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Oil Markets are Hedge Fund's Waterloo

by HiD Tue Sep 19th, 2006 at 09:08:38 AM EST

Just a brief diary to point out that the entry of hedge funds into the commodity speculation game isn't a one way street where they take average Joe's money.

Check this out. It shows that the conjecture I've been making that big time speculators are making the oil markets more volatile and that when they snap, they are a big cause of the washouts we've seen in natgas and gasoline.

Enormous losses at one of the nation's largest hedge funds resurrected worries yesterday that major bets by these secretive, unregulated investment partnerships could create widespread financial disruptions.

The hedge fund, Amaranth Advisors, based in Greenwich, Conn., made an estimated $1 billion on rising energy prices last year. Yesterday, the fund told its investors that it had lost more than $3 billion in the recent downturn in natural gas and that it was working with its lenders and selling its holdings "to protect our investors."

from the diaries with minor edits. - Jerome


I wish I had $100 for every oil speculator I watched blowup while I was in the biz  (came close a time or 2 myself).

This loss is associated with the Nat gas price collapse this spring.  I've got a nice bottle of wine to bet that you see similar reports in about 6 months re this gasoline/crude price collapse in August to now.

I don't agree that the oil markets are manipulation free.  I just don't see some over-arching conspiracy that can move heaven and earth to interfere with electoral politics.  And seasons do remain seasons regardless of when voting occurs.

Chris Cook has it right re the clearing houses:

In fact they are "single points of failure", undercapitalised in respect of the risks they run and vulnerable to major market "discontinuities" when - not if - a posse of hedge funds, coupled with investment bank proprietary positions riding on their backs - one day go for an exit of massive positions they have quietly taken on OTC - an exit which is simply not there.

this is what happens when a big player(s) gets stubborn and bucks the world or when the conventional wisdom proves to be bogus.  When they want to exit, the market drops a huge % as those on the other side just stand aside and watch until they finally see a reason to close their opposing positions.  That happens close to historical norms.

In GWI, Elf had a huge position in forward jet sales.  They probably sold at the normal $20-30/mt over gasoil (diesel) for a year out to airlines.  When the s--t hit the fan, that spread blew out to $175-200/mt as the US bought up the world's jet supply to move mateial to the middle east.  FYI, the new tanks operate on a common fuel = jet.

Elf's management tried to wait it out, but lost their nerve.  Their traders had to buy out of the position at $160-175/MT.  IIRC it was a $30 million or so loss.  Small enough that it got lost in a big Oilcos balance sheet but people were fired and the group was trimmed.  By the time the position was actually pricing in the outer periods, the spread was back down to $30.

Happens all the time.  Neste did something similar on crude and wiped out their trading desk about 1995.
Remember the Hunts on silver and Mr Copper at Sumitomo(?).  BSD's that ended up little squeaking bankrupt retirees.

 

Display:
I tried asking Chris Cook, but I didn't get any answer: Wouldn't there be a strong incentive for governments to somehow bail out banks, etc. if there was a collapse in the derivatives market? I have seen some commentators claiming that we could see some of the biggest banks in the world go down if the market unraveled. But I can't see how the US government (or other major countries) would sit idly by while a new crash on the scale of 1929 happened. Would a general collapse be too big for national governments to cover?

I am sorry if this is stupid questions. I don't know much about these matters.

by Trond Ove on Tue Sep 19th, 2006 at 07:37:16 AM EST
One caveat before I comment, some would say I know no more than you do!

That said, the history of the Savings and Loans issue and the saga of LTCM indicate that some kind of bailout is rather likely.

(And not necassarily a bad thing that we have enough folk memory of the depression to feel that the banking system can't be left to collapse.)

But, of course, the two worries are:

  1. Are the hedge funds leveraged to such a degree (and the banks so invested in/connected to their transactions) that the governments don't have enough money/power to bail out? That is to say they will only be able to bail parts of the system out and there will still be lots of economic chaos.

  2. Who will actually need bailing out and what will the politics of it all be? The system is so opaque, no-one seems to even have enough info to make a guess.
by Metatone (metatone [a|t] gmail (dot) com) on Tue Sep 19th, 2006 at 07:46:31 AM EST
[ Parent ]
Buyouts, not bailouts.

That way we would actually get banking for the public interest.

