Saudi Arabia and the Oil Bank

This is a guest post by Chris Cook. Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.

Max Keiser Interview: Besides writing this post, Chris did a Max Keiser interview on this subject, which is linked here.

Gail thought it would be a good idea if I put my article for 'Asia Times' - reprinted below – into context. Bearing in mind past discussion, I agree wholeheartedly, and will attempt to do so in this introduction in order to allow Oil Drum readers who wish to do so to engage on my chosen ground, which is the operation and architecture of the global market in energy generally, and oil in particular.

I see two secular trends in relation to the oil price. Firstly, I agree with the Peak Oil case, and consider that if we are not at the Peak level of global production we are close to it. I am not qualified to enter into discussion on that subject, but have learnt a great deal from those on this site who are. Secondly, I see the dollar continuing to devalue against 'real' assets generally and energy in particular, as a result of the fiscal incontinence of the US. Again, there are many better qualified to discuss that issue than me.

The combination of these two secular trends in the long term is that the oil price will, I believe, rise relative to the dollar. It's not Rocket Science. In my view, the oil price will rise over time between trending boundary lines: an upper bound ('seller's market'), at which demand destruction kicks in; and a lower bound ('buyer's market'), where marginal cost of production is the limiting factor.

The main thesis of my article is that there is a comprehensive misunderstanding - particularly in the US – as to what is actually going on in the oil market, and in particular, who is benefiting from the gyrations between these boundary trend lines.

Cui bono? Who gains from what's going on?

• Producers – gain from high prices, but lose from volatility and transaction costs;
• Consumers - gain from low prices and lose from volatility and transaction costs;
• Medium/Long Term Investors – e.g. Exchange Traded Funds (ETFs) gain from higher prices, but lose from volatility and transaction costs;
• Short -Term Investors /Speculators – e.g. hedge funds and investment bank proprietary desks, are transaction-oriented investors who are agnostic as to price, and may gain from volatility, but lose from transaction costs;
• Market-Makers/ Service Providers – are agnostic as to price, but gain from volatility and transaction costs.

In a nutshell, my thesis is that commercial (initially) and sovereign (now) producers are using cheap money provided by medium/long term investors to keep the oil price at or near the 'upper bound' and thereby maximise their income. They achieve this through intervention in the Brent/BFOE (Brent Forties Oseberg Ekofisk) complex of contracts. The "Dated" BFOE oil price as assessed by Platts price reporters is used as a benchmark price to set - directly and indirectly via arbitrage - global physical oil market prices. The futures markets are the tail – not the dog – and investors are the fall guys for 'macro manipulation' by the real beneficiaries, who are the producers.

I find it fascinating to think that Saudi Arabia may – through the use of the new financial oil leasing techniques I refer to – now be acting to all intents and purposes like a Central Bank aiming to keep an oil currency pegged within a range against the dollar.

So, here goes. . .

“Saudi Arabia and the oil bank”

Reprinted from the Asia Times.

As crude oil prices climbed back over $80.00 per barrel during 2009 - after the dramatic spike to $147 and subsequent collapse to $35/bbl - US politicians and regulators are in no doubt who to blame. They accuse 'speculators' such as Exchange Traded Funds (ETFs) and hedge funds of manipulating oil prices through the use of futures and options contracts not only on the dominant exchanges - the New York Mercantile Exchange and the Intercontinental Exchange – but also off exchange, through bilateral 'over the counter' (OTC) contracts. But the truth lies elsewhere.

Introducing Oil Leasing

In 2005 Shell had a brainwave. They agreed with ETF Securities - a provider of Exchange Traded Funds – that a new oil fund could invest directly in Shell's oil production. Whereas most ETFs which are exposed to the oil price use the oil futures markets, this initiative cut out the middlemen, and all of the costs associated with maintaining a position in a futures market over time.

The outcome was that Shell borrowed dollars from the fund, while the fund borrowed, or leased, oil from Shell through forward sale agreements or otherwise. Everything was, and remains, above board and relatively transparent, but this innovative form of financial oil leasing appears to have been turned to other uses by other market participants.

Macro Manipulation

Simply stated, producers have an interest in high prices. Cartels of producers have therefore often been created to openly manipulate prices by artificially supporting them. A classic example was the International Tin Council which supported the tin price by buying tin – and stockpiling it – if and when the price fell to its 'floor' price. Unfortunately, the high prices stimulated new production; eventually the ITC ran out of money; and the tin price collapsed in 1985 – literally overnight – from $8000/ tonne to $4000/tonne.

In the late 80s and early 90s Yasuo Hamanaka, a Japanese copper trader acting for Sumitomo Corporation, successfully manipulated the copper market not only for five years before someone blew the whistle, but even for another five years afterwards. The mechanism used was for investment banks to loan dollars to Sumitomo, who in return loaned copper through forward sales on the London Metal Exchange.

