And this contract is setting the price of oil for the entire oil supply chain.
Represents what Storage Facilities?

First of all the Brent contract needs to be tied to actual oil inventories in Europe so that supplies can actually be tracked and evaluated on a historical basis. 

For example, WTI is based upon oil inventories at Cushing Oklahoma, which can actually be tracked in a weekly report, and reported by an independent government agency in the EIA, for Brent to become a legitimate Oil contract it needs to do the same. 

Needs to be actually Regulated

Or frankly regulators need to force the ICE exchange to do so or discontinue the futures contract, as it has become far too important at setting world oil prices to remain in this non-transparency illegitimate status. 

Independent Governmental Agency Reporting of Supply Data

So once actual inventories of oil supplies are attached to the Brent Contract, there needs to be an independent government agency like the EIA in the US which collects data on an independent basis and provides weekly, quarterly, and annual reports on oil stockpiles.

We live in the Information Age

We do live in the modern age of increased technology, data collection, and transparency with unprecedented access to all types of information. 

ICE exchange has no incentive to change status quo without Regulatory Pressure

It is about time that the ICE exchange is forced by regulators to come into this century, especially given the important role that Brent has become as a benchmark for setting price in the oil markets, and thus derivatively gasoline and heating oil markets, by being forced to comply with these aforementioned instrumental changes, or be forced out of the market. 

Brent is so much easier to Rig than WTI: This attracts Fund Flows

You want to know the real reason that the Brent market has traded at so high a premium to WTI, and became so popular by the major players in the oil trading and investment community? 

It is because the contract is based on “nothingness” has no supervision by regulatory authorities, completely non deliverable, represents no actual storage facilities, no data tracking, has no independent weekly status reports, a forever positive carry, no transparency, and very easy to manipulate. 
Fund Inflows Set Price not the Fundamentals Anymore

Moreover, since oil prices are not set by the fundamentals of supply and demand, price is solely determined by fund flows, i.e., investment capital goes into a commodity it goes up, investment capital goes out of a commodity it goes down.

“Asset Class” Investing has a built-in Long Bias

I know theoretically capital inflows could come into a market and price could go down, i.e., they could all go short, but for various reasons these shorting periods are relatively few and far between in the modern era of oil trading. 

The same reason investment capital for the S&P 500 has a long bias applies to oil markets as well in the modern era of asset class investing. Funds want exposure, and the modern definition of an “asset class” by investors is inherently long biased. It is just how it actually plays out, theoretically it doesn`t have to, but it just does.

The Dirty Little Secret of the Brent Premium to WTI

So given this state of affairs, and prices have no real attachment to the fundamentals of supply and demand, fund inflows into the futures market increase price, and consumers all over the world pay for end use products based upon these fund inflows, not the fundamentals. 

So the dirty little secret why the Brent Contract is so much higher than WTI is it attracts more fund inflows by the large players who want exposure from an investing standpoint to the commodity, thus increased fund attractiveness equals increased prices, and a much larger premium to WTI than would otherwise be the case.

It all has to do with fund inflows, and the deleterious effects for consumers play out in the following: Fund inflows into Brent, Finished Petroleum Products pegged to Brent Price, Consumers pay higher prices with no change in the fundamentals of supply and demand in the marketplace. 
Given the slow growth economy, consumers should be getting a break at the pump!

We have gone from a supply and demand market to a funds flow market and this really sucks for consumers. 

This is where the regulators are supposed to step in and protect consumers. After all, this is part of what governments can offer citizens for taking substantial pieces of their income via taxes.

But the regulators to date have been unwilling to step in and regulate the oil markets, and consumers and businesses will continue to pay more than they should for gasoline and heating oil products in the marketplace. 

ZERO-SUM Game in Oil Markets

However, what sucks for one group is often great for another constituency, and for large banks, hedge funds, and financial institutions that have been known to rig a market wherever and whenever they can, this ICE exchange traded Brent Oil contract is a dream come true for their needs.


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