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Acceptable Market Manipulation

by ChrisCook Thu Nov 9th, 2006 at 05:49:46 AM EST

In the US "Unacceptable Market Manipulation" is a felony.

A fellow regulator at the London Metal Exchange joked to me when I was Director of Compliance & Market Supervision at the UK's International Petroleum Exchange that this implied that there was such a thing as "Acceptable" Market Manipulation - and my response to him was that he had just defined "Trading".

This came home to me about six years ago when I assisted the defence of a trader accused of manipulating IPE settlement prices. Over the course of the case - but too late for him - it emerged that it was the customers of the market who were manipulating the settlement price and I made a formal complaint which - because of my former status - led to the appointment of a Commissioner by the IPE.

Unfortunately I alleged "systematic" manipulation which the Commissioner took to mean one or two traders doing it most of the time - when in fact I should have said "systemic" - ie most of the traders doing it some of the time. It was so rife that the individual traders ("locals") called it "Grab a Grand". They made profits at the expense of the manipulating traders - who were quite happy to lose "on-exchange" because they made small fortunes "off-exchange" on deals priced against the manipulated "settlement price".

So the IPE was whitewashed, I was discredited and lost just about everything I had ("you'll never work in this town again").  But it became clear that not only did the IPE know the trader was not responsible for the actions of the customer whose orders he was filling but they had actually reported that customer's conduct to the Financial Services Authority, who at that time had no jurisdiction over customers. The IPE did not see fit to inform the Disciplinary Tribunal of this, naturally, which was cynical, indeed scandalous, conduct on their part.

The fact of the matter was I could not be seen to be correct, because it would have "brought the market into disrepute" Old Boy.

AVery British Solution ensued: the rules were quietly changed, one or two of the locals were admonished, the IPE - who had changed from a "mutual" to a "for profit" announced good profits (the "settlement" trading was huge) and the person responsible at the Treasury has since moved on to great things, while the person responsible at the FSA now operates a hedge fund.

And the then CEO of the IPE now runs Lloyd's of London, of course.

You really couldn't make it up.

As a result of this, in June 2001 I wrote to the Iranian Central Bank governor telling them Iran was being ripped off, and the whole "Oil Bourse" project was the eventual result.

All good stuff.

But of course, it's not just the producers who lose - it's consumers as well, and I was contacted by the US Senate sub-Committee on Investigations who were investigating the (North Sea) Brent contract and they sent two investigators to London (to see me and others), and I had a whole afternoon with them.

Unfortunately, just at the crucial point, the Republicans took legislative control and  that was effectively the end of it - a damp squib of a Minority Report was the only outcome.

So the people responsible for manipulating global oil prices  were now in control of all of US governance and have been for the ensuing six years.

All that ended two days ago.

The opportunity has now arrived - if the Democrats have the balls - for a comprehensive investigation into the operation of the global oil (indeed, energy) market and its effect on the US consumer. Several state Attorney Generals have been bouncing up and down - particularly when gasoline was $3.00 a gallon, but none of them have the resources or expertise to get to the bottom of it.

There is the structural issue - of the NYMEX/ICE duopoly - and then there is the issue of what is or is not acceptable market manipulation (particularly vexing at the moment in the field of credit derivatives.

And of course, how do you structure regulation in a global market place - a question to  which I have given about 8 years thought, and believe as a result is relatively straightforward to answer.

Beyond that there are particular relationships and courses of conduct which I do not believe would survive scrutiny.  In particular the relationship over the last 10 years between a major investment bank and a major oil trader, both household names.


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Thanks for the diary. Do you mind me asking how you've made your living since that episode?

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Nov 9th, 2006 at 06:01:52 AM EST
With great difficulty! I've been providing consultancy in relation to new partnership-based "enterprise models" through Partnerships Consulting LLP.

Hard work, especially when the business model is to share in the value created - I have lots of "investments" currently, therefore but very little cash....

But I believe that I am actually getting somewhere, particularly in Scotland and Norway, and particularly in the field of Micro-Enterprise (0 to 10 individuals) where we have matched funding from Innovation Norway, and both a Scottish and Norwegian Council, working with us to set up pilot schemes within the "Hanseatic Microfinance Initiative".

I'll post a Diary on that shortly, since it looks likely to happen.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Nov 9th, 2006 at 08:09:59 AM EST
[ Parent ]
This would actualyl be interesting to crosspost on dKos. I'll drop a link over there to this diary in any case or, if you're interested, may crosspost it under my name.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Nov 9th, 2006 at 06:02:57 AM EST
Please do crosspost.