Those whom the Gods wish to destroy They first make mad. — Euripides

by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 07:51:20 AM EST
[ Parent ]
I agree, but I keep forgetting to stick to the approved party language.

Sorry for the slip, Comrade Migeru.

by Metatone (metatone [a|t] gmail (dot) com) on Tue Sep 19th, 2006 at 07:52:54 AM EST
[ Parent ]
Haha!

This hasn't got the Jerome seal of approval AFAIK.

Those whom the Gods wish to destroy They first make mad. — Euripides

by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 07:55:40 AM EST
[ Parent ]


In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Sep 19th, 2006 at 09:02:03 AM EST
[ Parent ]


Those whom the Gods wish to destroy They first make mad. — Euripides
by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 09:05:09 AM EST
[ Parent ]
This actually happened in Norway with a pretty bad bank crisis we had between 1988 and 1991. The government ended up with sole or majority ownership of many banks in Norway, including the three biggest ones. There was a brief debate on whether the government were to keep its shares, as they were making good money on it after the crisis was over, but they decided to "diversify ownership" and I think most of the shares are now back in private hands.
by Trond Ove on Tue Sep 19th, 2006 at 08:12:39 AM EST
[ Parent ]
So, in the aggregate, did the government make money or lose money in the operation?

Those whom the Gods wish to destroy They first make mad. — Euripides
by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 08:19:31 AM EST
[ Parent ]
Since I can't easily find any numbers on this, I would guess they lost money on the transactions themselves. But they would have gotten much more back this way than if they had just handed out cash, of course.

It is interesting to read about it now thought. I was young when this was going on, so didn't really understand what was going on. From what I gather thought, 23 of the Norwegian banking sector was verging on bankrupcy because of a set of factors eerily similar to some advanced economies I know: First of all, the private banks increased their loan portfolio threefold in half a decade, after the government liberalised the banking regulations. Then, the economy started slowing in the late eighties, especially in IT and oil, two areas of big importance for Norway. Soon after, the norwegian housing boom, fed on by the increased aviability of cheap loans, collapsed. (About 20 percent of the bad loans were to private customers) The housing prices would take almost a decade to recover. (And that in a steadily growing economy)

Sources: (unfortunately in Norwegian)
http://www.nrk.no/underholdning/store_norske/4704274.html
http://www.ssb.no/00/aar2000/art-1999-11-10-01.html

by Trond Ove on Tue Sep 19th, 2006 at 09:11:42 AM EST
[ Parent ]
This does sound like a depressingly familiar set of conditions.

By how much did house prices crash in Norway?

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Sep 19th, 2006 at 11:02:30 AM EST
[ Parent ]
There is few online resources on this stuff from before the golden age of the Internet. I could have checked in the University library if I were in Norway at the moment thought. But unfortunately i am not. So sorry, no numbers. (Which of course means that what I have written about the extent of the fall in home prices are taken from my ass. But I still think it is approximately correct.)
by Trond Ove on Tue Sep 19th, 2006 at 02:41:56 PM EST
[ Parent ]
the shares of the banks that were rescued somehow ended up back in the hands of the entities that owned them before the Norwegian goverment saved their butt.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Tue Sep 19th, 2006 at 10:48:29 AM EST
[ Parent ]
The stockholders actually lost all of their money. There was alot of grumbling about that at the time, as far as i can remember. The big business banks were really technically bankrupt. The government took them over and then sold their shares for a profit.

So the same interests might have bought them back, but they would have to pay real money for them. When I read about it, i discovered that the norwegian parliament actually passed a bank savings bill which mandated that the Norwegian government kept a "strategic interest" in the biggest business banks. First at 51 percent, then from 97 and on to 2000 at 33,33 percent. The Norwegian government still owns a sizeable part of the shares in the biggest bank consortium in Norway, DnB-NOR (34 percent).

Another one of them was sold off to foreign (Finnish or Swedish) interests however, in contradiction with the set goals of the banking reform law. This after the norwegian Labour got back into power and started playing Blairite disciples.

by Trond Ove on Tue Sep 19th, 2006 at 02:10:54 PM EST
[ Parent ]
I doubt it with regard to this particular crash.

LTCM held beaucoup bonds so their collapse could shake credit markets, currencies etc which are the real foundations of international trade.

these guys just held spreads on nat gas futures (long front to back if the journalists got it right).  the gas is still there and will flow regardless.  All that has happened is $5 billion has transferred from one hedge fund to many others + the Wall Streeters like Morgan Stanley and Goldman.