The only way to manipulate commodity prices is through the ability to secure supply. In the oil markets, funds, whether ETFs or hedge funds, are categorically unable to make or take delivery of the underlying commodity, and are therefore unable to manipulate the price. It is only 'end user' producers and distributors, or the few traders with the capability to make and take delivery, who are in a position to manipulate oil prices, and in order to do so they require funding, or leverage.

I believe that it is macro manipulation by oil producers, funded by cheap money from investors, which has been the principal reason for recent movements in the oil price. The advantage which producers have over oil traders is that producers are able to store their oil in the ground for free.

The Brent Complex

Over 60% of global oil production is priced against the price of UK's North Sea Brent, Forties, Oseberg, Ekofisk (BFOE) quality crude oil. Most of the rest is priced against the US West Texas Intermediate (WTI) price, but in the past 10 years the WTI price has increasingly become the tail on the BFOE dog through 'arbitrage' trading.

There are typically 70 or less cargoes, each of 600,000 barrels, which are produced by the BFOE fields each month, and in order to support the global oil price it is necessary to ensure that BFOE 'spot' cargo transactions take place at the or above the support level. This may be achieved by forward purchases or other contracts in the opaque BFOE complex of contracts where transactions take place off-exchange.

By the standards of the relatively few major market participants involved in the market, this is easily achievable if the funding is available. As the Credit Crunch unfolded from late 2007, fund money began to pour in to existing and new ETFs.

The Zero Bound

As short term dollar interest rates fell to zero - “the zero bound” - investors switched their dollars into other assets, and particularly commodities, which also carry zero income, but which at least have intrinsic value, unlike the dollar or indeed any other 'fiat' currency. We therefore saw simultaneous spikes in the oil markets, agricultural markets and metals markets which had nothing whatever to do with underlying supply and demand.

These rises in price continued until the destruction of demand created surpluses beyond global storage capacity, and prices thereupon collapsed as the bubble of leverage funded by investors deflated. The oil price collapsed to about $35 per barrel, and since short term interest rates remained at 0% the conditions were ripe for a repeat.

Banking on Oil

What follows is necessarily speculative in the absence of hard evidence, but in my opinion the 2008 'spike' was driven by one or more major commercial oil producers leasing and hence monetising oil stored in the ground to one or more investment banks. In return the banks collected and deployed fund money through opaque structured finance products or otherwise. Liberal helpings of hype in relation to oil shortages helped to inflate and support the market price.

In the course of a 2 hour meeting in London in 2004 Mr Kazempour Ardebili -who had by then been the Iranian OPEC representative for some 18 years – explained that he had for almost all of that time been advocating an OPEC bank, and an OPEC investment institution, but that this had never found favour with the Saudis. Moreover, he looked back with nostalgia on the long periods of stability which pre-dated the development of the current market pricing structure. He pointed out that while high oil prices are in producers' interests, wild price swings destroyed Iran's ability to budget and invest.

The oil market in 2009 saw a rapid re-inflation from $35.00 to around $70/bbl and the price has for several months been relatively stable within a range of $75 to $85 per barrel. Commentators have suggested that perhaps $50.00 of that price is accounted for by supply and demand, while the balance is purely financially related.

It appears to me that Saudi Arabia – their participation is essential - could currently be playing the role of a Central Bank whose currency is crude oil, and backed by their reserves of crude oil in the ground. Through extremely opaque market interventions by investment banking intermediaries they could lend oil to the market – financial oil leasing - against dollar loans from investors in oil, and buy back their forward sales of crude oil in order to support the oil price within their chosen parameters.

The outcome – which has the effect of 'monetising' oil in the ground - is very similar to the way in which some governments maintain their currency more or less 'pegged' to the dollar and illustrates the reality that oil is not priced in dollars: dollars are priced in oil.

Whether or not it is in fact, as I suspect, macro manipulation by producers which accounts for movements in the prices of crude oil and oil products, and the flows and storage of crude oil and oil products, is a judgement I must leave to expert traders. But I am absolutely certain that the “speculator” investors blamed by US politicians and public for the movements in oil prices are not in fact responsible.

Unstable Equilibrium

The oil market has been swinging dramatically between a lower boundary price, where an excess of supply means that in a 'buyer's market' sellers compete for sales, and the upper boundary of a 'sellers market' price where demand destruction kicks in.

According to an OPEC spokesman, the current market price is 'perfect'. If it is the case that the price is being financially supported at the 'upper bound' within tighter pricing levels then this is a fundamentally unstable position, where increasing supply of crude oil, or falling demand for products, would lead to a collapse – due to de-leveraging - similar to that in the tin market in 1985, and indeed, of the 2008 'spike'.

Although the interests of consumers and producers diverge in terms of price levels – with many in the US still convinced it is their oil under the Saudi desert – both have an interest in price stability. That is not the case for trading intermediaries – the middlemen – and particularly not for the investment banks who thrive on volatility and opacity, and for whom the only bad news is no news at all.

So, like a RoRo ferry sailing in calm waters with water swilling about the car deck, I believe that the oil market will continue in a state of unstable equilibrium until it hits the next wave – which could be at any time – and the ferry overturns.

