THE BLOG

The Trade That Brought Us $100/bbl Oil Teaches Us to Be Afraid, Be Very Afraid

01/07/2008 01:45 am ET | Updated May 25, 2011

On January 2nd a single trade on the New York Mercantile Exchange pushed the price of oil to the psychologically freighted $100 a barrel. That trade made newspaper headlines or the front pages of newspapers throughout the world.

The trade itself was for a single futures contract of 1000 barrels of crude. The price quotation on the exchange prior to the fateful $100 trade was $99.53 so that the when that one contract at $100/bbl crossed the ticker, it jumped the market price of crude oil everywhere by nearly one half percent or 47 cents per barrel to be exact. At that moment that was the price on which all transactions of crude oil were based. The next trade on the exchange, that is the price at which the $100 contract could have been immediately resold, would have incurred a trading loss of $600 to the trader who executed the trade, understood to be one Mr. Richard Arens. Thus Mr. Arens, by being the first trader to have closed a $100/bbl trade on the NYMerc purchased a slice of immortality at a cost of but $600.

But then consider the following. By making that trade at some fifty cents above the going market Mr. Arens, by himself with an an investment of $6750, the margin required by the exchange for an oil futures contract, was able to move the market dramatically. At that moment of time and as long as the $100 marker was on the trading board, all oil produced, or shipped, bought or sold in the United States and given their close interrelationship, on markets throughout the world, that forty-seven cent jump was reflected in virtually all transactions. With some 85 million barrels of oil being produced and shipped each day, that trade alone increased the value of oil by over $40 million at that moment in time. All that based on one trade, requiring only $6750 as a margin deposit. An incredible and frightening degree of leverage. Thus we have been shown the clearest, most up to date, real time example of the risks inherent in basing the world price of oil on the vicissitudes of the commodity trading floor.

On these postings I have repeatedly tried to alert the field that the trading in oil futures on world commodity exchanges (electronic, New York , London, Singapore and on) is not a straight forward, unencumbered market (Please see "Energy Trading Oversight Awakens From Its Slumber With Anticipated BP Settlement" 10.25.07; "Oil Prices Pushed Ever Higher By Manipulating Oil Futures Trading", 04.05.06). That it is riddled with special interests (pushing up oil prices to levels as high as they will be tolerated) and oil patch agendas, or as in this case, reaching for an historic breakthrough. This argumentation has been met with considerable skepticism by the press ("the market sets the price") and outright hostility by those who have a vested interest in high oil prices, the oil industry and its friends in government.

Yet here is a prima facie evidence of the of the susceptibility by the commodity trading markets to play out specific agendas, and the ability of the trading markets to facilitate those agendas. Mr. Arens, with one oil futures contract representing 1000 barrels of oil, necessitating a deposit of only $6750, was able to bullseye the $100/bbl mark.

Now consider the following. Saudi Arabia, Kuwait, the United Arab Emirates, Russia all have Sovereign Wealth Funds. Saudia Arabia alone has $900 billion to invest, or to trade or to go dancing with. We don't know how these funds are spent or invested, because their activities and goals are completely opaque. The exception being when a Citigroup or Merrill Lynch go knocking at their door. For these countries oil is the core of their economy, and the higher the price of oil, the fatter those Sovereign Wealth Funds. It is the price of oil on the commodity exchanges that determines the price at which the physical product is bought and sold. Is it then unreasonable to assume, given the market's susceptibility to direction, as witnessed by that first $100/bbl tick, that a portion of that ocean of money in the hands of the world's most important oil producers is being used to trade oil prices toward the highest levels that the world's oil consuming economies can either bear or tolerate. What I'm trying to say in a perhaps overly long winded way, if a single trader with only $6750 can move the market, how can you expect those with billions at their disposal not to do the same as well!

It is long overdue that our government institutions, preferably conjointly with their international counterparts, take a seriously close look at commodity trading practices as they are currently structured. This to determine the likelihood and extent of manipulation, and the cost of that manipulation to the world at large. Somehow we must find ways to bring these markets back to becoming accurate and honest price mechanisms, reflecting real supply and demand. Otherwise we are participating in a game of loaded dice with purveyors of a basic commodity that exerts enormous influence on our fiscal, environmental and social well-being. Certainly anything less than a fully hands on, transparent, and effective oversight, will inevitably portend economic, social and environmental disaster.

Be afraid, be very afraid!