If the exchange failed over it, the other side of the trades just wouldn't get paid.  Perhaps that could feed through to the real world, but $5 billion spread around isn't enough to break Wall Street.

by HiD on Tue Sep 19th, 2006 at 08:38:15 AM EST
[ Parent ]
Missed your question.  Sorry about that.

Of course Governments would step in and bail out key parts of the financial system.  They always have: although this is one of the key issues when those self-same infrastructure assets go into private hands.

I believe that the problem with an energy market meltdown could be that, unlike in the LTCM saga, the Fed cannot print oil, so that there is no limit to where the price could go.

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

by ChrisCook (cojockathotmaildotcom) on Tue Sep 19th, 2006 at 08:43:35 AM EST
[ Parent ]
but Chris no matter what the bets are doing, the oil is still flowing.  having the futures markets self destruct won't change the fundamental production and consumption of oil.  Very little actually delivers on WTI and none on Brent off of futures.  

so there is no need to "print oil".  price setting could and would go back to voice brokers or oilco traders could actually talk to clients instead of staring at screens trying to make sense of ticks.

I sold millions of bbls of fuel oil without a futures or forwards market.  No EFPs, no nothing.

by HiD on Tue Sep 19th, 2006 at 09:18:50 AM EST
[ Parent ]
Wouldn't there be a strong incentive for governments to somehow bail out banks, etc. if there was a collapse in the derivatives market?

There would a strong incentive and various goverments would bail out the banks and other financial institutions.

Remember, Neo-Liberal economic theory states goverments should not interfere in the market.  

Neo-Lib practice shows as long as companies or economic entities owned by the plutocrats are making money but immediately, or as soon as possible, support companies or economic entities owned by the plutocrats whenever there is a danger of those companies & etc going broke.  This always seems to be in "The National Interest" for some strange reason.

 

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Tue Sep 19th, 2006 at 10:44:15 AM EST
[ Parent ]
wiping out the savings of the country is how you end up with a depression.

they need to be regulated like crazy to protect us from their mistakes.

by HiD on Tue Sep 19th, 2006 at 05:16:37 PM EST
[ Parent ]
The biggest discontinuity I remember was the 1985 London Metal Exchange ("LME") tin crisis, when the tin producer government members of the International Tin Council pulled the plug on supporting the tin price which promptly collapsed overnight from $800 to $400 per tonne. (Put not your trust in Princes, eh!)

(Imagine if the oil price doubled or halved overnight?)

Many of those holding "long" positions were prepared to default if made to sell out at at the market clearing price of $400 and we therefore got the infamous LME "Ring-out" - a settlement price imposed at the lowest price at which no-one would default - ie about $600.

The litigation by the "shorts" (wishing to collect the other $200/tonne) went on for years.

The interesting thing in structural terms is that the LME, which had hitherto traded bilaterally or "Principal to Principal" were forced to "clear" their trades thereafter through a "central Counterparty" - the London Clearing House.

This was because, hitherto, nobody knew quite how exposed the market was to the International Tin Council, because it dealt privately with the LME broker/dealers.

It's a pity they didn't stay as they were but implement a "Guarantee Society"/ Clearing Union instead - which is one of the aspects of the solution I am putting forward for Iran.

I believe that the only sustainable solution is International Trade Associations - consisting of ALL stakeholders: producers, consumers and intermediaries alike - and with the exclusive right to register transactions in a "transaction registry".

This neutral global infrastructure would be supported by a consortium of service providers at an agreed cost.

ie essentially a co-operative of service providers working with a co-operative of service users. My realisation that the new UK LLP is an optimal corporate form came about in considering its use for structuring such a co-operative of co-operatives.

http://www.exchange-handbook.co.uk/index.cfm?section=articles&action=detail&id=38754

set out the analysis about four years ago. But this was written before I understood the monetary system.


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

by ChrisCook (cojockathotmaildotcom) on Tue Sep 19th, 2006 at 09:07:35 AM EST
playing in a market where 1 player can halve the price with one phone call is insane.

Can't do that on oil.  we've ticked all the way up and all the way down.