The current market architecture is fundamentally dysfunctional, and in my view a new settlement is both possible, and long overdue.

(Copyright 2010 Asia Times Online (Holdings) Ltd.)


Yours is a very interesting thesis. Thanks for the post. I have a few questions and a comment.

Given your line of reasoning, would you say that the KSA-led cartel of producers were tossing all caution to the wind and simply shooting for the moon in '08? Would you say that they totally disregarded the possibility that $100+ oil would cause demand destruction... or did they just 'go for it' anyway... or did they somehow lose control of the market to the 'Animal Spirits' of which Keynes first spoke (and Akerlof and Shiller recently expounded upon)?

Would it not be more accurate to blame the price run on an actual inability to increase production? And what specific evidence can you provide which supports one conclusion over another?

I understand that you are sympathetic to peak oil, and as a consequence, I wonder how much oil you think the KSA and others are pumping out of the ground only to buy it from themselves so that they can pump it back into the ground thereby starving supply and supporting falsely inflated prices. My reading of James Hamilton's Brookings Institution research paper is that supply would have had to have increased by 5 million bpd between 2005 and 2008 to maintain a price somewhere around $50 per barrel, but that production only climbed by 500,000 bpd. It seems to me that either Hamilton is wildly wrong in his estimate, or that 4.5 million bpd were recirculated by the cartel. Alternatively, I admit that fuzzy logic may have wrested control of my normally lucid mind.

-Searching for evidence and explanation in Seattle

In addition to drinking the Koolaid, I've now had a few glasses of vino rosso... so I'm feeling bold... not tequila bold, but box-red-bold... so here goes nothing...

In this post you write:

The futures markets are the tail – not the dog – and investors are the fall guys for 'macro manipulation' by the real beneficiaries, who are the producers.

In a previous post ( you wrote:

We have now reached the culmination of a process of financialisation of the oil market to a degree where the market has become entirely sociopathic. It now operates to the detriment of consumers and producers alike and for the benefit of the intermediaries who control the market.

What gives? Aren't the intermediaries the investors?

-Awating hangover and still searching for evidence and explanation in Seattle

Chris, everyone gets that Saudi Arabia and other OPEC members try to exert control on oil supply to generate higher prices by restraining supply when they have spare capacity. They do this in the open.

However, in your post you say:

"in my opinion the 2008 'spike' was driven by one or more major commercial oil producers leasing and hence monetising oil stored in the ground to one or more investment banks."

So you are saying that Shell is more powerful than OPEC?


So you are saying that Shell is more powerful than OPEC?

Nope. I don't think Shell were driving this, since they have always operated in the open..

I think that the most likely culprits were BP and Goldman Sachs, who have been joined at the hip - or more to the point, at the head - for the last fifteen years. That combination was the probable route for leveraged support of the price as fund money flowed in, and Goldman consistently hyped the price for years.

I'm not saying tightening supplies weren't a cause - of course they were - but I have no doubt that a very considerable component of the price increase was the money borrowed from funds via investment bank intermediation. Without this, the price would have trended up along the lower boundary line.

Shell and OPEC are both producers. The difference is that Shell were the first to enable and tap in to a new breed of financial investors.

Any proof or evidence that BP and/or Goldman were storing oil secretly somewhere? Or is this pure speculation?

Buster, can you quote the passage where Chris stated that BP and/or Goldman was secretly storing oil? Or did you just assume that was what he meant, i.e. pure speclation on your part?

Ron P.

@Ron P

Thanks, but Buster misunderstands what is going on, which is that BP are - like Shell and any other producer - effectively storing oil in the ground for free. BP has a pool of production in the ground which they are able to monetise using financial oil leasing in one form or another.

Unlike Shell, who dealt openly and transparently with ETF Securities - BP obtained their funding through their joined at the hip/head relationship with Goldman, probably via structured financing, and other mechanisms, backed up probably by bilateral BFOE/Brent deals and derivatives that were unreported.

Chris, I agree in part but I don't think BP can hold enough oil off the market to really affect the price that much. Only OPEC has that much clout. However keeping oil off the market can only be regarded as a fundamental cause of price changes. OPEC has cut 2.5 million barrels per day of production. That is the fundamental cause that is keeping prices where they are.

Financial shenanigans cannot, in the long run, affect the price of oil. Though they do, very often, cause short term price swings. Oil supply, whether deliberately held off the market or due to depletion, can only be regarded as a fundamental determining cause of oil prices. But as I said, I just don't think BP can hold enough oil off the market to make much difference.

Ron P.

If I'm understanding the concept correctly, isn't it that the "monetizing of oil in the ground" is a financial tool offering a larger effect, proportionate to the oil involved, than simply lowering production and waiting for demand to drive up price?

That is, with this its not necessary to lock up supply, only to be able to multiply the effect of your supply, much as fractional lending allows a bank to multiply the effect of its assets?

