As Stocks Gyrate the Oil Patch and Their Casino Cronies Continue to Strangle the Economy

Aug 15, 2011 | Updated Oct 15, 2011

Just this Friday Thomson-Reuters posted an article which succinctly said it all: "Analysis: Recession risk unless oil prices fall further". The piece states unequivocally the urgent need for oil prices to fall significantly in order to avoid a deep recession. To quote the article's essence:

Every time that the cost of oil relative to global economic output has hit current levels-and that's even after sharp falls in spot prices this month -- it has heralded a slump.

And while economists and analysts say a serious slowdown can still be avoided, many add that unless oil and energy prices fell much further and-most important-stay down, the world economy could be in serious trouble.

But for the price of oil to continue going down and to stay down, unfettered speculation and manipulation must be reined in by our oversight agencies such as the Commodity Futures Trading Commission (CFTC). Sadly the CFTC is an agency that has been derelict in its duty to protect American consumers, impotent in carrying out its responsibilities, going on years of "studying the problem".

Not to give the CFTC any succor, but something stinks in London as well. For the past year or so the price of oil quoted in London has parted ways with the price of oil quoted on the New York Mercantile Exchange. Today the difference in price is approaching $25/bbl ($85/bbl for West Texas Intermediate -- 'WTI' -- traded on the NYMerc and near $110bbl for 'Brent' crude traded on the London ICE exchange). This, after years of oil trading whereby the WTI price was generally considered the world barometer for oil prices and given widespread arbitrage, with almost simultaneously direct influence on the price quotations for Brent in London and other world exchanges such as Singapore, Dubai, Hong Kong, Tokyo. Differences existed, yes, but with generally applied arbitrage, they were marginal, with nothing approaching the current disconnect. Why the difference now, and why is the price of Brent crude not more in line with WTI prices -- an important question because we now have a massive reversal in relationship whereby the higher price of Brent crude has a significant influence on the price level of WTI. The higher the price for Brent, the higher the perceived justification for WTI.

Two issues have come to the fore which may help explain the emerging dichotomy. In 2009 with serious Congressional focus on financial regulatory reform legislation that was later to culminate in the passage of the Dodd-Frank Bill it became clear that the CFTC would be mandated to become a much more aggressive supervisory agency with expanded powers. At the time the WTI quoted price was still the major pricing determinant for global oil trading.

Along with the renewed focus in the halls of American government on financial and financial instrument trading reform, Saudi Arabia let it be known that henceforward their oil pricing would be based on a new benchmark, 'The Argus Crude Oil Index', based in London. After a short hiatus The Argus Index would quickly begin to influence the prices traded on the traditional London exchange for Brent crude, and in turn other world exchanges. Not a smoking gun, but clearly the prospect of Saudi intervention in futures trading to 'manipulate' the quoted price of oil could now be achieved without exposure to a Dodd-Frank enhanced CFTC or other U.S. supervisory agencies such as the Federal Trade Commission.

Then there is another factor: The price of Brent crude is a core multiplier in the pricing of the massive, long-term Russian gas contracts supplying Western Europe, contracts that run well into the billions upon billions making Russia the largest energy exporter in the world. The price of gas bought and sold under these contracts fluctuates according to the exchange quoted price of crude oil. Simply put the lower the price of Brent crude the lower the level gas receipts flowing to Russian gas suppliers.

Most of these contracts were signed at a time when gas prices were around $10 mmbtu with the confident assumption that they would veer higher. Then lurking disaster began to rear its head. While European industry was/is paying some $10mmbtu to Russian suppliers at today's price tabulation based on $100+bbl oil, something very fundamental has changed. Gas prices in the United States have collapsed to some $4mmbtu. This is due in large measure to the enormous expansion of American natural gas reserves and production integral to the development of shale gas drilling techniques and major discoveries such as the Marcellus and Barnett Shale Gas formations. At $4mmbtu the 'energy' equivalent per mmbtu is crude oil priced at $24/bbl (an augury of the price of oil to come? Remember in February 2009 the price of crude fell to just over $30bbl).

Of course anything approaching these levels would be disaster for the Russians, while not making major adjustments in their firm and very long term contracts will place their West European customer base at enormous competitive disadvantage to United States industry in the production of natural gas based petrochemicals, nitrogen based fertilizers such as ammonia and urea and ancillary gas based products such as plastics, and on, not to speak of the basic cost of energy.

One can well imagine that the Russians will do all they can to prop up the price of Brent Crude if they have not already and aggressively done so. This, especially in the light of the International Energy Agency's very recent pronouncement that "Sustained High oil prices and slowing economic growth have dramatically curbed global oil demand."

Have they? I do not know, but it is a possibility touched upon well before the collapse of U.S. natural gas prices.

You may ask, can prices on the exchanges be easily manipulated? Please know one trade requiring a cash margin of only $6,750 by one trader, achieved the landmark $100 threshold on January 2nd 2008 causing the value of some of the oil traded on that eventful day to increase by totals exceeding tens of millions of dollars. Talk about leverage in oil trading!

If these theories have any basis in reality it becomes ever clearer that the formation of oil prices in this day and age is a farce, having little and ever less to do with the market disciplines of supply and demand.

By the way has anyone heard anything further from the 'Oil and Gas Price Fraud Working Group' formed to focus specifically on fraud in the energy markets? The OGPFWG was established amidst much fanfare by President Obama and pointed pronouncements by Attorney Genera Eric Holder's Justice Department in April. No?! Well maybe they haven't come back from lunch yet...