If RT was nuked, oil would go to $200 but worrying about which trader went bankrupt and which one didnt get his profit would be the least of our concerns.

by HiD on Tue Sep 19th, 2006 at 09:22:58 AM EST
[ Parent ]
RT?
by Trond Ove on Tue Sep 19th, 2006 at 09:26:07 AM EST
[ Parent ]
sorry,  I'm tired and lazy.  Ras Tanura = Ghwar oil field = the Saudi crown jewels.
by HiD on Tue Sep 19th, 2006 at 09:29:39 AM EST
[ Parent ]
I can't follow your market design.  I need my old Bedales (spelling) partner to translate for me.

that and I just believe too many of the oil market traders are just too dishonest to make fair use of a commons.

check this out:

http://www.cnn.com/2006/WORLD/africa/09/14/ivorycoast.toxicsludge.reut/

Trafigura (marc rich spin off) was one of the trader's I did everything I could to avoid playing with.

by HiD on Tue Sep 19th, 2006 at 09:28:04 AM EST
[ Parent ]
Charming fellows.

Those whom the Gods wish to destroy They first make mad. — Euripides
by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 09:29:55 AM EST
[ Parent ]
I actually went on a job interview a head hunter set to either those guys or one of the other spin offs (there were several when Marc Rich fractured).  I went thru with it just to see what they were all about.  very eye opening and I'd already been dealing with NNPC (Nigerian National Petroleum Co).  
by HiD on Tue Sep 19th, 2006 at 09:33:06 AM EST
[ Parent ]
The design is based upon the simple idea that there are two generic functions across all markets.

Firstly, you have to have a legally binding contract (ie transaction registration) and secondly, you need to exchange value(ie title registration)

It is the former which is behind the "International Trade Association" concept, since a market is defined by those who enter into contracts on it.

The ITA gives rise to a global market through an entity which is BOTH "open" AND  "closed".

Closed, in that only members of an International Trade Association can register trades.  Open, in that anyone who meets the ITA standards can be a member.

Anyone (ie those hugely rare "dishonest" traders) who fails to meet market standards could lose the right to register trades.

Analagous to becoming an Outlaw.

It's a global form of self-regulation, but not one dominated by the intermediaries, as now.

Armed with both information (since ALL transactions, on or off-exchange, are captured, if not necessarily published) and teeth (the sanction to suspend or terminate the right to register trades) the ITA would also operate dispute resolution (in the same way that the LME usually arbitrates off-exchange contracts which include LME arbitration as a contract term).

The ITA legal protocol (essentially a Market User Group "Club Rules") is analogous to the technical protocol XML - except that instead of transcending disparate hardware and software, it operates to transcend disparate jurisdictions and (intermediary-centric) regulation.

Hope that makes sense.

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

by ChrisCook (cojockathotmaildotcom) on Tue Sep 19th, 2006 at 09:58:00 AM EST
[ Parent ]
I don't see how you can prevent OTC transactions.
And how can all transactions can be captured but not made public?

Would you expand further?

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

by Jerome a Paris (etg@eurotrib.com) on Tue Sep 19th, 2006 at 10:36:16 AM EST
[ Parent ]
It's not a matter of prevention of OTC transactions, merely giving them global legal effect through a global legal protocol - a "Market User Agreement" if you like.

A generic trade confirmation mechanism, owned by no-one and everyone.

The mere fact of transaction registration does not automatically lead to publication. That is a matter of choice by the relevant participants in the particular subset of contract terms.

Exchange contracts are different because Exchanges are open to retail clients (ie the Public) to trade on through brokers. The sort of nonsense that was going on in London before the Financial Services legislation in 1985/6 (where clients were routinely stuffed by brokers since prices were not visible to clients anything like real-time)is why we got regulation, and I had great fun working for the UK Association of Futures Brokers and Dealers getting rid of at least some of the cowboys.  (the ones that weren't on our Board, anyway ;-))

OTC markets are for consenting adults, and it is up to the market participants to decide what level of transparency they need.

Having said that, the fact that the data is available to an ITA in enforcing whatever standard of market conduct they consider reasonable should help to keep things honest.

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

by ChrisCook (cojockathotmaildotcom) on Tue Sep 19th, 2006 at 02:59:52 PM EST
[ Parent ]
thanks.

but I've less confidence you can pull it off.

Until you eliminate the criminals that control oil flows out of so many oil producing areas there's no chance.

this is like asking the Mafia to fund a police force to supervise them.  