(on edit) - and reading down-thread, if I understand the thrust of the argument, it is primarily to explain the current high stable price, and secondarily to speculate on the goings-on behind the scenes in years past? I find it possible to accept the likelihood of the current condition, and question the explanation of previous conditions.

Can't you even look for a correlation between, say, UK production/stocks and Brent price? Find a statistician to collaborate with; until some real data is presented this is just another batch of hollow suppositions. Why not GS controlling offloading at the LOOP? OPEC ordering a key batch of tankers to steam about in circles, which they're all too happy to do given the thin margins of the Baltic Dirty Index at the moment? And I could go on, right down to the mad theories of Lindsay Williams.

OPEC ordering a key batch of tankers to steam about in circles, which they're all too happy to do given the thin margins of the Baltic Dirty Index at the moment?

Rolling in the floor laughing. Keep them coming KLR. What would we do without a little comedy to lighten our day?

Ron P.

Yes you are. Your link said nothing about "OPEC ordering a key batch of tankers to steam about in circles," You just made that up. You and I both know that would be utterly stupid. Anyway OPEC does not own the tankers and would not have the power to order them to steam in circles.

However it was very funny. Keep them coming. We need all the comedy relief we can find.

Ron P.


As I just explained to dandyone, keeping oil off the market ie physical manipulation does not come into it, although of course keeping oil off the market - like stock-piling tin by the ITC - would work to support the price.

Artificial support of a benchmark price - Hamanaka/copper style - through the use of forward and derivative contracts is the financial manipulation which has been going on here, I believe.

Chris, you wrote in you opening statement:

They accuse 'speculators' such as Exchange Traded Funds (ETFs) and hedge funds of manipulating oil prices through the use of futures and options contracts not only on the dominant exchanges - the New York Mercantile Exchange and the Intercontinental Exchange – but also off exchange, through bilateral 'over the counter' (OTC) contracts. But the truth lies elsewhere.

Yet you write here:

Artificial support of a benchmark price - Hamanaka/copper style - through the use of forward and derivative contracts is the financial manipulation which has been going on here, I believe.

Well, I agree with your first statment but disagree with you when you say the exact opposite in the second. The futures market may cause short term swings in the market. That is speculators, or even oil companies, that buy and sell futures contracts may cause short term swings but cannot cause long term movement in the oil market.

No, no, it cannot happen regardless of what politicians say or anyone else says, the speculators, that is the futures market cannot possibly cause long term movement in the market. By its very nature, the futures market is short term. Two thirds of all contracts traded are for the near term contract. On average the average contract is held but a few days, sometimes only an hour or less, and they all must be closed at experation. For every long contract bought there must also be a corresponding short contract purchased. And if buyers bid the price up then when they must sell, at closing, it would have the exact opposite effect.

OPEC, holding two and one half million barrels per day off the market most definitely causes the price to be higher. The only to manipulate the market is with actual oil. It simply cannot be done with futures contracts.

Just a little info. Friday, on the NYMEX, there were 506,748 WTI contracts traded, 65 percent of them for the near term (March) contract. Each contract was for 1,000 barrels. That comes to contracts on 506,748,000 barrels of crude oil or seven times as much crude oil as was actually traded in the entire world. And that is only the floor trading, or open outcry trading. That does not even count the electronic trading.

The data came from NYMEX Light Crude Oil by adding up all the numbers under "Vol". As you can see 327,417 March contracts were traded Friday, January 22.

No doubt similar amounts were traded on other exchanges. You simply cannot buy enough contracts to affect the price of oil for more than a few minutes. And when you sell those contracts you will drive the price down just as much as buying them drove it up.

Edit: This point needs to be stressed. It simply does not matter whether you, or your ETF, buys a contract to hold for months or buys a contract to hold for a few minutes, one has no more effect than the other. A contract is a contract is a contract. All have equal weight on the market. The market does not know the difference.

Also, the futures market is a zero sum game. There must be a short for every long and sellers have the same weight on the market as buyers. A short term inbalance will cause short term swings but any inbalance must, by definition, be short term. The reason is, if you buy you must also sell... sooner or later.

Ron P.

More on selling short here in the WaPo

An excerpt from the new book "The Quants".

Web, the term "selling short" applies only to equities, that is stocks. The term does not apply to commodities. Selling a stock short means selling a stock that you do not own. You must borrow them from your broker to sell them. Then at some time you must "cover your shorts". That is you must buy back the stock you sold and return them to your broker. Sometimes a market rally is called a "short covering rally". That happens when the stock market starts to rise and people who are short must quickly back their shorts before they lose more money.

There is a thing called "naked short selling" which means selling a stock you do not own and did not borrow either. It is illegal but still sometimes practiced.

Commodities are never "sold short". However you may go "short" oil or any other contract. That means you you purchase a contract to "sell" a commodity at a given price. There is always someone who holds the corresponding "long" position. That is every contract has two sides, and two parties involved. The person who holds the short side of the contract and the person who holds the long side of the contract. So every single contract traded on the exchange involves two parties, the person who holds the long side and the person who holds the short side. That is not the case for stocks. It would be possible for there to be no shorts on the stock market whatsoever.