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Thu Nov 9th, 2006 at 08:10:53 AM EST
[ Parent ]
but not today, as I have already used my diary quota with this effort: Let's talk about energy (and a gas tax) now

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Thu Nov 9th, 2006 at 08:49:14 AM EST
[ Parent ]
And that one was really good now.

And pretty well received it looks like.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Thu Nov 9th, 2006 at 03:58:01 PM EST
[ Parent ]
good time to post it too, the nice buzz from the election hasn't worn off yet.

you are the media you consume.

by MillMan (millguy at gmail) on Thu Nov 9th, 2006 at 04:04:13 PM EST
[ Parent ]
I found the welcome glacial, and so did a couple of other Energizers. There seems to be such an absolute hostility to the idea of the gas tax, that it's even impossible to contemplate trying to change mentalities on this topic, or on the wider topic of taxes.

Kossacks do not seem willing to challenge the now prevalent idea that all taxes are evil.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Nov 9th, 2006 at 04:33:12 PM EST
[ Parent ]
..it is completely clear that humans just copy what they see in the movies... gee

As they say.. I hope you are in a safe location :)

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Thu Nov 9th, 2006 at 01:22:37 PM EST
I had an interesting and appreciative audience in Stavanger - quite a major oil town - who replied to my provocations with further provocations and we subsequently had a jolly night on the town talking some outrageous business ideas. I really liked the feel of the place.

Next morning I revisited the Oil Museum (where I had given the seminar) to see the exhibits. It was informative enough to cut thru my haze.

I especially liked this huge cube with perfect mirrors on the walls and a screen on the floor and ceiling. Half way up the wall a narrow gap had been cut all round so you could walk round a gangway and stick your head in and see what was happening.

What was happening was that a projector in the middle of the floor of the cube was projecting a movie on the ceiling, and a projector in the ceiling was projecting onto the floor. The mirrors then reflected it all into infinity. It was an' artistic' interpretation of oil exploration. Very very weird - especially with a hangover...

You can't be me, I'm taken

by Sven Triloqvist on Thu Nov 9th, 2006 at 02:12:31 PM EST
First, the US market is less prone to settlement rigging than the IPE.  WTI has a real, wet settlement.  You just can't screw with it too much or you get handed wet oil in Cushing OK and have to cope with it.  Not so much fun.  Or wet mogas/diesel in NYH on products.
Volumes are much larger, the number of players are larger and it's much more difficult to move the print much.  IPE is structurally flawed in that the smallest Brent cargo is 500MB vs the IPE contract of 1 MB.  No way to force a real physical transaction.

Secondly, you've yet to show me any evidence that the game playing is skewed only to the upside.  I saw just as many players taking the print down as up.  Most of what I did was real, wet oil without any exchange contract to mess with, but I sat with some of the big boys and watched them play.   It's easier to skew upward as the producers are happy to play along but the gamers need movement not a fixed offset in one direction.

third, the problem in the US isn't the last one tenth of one percent  on WTI.  It's the lack of competition in the refining and marketing area.  Hard to get excited about a nickel per bbl on crude when lack of competition is uping gasoline pricing by cents per gallon.  (our local Costco is 25 cpg or $10/bbl!!!!!!!! under the other retailers.)  The FTC letting all those mergers through has done far more to hurt the consumer than settlement manipulation.

As for acceptable manipulation.  It's a rough game as you well know.  But if the deals are being done in open outcry with all players and regulators seeing the trades, it's hard to bitch.  If those who feel screwed grew a spine and did their business fixed price instead of using settlements, the problem goes away overnight.  No one has a gun held to their head to trade in oil derivatives either.

Your Iranians/Norwegians could just put a fixed weekly price on their oil or sell it cargo by cargo.  They don't have the guts to make their own pricing decisions.  They'd rather term up their sales and complain about other people setting their prices before heading to the bar in the evening.  bunch of whining little wusses in my experience.  Abdicating pricing decisions to the IPE/WTI or Platts/Argus is the root of the problem.

by HiD on Fri Nov 10th, 2006 at 01:46:27 AM EST
My macro take on the Market is this.

Physical oil prices are a matter of supply and demand. But hedging is far more expensive than it needs to be because volatility is far higher than it needs to be because we allow speculative money to be involved in the price setting mechanism - albeit indirectly.

So option premiums are systemically higher than they should be, for instance.

