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Oil Embargoes, Sherlock Holmes, and the Russian Butler

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I have no smoking gun, but the butler looks very suspicious. Sherlock Holmes is weighing the suspects, questioning why the high price for Brent Crude Oil, the benchmark for Europe and much of the world, is being quoted on London's exchanges at prices far exceeding the price of West Texas Intermediate (WTI), the U.S. benchmark. WTI is already being quoted at the suspiciously high price of $103/bbl while Brent crude is being pegged even higher, at $120/bbl. A difference of some $17/bbl. The oil interests will tell you, whether the oil companies, their financial industry pundits, or the talking heads on television or in the press, that "Iran is the wild card," with its implications for oil supply, the Straits of Hormuz, and "by the way let's add another dollar or two to the price."

Set forth in this space some two weeks ago, there is ample supply of oil with or without Iran. (Please see "Iran's Oil Threat, Déjà Vu All Over Again," which pointed out that there are extensive supplies of oil, even if there is an Iranian cut off of shipments to certain European buyers, as they have just announced). As Iran's intransigence on matters nuclear continues, its oil exports will be embargoed in a manner similar to Europe's embargo of Syrian oil, and will be replaced by strategic inventories, supplies from Saudi Arabia, The Gulf States, and, yes you guessed it, Russia.

Russia, currently the world's largest oil producer, is shipping massive quantities of oil, mostly to Europe, but also to the Far East though its extensive and far-flung and expanding network of pipelines. As the NYTimes reported, "The Russian oil industry was already reaping the rewards of higher oil prices from Iranian tensions." The Russians have been cashing in brilliantly while rendering support to Iran by such acts as vetoing or emasculating any and all meaningful U.N. resolutions that would force Iran to comply with the terms of the U.N.'s International Atomic Energy Agency mandates. It is an open question whether this is being done in solidarity with Iran, or more malignly, to solidify Iranian intransigence on matters nuclear, in the hope that the European and other world consumers' boycott of Iranian oil has maximum impact, making Russian oil more sale-able at ever higher prices.

Meanwhile, the tumult and fabricated anxieties over Iran's oil supply give ample cover to an oil price veering ever higher -- prices explained away by the political tensions at hand. But the question needs to be asked -- what is really driving oil prices?

Consider the following. The price of natural gas in the United States is less than $3.00 per mmbtu. Russia is a major supplier of natural gas to Western Europe. Gazprom, the Russian gas giant's contracts with European consumers have an especially onerous clause under current circumstances and conditions. The price of natural gas is calculated in relation to the quoted price of Brent Crude, so that at $120 bbl/oil, Europeans are paying some $15.00 per mmbtu, significantly more when compared to U.S. consumers, be they homeowners or industrial buyers (i.e. as but one example; manufacturers of ammonia or nitrogen fertilizers, for which natural gas is the core building block). This is a staggering difference in cost, putting swaths of European industry at enormous disadvantage to their American counterparts.

Clearly, given their growing capability to produce and deliver oil wherever the market dictates, and the tie between the price of oil and price of gas in Russian supply contracts, it is in the clear interest of the Russians to push up the price of Brent crude. Therefore, could it be that the tumult around deliveries of Iranian oil is merely a smokescreen to escalate prices, and that some thing far more nefarious is taking place?

In 2008 this space posted "The Trade That Brought Us $100/BBL Oil Teaches Us To Be Afraid, Very Afraid," setting forth the circumstances of the trade that caused the price of oil to touch $100. That trade was implemented by a single trader, buying one futures contract covering 1,000 barrels of oil for which he needed a margin deposit of $6,500 only. That one trade moved the market by more than $0.40/bbl, a sum that over a day's time would have increased the transfer of wealth to oil interests by some $35 million, calculated on the world's consumption then of near 85 million bbls/day. To his great regret, the trader made the vainglorious mistake of boasting about his "vanity trade" only to have the Commodity Futures Trading Commission fine his employer, the former division of ConAgra Foods, a massive $12 million purportedly as a clear message to traders that making a non-bona fide trade to simply move prices was contrary to the Commodity Exchanges rules (Please see "U.S. Speculators Fined For $100-a-Barrel 'Vanity Trade," The London Telegraph).

Clearly it raises the very ominous question, if a single trader, with only $6,750, can move the market, how can you expect those with billions at their disposal not to do the same as well?

So here we have Russia, a major supplier of oil and gas with an economy deeply dependent on the revenues received from the sale of those commodities. According to the NYTimes article, "And the taxes the Russian government has received from those sales have been a political windfall for Prime Minister Vladimir V. Putin as he campaigns to return as Russia's president. The extra money has helped further subsidize domestic energy consumption, tamping down inflation." Combine this with a Russia that is in large measure governed by that unique version of our Wall Street "ole boys network," the alumni of Russia's highly touted secret service, the KGB. The KGB helped form Putin and many of his associates in government. Here was an organization that was the nonpareil masters of clandestine intrigue, knows how to keep secrets, and now in a sense, is running the country albeit with the trappings of democratic governance.

Fast forward-only this week, "a group of brokers and traders successfully managed to manipulate an interest rate that affects loans around the world" (Please see "Traders Manipulated Key Rate, Bank Says," Wall Street Journal). If this could happen to interest rates, so widely traded throughout the world, just think what a KGB oriented Russia could do, and not with $6,500 at their disposal, but billions upon billions. It should not be a stunning surprise to those, be they government agencies, the press, or energy focused think tanks, that the traded price of Brent crude is being gamed.

Sorry folks, not meaning to ruin the ending for you, but that Russian butler does look awfully guilty to Sherlock Holmes!