I know it is confusing to some people when someone talks about being "short oil" or "short pork bellies". But that is totally different from selling short a stock like IBM or General Electric.

Ron P.

Still an interesting article.

Too bad that there is only one definition of "short" that covers everything related to finance.
I dare you to change the Wikipedia entry to reflect your semantic interpretation. Stick what you wrote right at the beginning of the article. That would help people sort through the mess. Most everything relating to finance is based on deception and game theory. The more that the confusion is removed the better for everyone. IMHO

I dare you to change the Wikipedia entry to reflect your semantic interpretation.

Web, I was a stock and commodities broker. I know what the hell short selling is. It is not my semantic interpertation. Do you think I just make this crap up like some people on this list? There is no need to change the Wikipedia definition because it agrees exactly with what I wrote!

Wikipedia (definition of short)

Futures and options contracts
When trading futures contracts, being 'short' means having the legal obligation to deliver something at the expiration of the contract, although the holder of the short position may alternately buy back the contract prior to expiration instead of making delivery. Short futures transactions are often used by producers of a commodity to fix the future price of goods they have not yet produced. Shorting a futures contract is sometimes also used by those holding the underlying asset (i.e. those with a long position) as a temporary hedge against price declines. Shorting futures may also be used for speculative trades, in which case the investor is looking to profit from any decline in the price of the futures contract prior to expiration.

Shorting stock in the U.S.
In the U.S., in order to sell stocks short, the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. This is referred to as a "locate.” Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted security.

Please Web, when it comes to futures and equities trading, don't insult me by insinuating that I don' know what the hell I am talking about. I do! You will notice that the Wikipedia definition agrees with everything I wrote. Shorting stock and holding a short futures contract are two entirely different things. They are not remotely related. The Washington Post article was all about shorting stock and our discussion, prior to your post, was all about futures.

Ron Patterson

Edit: Most people on this list are very familiar as to how the financial markets work. Most of us have traded both equities and futures at one time or another. Most of us who have traded futures have been on both sides of the market we were trading, the long side and the short side. Anyone who has ever traded futures knows, or should know, how the futures market works.

Few of us however, even if we do trade equities, ever short equities. That is an entirely different game. It is usually left for professional traders who get in and out every day. You must have an active broker account because your broker must loan you the stock you are shorting. All kinds of SEC rules apply to short sellers that have nothing to do with the futures market. An example is the recently repealed "uptick rule" that stated a stock could only be shorted after an uptick.

I am shocked that any adult who has any familiarity with the market would think shorting stock and holding a short futures position are even remotely related.

So why isn't that clearly stated?
That represents the difference between engineering/science and business.
Engineers would categorize the distinctions, while business people don't dare because confusion helps them make money.

OK, so I modified the Wikipedia page:

Shorting of equities differs from going short in commodities. The term "short" is overloaded in the descriptions that follow.

Let's see how long it lasts.

Dear God, spare me. A person who knows absolutely nothing about trading equities or commodities has seen fit to give descriptions to the world pertaining to the trading terms of both.

Ron P.

Excellent, so go change it.

It's no skin off my nose.

Webster, I apologize for the tone of my last post on TOD. But you must understand how pissed off I was. I first began trading stocks in the late 70s. I went to Saudi Arabia in 1980 and stayed five years. After I came back I studied and passed my Series 7 exam. That is a six hour examination given to all who wish to trade securities. Passing it allows one to be employed by a brokerage firm and trade equities on behalf of clients.

I went to work for Thompson McKinnon, (now defunct), as a stockbroker. A couple of months later I took my Series 3 exam, the Commodities Traders Advisor exam, which allowed me to trade commodities, on behalf of your clients, as well. About four months later I finally figured out that the term "Stockbroker" was just a fancy term for "Salesman" and got out of the business. I was really not a very good salesman. So I went back to the computer business.

But I continued trading, both equities and commodities for several years. I have not traded since I retired in 2004.

I thought I was being helpful when I tried to explain to you that short selling equities, the subject of the Washington Post article, was something completely removed from being short a futures contract, that the two "shorts" really had absolutely nothing in common. Then you suggested that Wikipedia showed that I was mistaken, that they meant virtually the same thing. That flew all over me for I knew goddamn well what I was talking about.

So please accept my apologies for I realize you had no idea as to my experience and just assumed that Wikipedia was the final arbitrator on such matters.

Warmest regards,

Ron Patterson.

I put the caution at the top of the Wikipedia page describing the overloaded nature of the term "short" but somebody named Hufggfg removed it about an hour ago.

Oh well, I don't invest in anything more risky than CD's anyways.

@Ron P

I think that you are under a misapprehension as to the London Metal Exchange.

I agree with you that conventional futures markets cannot cause ANY swings in physical market prices - it is the reverse that is true. The physical market is the dog, and futures the tail, and for deliverable contracts the futures market converges on the spot market price on expiry - not vice versa.