Now hedge funds make money and hedge funds lose money and that's a zero sum game FOR THEM.

The winners in the game - and they are increasing their take year on year - are the Investment Banks, and any major oil trader working with them.

And the Investment Banks OWN one of the major trading platforms while another bunch of "locusts" (as the Germans have it) own the other.

Where do all the profits now needed to pay shareholders in these IPO'd exchanges come from?

When its quiet, (and indeed, whenever they CAN) I am convinced that some of the players deliberately jerk the market around and compensate each other OTC for any losses, making money on deals priced against the manipulated prices.

Not to mention the squeeze plays that were pretty much endemic until - inevitably, one of the buggers gets too greedy and the rules/specs get changed until the next time.

Still, one may argue (and I have some sympathy) that this is "acceptable" market manipulation - among "consenting adults"...

I am also convinced that certain major traders routinely share market sensitive information with certain investment banks and essentially operate in partnership to screw the rest of the market.

The profits that these intermediaries take out of the market directly and indirectly (eg Prime Brokerage and knowledge of trading stops....) are at the expense of trade hedgers and speculators such as hedge funds (for whom I have little sympathy).

The overall picture IMHO is that the intermediary lunatics are running the market asylum.

New neutral (as between end users and intermediaries)global market infrastructure is needed for which there is certainly an appetite among producers, and I believe that if the US government were remotely representative of the US people then they would support new and disintermediated infrastructure as well.

 

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Nov 10th, 2006 at 05:25:00 AM EST
[ Parent ]
Market makers do have too big a piece of the pie.  A small few are making waaaaaay too much money.  I have old colleagues making $5meg/yr+ because their groups are taking $200 meg out of the middle with roughly 10 traders.  

Without market makers, you won't have a market.  The sellers simply refuse to set their own prices and defer to settlements or Platts or anyone but themselves.  Selling fixed price sets them up for real metrics measuring their performance and you can't have that or well paid wankers might lose their jobs.

The current system suits the producers just fine though they'd love higher prices without taking any personal risk.  They have no obligation to use exchanges or any derivative pricing mechanisms.  The buyers would just as happily take posted prices or negotiate other fixed price arrangements or EFP everything.

Your words make it clear you believe this systemic rigging is to the down side (otherwise why would crude producing players mind).  This doesn't hurt consumers.  If Morgan and Phibro take money off of Statoil, INOC, et al, no skin off my behind.  

Buy side hedgers aren't being hurt by settlement rigging.  There is nothing stopping them from trading during the middle of the day.  As for options, my gut says the bigger problem is the few number of players who will make a market for anything esoteric.  When I was doing a bit of that sort of thing, there was just Aron, Morgan and a couple of other banks that weren't too good at it.  It was easy to make a fat margin as there was no competition.   But again, no one is forced to hedge and truly hedging may well minimize price swings, but there is a cost.  the broker/dealer will be paid for taking the risk away.

by HiD on Fri Nov 10th, 2006 at 09:35:26 PM EST
[ Parent ]
Settlement manipulation was just one instance of what goes on.

I believe that there is at least one case of long standing collusion on a cosmic scale. I obviously can't name names, but you can imagine

I acknowledge that market makers have an important role but consider that we need an entirely new structure, not a million miles away from the LME structure.

ie firstly a new physical benchmark setting mechanism, and secondly a market network involving market-makers.

In order to achieve this we need a new take on contract design to produce a more homogeneous "asset-based" crude oil contract, which is exactly what I am proposing.

But let's look at it this way.

The Barclays Capital guy (I forget his name - and BC were said to have made $500m last year to come in third after Goldman and Morgan Stanley) was quoted in the FT as saying that he reckons the intermediary take will double to $26 billion a year within 3 years.

Ask yourself this.

At whose cost?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Nov 11th, 2006 at 05:49:37 AM EST
[ Parent ]
The thing about traders and intermediaries is that they take a cut of a trade that might not have taken place without them, which remunerates bringing the buyer and the seller together at conditions acceptable to both, i.e. by taking some risks and bridging the gap in the needs of the two parties.

So it's not a cost, it's the remuneration of a very real service that allows for the value generated by the trade to be realised.

As HiD pointed out, buyers and sellers are under no obligation to use these intermediaries. They must find them convenient, somehow.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sat Nov 11th, 2006 at 06:46:55 AM EST
[ Parent ]
The market obviously works well enough for people to come there, otherwise it would be abandoned.

