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The Enron Loophole Helps OPEC Serve Up a Hefty Helping of Oil-Price Baloney

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Last week, the price of oil hit an all-time high of $78.40 a barrel, to the pious discomfort of the Organization of the Petroleum Exporting Countries (OPEC). In the words of Edmund Daukoru, the president of the oil cartel and Nigeria's Minister of State Petroleum, the world economy is 'hurting.'
"The latest shoot-up to the mid-70s and above is very uncomfortable," Daukoru told Reuters. As for the increasingly deadly clashes in the Middle East, the oil czar commented: "It is always unfortunate if we have to address issues outside the power of OPEC." And without skipping a beat, Daukoru went on to advise that OPEC had plenty of spare production capacity.

I found Daukoru's comment about spare capacity particularly interesting, given that the oil patch endlessly whines that oil production is stretched to the limit and high prices are its consequence. Yet, we know that inventories are generally larger than they were last year at this time, and now it seems that OPEC can add even more if it wants to. So why are prices heading for the moon when there is oil available to draw down from storage and spare capacity to pump if the market needs it? Sure the political turmoil is making the market anxious. But is that enough to propel prices to a new record when there is no evidence of shortages? Highly doubtful.

Something else, it seems, is happening. Not that many years ago, oil and other commodities were traded on a real "wet barrel" basis. Producers sold to buyers at posted prices. When the market got tight they might extract a premium, or more stringent payment terms, or loading or discharging terms to reflect given conditions on a given day for a given trade. Conversely, if storage tanks were full, there was always a willingness to discount or make other adjustments to move product.

Then, some years back, futures trading came along and prices were set in trading-floor shouting matches in New York, Chicago, London, and Singapore, and they fluctuated in realtime and volumes grew (now prices are set electronically as well.) "Virtual" barrels on the futures exchange rather than wet barrels of actual product came to determine the purchase and sale prices of oil and downstream products.

Last week, at a conference on energy, the economy, etc., a discussion ensued about the reasons for the very high price of oil and the ever-present perception of shortages. I heard the director of the services group for the Saudi government-owned Aramco Oil Co. say that Aramco had ample spare capacity, but no takers. He volunteered that the big oil producer was ready to load additional cargos at any time.

Donning my old trading hat, I asked a simple question: "Why don't you lower the price?" I reminded him that when you have too much product, traditional business theory suggests that if you cut the price a bit, you might be able to move it. The Saudi representative answered: "Why should we sell for less than the prices quoted on the futures exchange?" He went on to say that the refiners are making too much money as it is.

"So how much are you making on each barrel?" I cheekily responded. My follow-up question was met with an icy dismissal that Saudi profits were none of my concern. That's probably true, but I wouldn't have asked had he not brought up refining margins. It was quite clear that this issue was not open to discussion.

So there we have it, straight from the horse's mouth, as it were. The price of oil for the Saudis, the godfathers of the OPEC cabal, is based on trading of "virtual" barrels of oil, not on real-time product in storage or in the production chain. And in pointing to the futures market as the determinant factor of price, the obvious question becomes: Is the futures market a fair reflection of market forces? Or, is it a manipulated cipher behind which the Saudis and others can hide to rationalize away market price distortions, claiming that "the free hand of the futures market" is in control and the producers can only set their prices accordingly.

In my July 12 post, "Gasoline Over $3.00 Gallon, Why?. . ." I called into question, with specific example, the presumption that oil and product trading on the futures exchange is free of manipulation. I am not alone.

Senators Carl Levin (D., Mich.) and Norm Coleman (R., Minn.), the ranking minority member and chairman, respectively, of the Senate Permanent Subcommittee on Investigations, are urging Congress to enact legislation that would close major loopholes in federal oversight of oil and gas trades. The so-called Enron loophole put limits on the ability of the Commodity Futures Trading Commission (CFTC) to prevent speculative trading in energy and commodity markets. It's interesting to note that since the Enron loophole went into effect in 2000, the price of crude has risen by nearly 500 percent. Coincidence? Perhaps.

To quote Sen. Levin, "Right now there is no U.S. cop on the beat overseeing energy trades on over-the-counter, electronic exchanges or foreign exchanges. . . . Enron has already taught us how energy traders can manipulate prices and walk over consumers if they think no one is looking. . . ."

Sen. Coleman cut to the chase: "We need to explore legislative ideas to ensure that energy prices reflect the true market forces of supply and demand. . . ."

In the meantime, OPEC and the oil patch are munching their baloney sandwiches, salted with crocodile tears, as they lug their loot to the bank.