The dirty boys don't need to register trades.  They just sell to someone a little cleaner who sells to an end user who is happy with a slight discount.  This was the recipe for the flow out of Russia after the SUnion disintergrated.

by HiD on Tue Sep 19th, 2006 at 05:14:16 PM EST
[ Parent ]
What can one person do to "pull off" a new global market infrastructure?

I put together a dotcom about eight years ago called OilClear, which was essentially a generic transaction registration mechanism for oil, oil products etc.

Extended it to MetalClear, BullionClear etc.

It worked just fine as a "Proof of Concept".  The problem with what I called a "Market Operating System" - which is what it was - was that everyone said: "...brilliant idea, but we want to own it".

Except Platts, who didn't want to get involved in regulation.

So we've seen all the exchanges go for proprietary trade confirmation systems, of course.

It was as a result of this expereience that I realised that the problem lies with the absence of a neutral enterprise model for monopolies - since what I am proposing is a monopoly, or it is nothing.

Enter the UK LLP as a solution for the Enterprise model problem.

The dirty boys don't get to join the ITA club, and any club member who deals with them could find they have a problem remaining a member as well....

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

by ChrisCook (cojockathotmaildotcom) on Tue Sep 19th, 2006 at 07:10:58 PM EST
[ Parent ]
he dirty boys don't get to join the ITA club, and any club member who deals with them could find they have a problem remaining a member as well....

and soon you have no members because there is just too much money in flows to/from corrupt governments and their trading partners of choice. In my day you would have had to ban dealings with Italy based on Enel's approach.  Ditto Elf.  And much of the Russian flows, Iraq, Nigeria, much of Asia and South America too.    Not to mention dozens of major trading houses.  None of them could have survived a phone tap and an agressive EU anti-corruption enforcement program.  Not a whole lot better in the US based on some horror stories I've heard around North Eastern utility fuel buyers.

I hope you can pull it off, I'm just very skeptical.

by HiD on Wed Sep 20th, 2006 at 04:52:21 AM EST
[ Parent ]
Do you think the folks in Greenwich CT were reading "countdown to $100 oil" diaries?

I know this sort of crash benefits no one, but I'm glad to think that speculators are subsudising my tank of gas this week.

by dmun on Tue Sep 19th, 2006 at 09:22:49 AM EST
I wouldn't be surprised.  those guys sit around gleaning info from all over 24/7.  that and swapping filthy jokes.
by HiD on Tue Sep 19th, 2006 at 09:23:56 AM EST
[ Parent ]
They certainly were not reading "Countdown to $50 oil" diaries...

Those whom the Gods wish to destroy They first make mad. — Euripides
by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 09:25:12 AM EST
[ Parent ]
every trade has 2 sides......
by HiD on Tue Sep 19th, 2006 at 09:28:44 AM EST
[ Parent ]
Amaranth is a really ironic chice of names.

every trade has 2 sides......

TEHEHE.

"When the abyss stares at me, it wets its pants." Brian Hopkins

by EricC on Tue Sep 19th, 2006 at 10:13:49 AM EST
[ Parent ]
that guy is full of it.
by HiD on Tue Sep 19th, 2006 at 09:42:10 AM EST
[ Parent ]
LOL

One could also be reading both, bet on $50 or $100 and be stuck with the market at $70.

Those whom the Gods wish to destroy They first make mad. — Euripides

by Migeru (migeru at eurotrib dot com) on Tue Sep 19th, 2006 at 09:45:20 AM EST
[ Parent ]
If Bunker Hunt's still alive, and I think he is, bet he's laughing too.

You guys are cracking me up here.

"When the abyss stares at me, it wets its pants." Brian Hopkins

by EricC on Tue Sep 19th, 2006 at 10:18:56 AM EST
[ Parent ]
I've been missing your fabulous clock series for a while now - good to catch you here. I was wondering whether you'd wrapped it up, but I just read you were taking a short sabatical to do some home renovation, hope that worked out for you.

Sorry to be so completely off-topic... Couldn't help "jumping" you.

by Nomad on Tue Sep 19th, 2006 at 09:44:12 AM EST
[ Parent ]
Thanks nomad,

Yeah, my project proceeds at a snail pace:

http://fornobravo.com/forum/showthread.php?t=765

I've been meaning to get back to clock blogging.

Thanks for asking

by dmun on Tue Sep 19th, 2006 at 10:45:17 AM EST
[ Parent ]


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