That is not the same thing as people getting a fair deal or not getting suckered.

Disclaimer: as I still know next to nothing (but I am learning) about the oil market, I do not know if people get suckered there. So I am speaking in general terms.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Sat Nov 11th, 2006 at 07:02:27 AM EST
[ Parent ]
It is currently institutionalised suckering: what Galbraith memorably called "the Bezzle", when the losers don't know they are losing.

A couple of analogies come to mind: like a roulette wheel with half a dozen "zero's" with new ones being added all the time.

Or the analogy of investment banks with submarines: beautiful pieces of engineering, but with the malign purpose - sinking ships and launching nuclear missiles.

And we currently allow the submarines to manage the convoys and even make the depth charge settings....


"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Sat Nov 11th, 2006 at 08:23:41 AM EST
[ Parent ]
no one in the system doesn't understand the high salaries or the high profits of Morgan, Aron, BP or the commercial banks.

there is no blind "sucker".

by HiD on Sun Nov 12th, 2006 at 02:30:28 AM EST
[ Parent ]
At 85 MMBD of crude at $60/bbl I calc $5 billion of crude being produced per day.  The same volume at a higher price moves as product after refining. Then you have nat gas.  So $25 Billion+ per day compared to $26 billion/year is about 0.3 percent???  Microsoft makes 28% flogging software (sales of $50 billionish).   I'm having a hard time getting excited about that level of cost for hedging.

Moreover, the real physical buyers/sellers dont need middlemen. Saudi sells to Chevron/Exxon/Shell/whoever and don't hedge, period.  If Chevy et al were losing $26 billion hedging they'd stop.  In my day losing a few million ended all speculation and hedging at Chevron (watched it happen) and Exxon didn't hedge at all at that time.  When the hedge funds get tired of losing (and they will over time), this game will dry up.

So just who will pay up for that much "service"?  In my era Russian gasoil was a big speculative vehicle.  Cargos of 20-25 KT could be passed down chains of 20-100 players each of whom paid a broker 25cts/metric ton in sales commision.  The oil was only worth about $110/mt then so theoretically 25% of the oil value disappeared into commissions.  Yet the original Russian got $100ish and the end user paid $110.  Most of the difference was shipping, losses etc.  Where did the rest come from?  Pretty easy.  Within my 6-8 year cycle through the biz, the Russian Roulette as it was called went away.  The losers went bust one by one or just stopped when the pain got too much.  Russian still flowed to end users with a few middlemen, but the speculation dried up and migrated to the IPE where the brokerage commission was peanuts.  We killed off all the "players" in my area as well to the point it was hard to find a counterparty to trade with at times.
So off to derivatives we all rushed.

If people get tired of big extraction in the spec markets, they can just term up their biz at fixed prices.  I have a friend that is a very small nat gas producer.  He sold his gas last year at $10/mmscf for the year.  No hedging cost.  If the utility he sold to just sells to their customers at a fixed cost as well, no hedging again.  That works fine with industrial users.  And when mom and pop decide for an annual price, they can play too.  No need for some overarching system.  'course people bitch when the market price goes down and they have a fixed price so there's the rub.

barclays can talk big, but lets see how well that goes when they blow up like Amaranth or Neste (ca. 1994) or several others I could name.  I seem to recall Barclays firing all their people at one point in the 90's as well though it may have been one of the other commercials.  One of them couldn't calculate the value of accumulating forwards to the point their bid/ask was so off the market that one of the oilco's back to backed them to Aron and Morgan at a huge profit.  bye bye trading team.

As for corrupt dealings.  No question.  The UK authorities should have been bugging a few phones about 1993-5 in my opinion.  I had a Vitol trader come right out and suggest divving up the market in one specific type of Russian product.  That appeared to be their style across the bbl.  Another Ex Marc Rich player virtually admitted they bribed gov't officials if that's what it took.  BP's approach to the US propane market matches my recollection of their style as well though I never saw anything obviously illegal.  many rumors of collusion among these sorts but I've no proof .   The guys I sat with who got fired for colluding on cutting brokerage commissions (allegedly or maybe the insults toward the management when the tapes were replayed did it???) moved over to Phibro/SB where they continued to ram markets around.  Last time I googled they were still doing it for yet another outfit.   Without an Eliot Spitzer this shit keeps on keeping on.

Real market regulation will take a lot of the crap away.  But hedging itself is not cheap.    

by HiD on Sun Nov 12th, 2006 at 02:28:26 AM EST
[ Parent ]


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