Moreover, the ONLY market participants who are allowed to participate on the spot month of a deliverable oil or products contract are those capable of making or taking delivery in accordance with exchange rules. This is not really a matter of regulation - the reason is that it is the broker/clearing member whose arse is on the line to the clearing house if a client is unable to make or take delivery. That is why funds typically roll over their positions from month two to month three.

I managed the IPE's deliverable Gas Oil contract for six years, so I think I can speak with some authority on this subject.

NYMEX has been increasingly irrelevant to global oil market pricing for at least ten years 10 years, and has long been ancillary to Brent/BFOE WTI is kept 'in line' with Brent/BFOE - subject of course to NYMEX WTI shenanigans in the delivery month - by massive arbitrage on the ICE platform. The fact that the oil market is no longer US-centric is not a fact that either US politicians or regulators find easy to comprehend.

The Dated Brent/BFOE price as assessed by Platts is the benchmark price for maybe 60% of global physical oil trades. Dated Brent/BFOE cargoes arise out of bilateral BFOE/Brent forward contracts which have gone into the delivery cycle. Most Brent/BFOE forward contracts do not go to delivery, being 'closed out' bilaterally or via 'chains' of contracts, and cash settlement.

The ICE Europe Brent/BFOE futures contract is not deliverable, but is cash settled upon expiry against an index based upon the prices of BFOE/Brent forward trades on the expiry day. Like any cash-settled contract, it has no more effect on the physical market price then you and I would have if we bet each other. Also within the Brent/BFOE complex of contracts are a bevy of other contracts - such as swaps and 'Contracts for Difference' which are used to manage the basis risk between the expiry of the ICE contract, and the actual delivery.

But the London Metal Exchange is different.

The LME price - which Hamanaka was manipulating for years - is very different from every other futures market in a couple of ways.

Firstly, it is a unique hybrid market - essentially a cleared forward contract with bilateral trading most of the day, and multilateral price setting 'Rings' four times a day, of which the price set at the second morning Ring is used as the global benchmark price.

Secondly, warrants on metal stored in a global network of LME accredited warehouses are much more investor-friendly than oil and oil product logistics. Having said that, I have no idea to what extent funds get involved in holding LME warrants these days - they never used to, as I recall, even via brokers.

In other words, it is uniquely possible to manipulate the physical metals market via LME firstly because it is not a conventional futures market, but a cleared forward market, and secondly through the different storage characteristics of metals.

Is that a verifiable fact or speculation on your part?

What gives? Aren't the intermediaries the investors?

The intermediaries are those who buy and sell for a typically short term transaction profit.

These are the oil majors; oil traders; hedge funds; the prop desks of investment banks; and retail speculators.

I see ETF funds as being investors, which I see as holding a position over a medium/long term time horizon. This is the precise opposite of 'speculation' in my view. They are essentially not so much looking for a transaction profit, and rather seeking to avoid loss - ie to 'hedge inflation' in the jargon.

ETF investors are getting rid of dollar price risk (hedging inflation) in favour of taking on oil price risk. This is of course the precise opposite of what producers who are hedging oil prices are doing: ie producers are getting rid of oil risk and taking on dollar risk.

Shell worked out in 2004/5 that it makes great financial sense to cut out the risk intermediaries - aka futures exchanges and investment banks OTC operations - and to connect 'Peer to Peer' with the funds.

Moreover, they did so quite openly. It was not Shell responsible for the inflation of prices to the 'upper bound', I think.

Peak oil news might have permeated the mindset of a large group of people who thought oil might be a good investment. For months prices of oil rose without any sign of a drop in demand for oil. Reality of the elasticity of oil demand dawned in 2008 Q4. Production was also elasic as oil/liquids production in 2008 surpassed peaks reached in 2005.

Did AIG have any responsibility for the housing bubble that has resulted in the closing of many small banks in the United States? Was it more likely an entire nation became aware of the rapid appreciation of real estate values and many sought to earn easy money as they easily saw prices were rising without interruption?


So the producers are among the group of intermediaries, then?

This simply does not fit with your previous assertion made in your July 26, 2009 post which reads, "It [the market] now operates to the detriment of... producers... and for the benefit of the intermediaries who control the market."

If producers are constituents of the group of intermediaries, the operation of the market works both for and against them.

Please explain.


The State owned or controlled National Oil Companies (NOCs) are the producers I am referring to here and these are 'end users'.

At the other end of the value chain are the business and individual consumers who buy and use oil products.

There are hosts of intermediaries operating in pursuit of profit in the value chain between end user producers and consumers, and the big ones are commercial 'for profit' International Oil Companies (IOCs).

IOCs are intermediaries who acquire production rights/ 'ownership' to the extent that States allow them, and they are hybrids in the sense that they may produce, trade, refine and distribute oil and oil products. No two IOCs are the same in terms of structure.

Whether producers are NOCs or IOCs they may monetise their oil production in various ways. They can borrow money secured against it; create 'Royalty Trusts' - as in Canada - by unitising revenues within a trust framework; or use more complex structured finance.

I regard the use of forward sales of reserves - which is what underpins financial oil leasing - as another form of monetisation, of recent origin. I think that the use of financial oil leasing - borrowing dollars and lending oil - has been changing market architecture and dynamics by enabling producers to cut out risk and credit intermediaries.

Thanks, Chris, for all of the responses. I look forward to reading future guest posts.

A couple of points.

Firstly, these are purely financial transactions.

No-one pumps out oil from the ground and pumps back in again. What happens is that producers enter into forward sales - the BFOE/Brent market has consisted of just such sales since it began and these form the basis of the ICE BFOE/Brent cash settled futures contract.

They then simply buy back these contracts. The BFOE market typically has many times more forward sales than there are cargoes, and most of these are settled financially, often via 'Daisy Chains' and 'book-outs' eg A ends up selling to B sells to C sells to D sells to A, and there is a financial settlement up the chain.

All pretty opaque, but it is the Brent/BFOE price - as asessed by Platts - of the actual 'dated' cargoes which go to delivery which sets the global oil market prices, either directly or indirectly.

I think that the financial support ends either (for a commercial producer) when upstream profits from oil sales are outweighed by downstream losses from refining overpriced crude or (for national producers) when buyers of forward contracts retreat on price. ie ETF fund money ceases to flow in via the investment banks.

Secondly, the rise in price is clearly due - in the long term - to supply and demand considerations which is why I see that the trend in upper and lower price bounds can only be upwards.

If cheap money is available to bid up house/land prices, then why are other asset prices any different? They are not, and from 2005 onwards what is essentially interest-free money from ETFs has been available to bid up the physical oil price for those interested in doing so.

Every producer is interested in physical market prices being as high as possible.

To me, the conclusive evidence that the 2008 'spike' - as opposed to the previous run up in price - to $147 was not a reaction to Peak Oil is that every other commodity spiked as well. Did we see Peak Metal, Peak Rice, Peak Copper all at the same time? No - we saw dollar interest rates at the zero bound, and investors thinking that they are better off with commodities paying 0% rather than dollars paying 0%.

The oil market is entirely out of control, and is operating in no-one's interest other than the intermediaries.

Every producer is interested in physical market prices being as high as possible.

I would add, "Within limits," and that is where the role of the swing producer comes in. Here are annual US spot crude oil prices (which is a far better indication of what consumers actually paid and what producers actually received) and annual Saudi net oil exports by year, starting in 2002 (EIA):

2002: $26 & 7.1 mbpd

2003: $31 & 8.3 mbpd

2004: $42 & 8.6 mbpd

2005: $57 & 9.1 mbpd

2006: $66 & 8.6 mbpd

2007: $72 & 8.0 mbpd

2008: $100 & 8.4 mbpd

From 2002 to 2005, the Saudis clearly tried to stop the rise in oil prices, and in early 2004, they explicitly stated as much:
(April, 2004)

Mr Al-Naimi said: "Saudi Arabia continues to be committed to OPEC's $22-28 price band. There are signs that worldwide inventories have begun to build but no one really knows for sure. I do not believe there is a fissure [within Opec]. There is dialogue. Opec in general is committed to the band," he said.

The Saudis followed through on their pledge to try to reduce oil prices, as they significantly increased net oil exports in 2004 and 2005, but then we see the significant reductions in net oil exports, as oil prices continued to increase in 2006-2008. The Saudis did of course show a year over year increase in 2008, but it was to a rate well below their recent net export peak of 9.1 mbpd in 2005.

So what happened? Based on the logistic models, Saudi Arabia in 2005 was at about the same stage of depletion at which the prior swing producer, Texas, peaked in 1972.

IMO, we are seeing demand having to accommodate itself a slowly falling supply of global net oil exports. Of course, supply can still exceed demand, which we saw in 2009, but the average oil price in 2009 only fell to $62, and I think that we are in the process of transitioning from a combination of voluntary + involuntary reductions in net oil exports in 2009 to mostly involuntary reductions in net oil exports in 2010, and in following years.

The following chart shows US annual spot crude oil prices (vertical scale) versus annual net oil exports from the (2005) top five net oil exporters, which account for about half of world net oil exports:

Incidentally, while the global net export decline rate has been low, our model and recent case histories suggest that the net export decline rate will accelerate with time, and the underlying post-2005 global net export depletion rate is probably on the order of 5% to 7% per year, which suggests that the world may be consuming one percent of the remaining supply of global net oil exports about every two months.


Excellent comment. I think that the Saudis have long had a Faustian pact with the US, and that the full extent of that understanding is wide, and is built upon strict adherence to dollar hegemony in particular, and relatively cheap oil in particular.

But Saudi Arabia, insofar as they are a swing producer, is between the Rock of the US (requiring low prices) and the Hard Place of other more activist OPEC members, not to mention that OPEC is anything but a cartel.

But in any case, what the numbers clearly show is that the Saudis tried to bring oil prices down from 2002 to 2005, and in my opinion, they did the best they could to bring prices down from 2005 to 2008.

The problem they had, in my opinion, from 2005 to 2008 was that they could not maintain or increase their 2005 net export rate of 9.1 mbpd.

This is actually the same pattern that we saw in Texas in the Seventies, when oil prices went up roughly ten fold, as oil production started falling in 1973.

I think that you are right. The Saudis were definitely trying to bring oil prices down and they absolutely did not want it to spike at $147/bbl.

They're not fools. They knew that prices that high would cause demand destruction and a steep fall in both prices and oil sales. Their goal is clearly to keep prices high, but not so high that it causes demand destruction. They understand the economics of this far better than most westerners.

They also have a lot of investments outside of Saudi Arabia, and precipitating a recession with high oil prices causes the value of these investments and their net worth to fall sharply. They also understand that very well.

The disconcerting thing is the fact that oil did peak at $147/bbl despite their best efforts. The Saudis understand oil markets very well. If somebody started bidding up the price of oil past their target levels, they could put a stop to it very quickly by dumping oil on the market in exactly the right places at the right times. The fact that they did not do this implies that they did not have the oil to do it, despite their statements to the contrary.

The days when the Saudis could just open the taps and pump out more oil on demand seem to be gone. Now, they are involved in an ambitious and expensive drilling effort just to keep production from falling.

To me, the conclusive evidence that the 2008 'spike' - as opposed to the previous run up in price - to $147 was not a reaction to Peak Oil is that every other commodity spiked as well.

Well, all commodities did not peak at exactly the same time. Most metals peaked a bit earlier in the year and gold did not peak until a year later. However it is quite possible that other commodities ran up in response to oil prices. After all oil is used in the production of virtually everything and the higher the oil price the higher every other commodity must be if it is to be produced at a profit.

Yes, I think the price of oil in 2008 was a response to peak oil. Crude oil actually peaked in 2005, (all liquids peaked in 2008). And crude is what we are actually talking about here, that is the stuff that went to $147, not all liquids. Anyway the economy was booming in 2005 and as the supply stopped growing users had to bid the price up to get the oil they needed.

Since supply stopped growing in 2005 but demand was still there, the people who could afford the oil simply bid it up, and up, and up. They bid it up until the price of oil, along with everything produced by oil, got so high it drove us right into a recession. Then demand dropped like a rock and the price did also.

And right now the high price of oil is keeping us at the recession's edge. The economy wants to recover but the price of oil will not let it. The price of oil is like a governor on the economy. Those who are familiar with diesel tractors are familiar with the "governor". If the engine revs up too high the governor cuts the flow of fuel and keeps it from going any higher. Right now the economy is trying to rev up but that requires more oil at lower prices. But the governor will not deliver more oil. The price increases but that kills demand and drives it right back down again.

Ron P.

Ron, the problem with your governor analogy is that we have multiple engines (say countries, or secors of the economy), and a single governor (oil supply). Some of the engines Chindia for example are less sensitive to the price than others, so the governor can constrain the absolute level of economic activity, but not the distribution of it by country or econmic sector. Of course there are also nontrivial lags in the system, so any economic correction doesn't ocurr quickly enough to choke off overshooting.

I think the connection to other commodities, is not just one way, commodities needing oil for their production, but oil
needing commodities for its own production. Remember how the price of well pipe was being driven up during the oil spike. This was probably substantially a result of a drill more at any price psychology setting in among producers.


Thanks for the responses.

So, the aggregate of all producers let 4.5 mbpd of oil rest in the ground while the price was running up. At $100/barrel that would be $450M per day (at the height) of foregone sales, right? Well, no, because if all that extra oil production was actually put on the market the price would fall to $50/bbl (if Hamilton is correct in his modeling efforts). Still, that's a lot of cash income to forego (replace).

For this to make sense to me, it seems that the producers who were withholding up to 4.5 mbpd of production when the price was nearing it's $147 peak would have to have been *equally* rewarded through the conduit of alternative revenue flows which you propose.

So, it seems to me that:

1) what you propose would require intense collusion between producers (at least tacitly) since no single producer had 4.5 mbpd of excess capacity at the height.

2) unless the 'financialization' process you are attempting to describe brings *richer* rewards than selling the commodity at a historical price peak, your thesis would require individual actors (IOCs and NOCs) to forego significant revenues.

While the U.S. was able and willing to turn down the tap (until 1970) to put upward pressure on prices, they did so for quite different purposes and to quite a different effect. The TXRC's goals were to reduce volatility while maintaining profits for producers. If the price went too low, the industry would be negatively impacted. If the price climbed too high, demand would be destroyed (or at least be restricted from growing at an 'optimal' rate). Perhaps the most important impact was to reduce volatility. In this case, there was a single dominant pivot producer which also happened to be a rising superpower and economic hegemon.

The situation today is completely different. We don't have a single pivot producer that is an economic hegemon and rising superpower. Unless the KSA could have raised production *significantly*, collusion would be required between at least a few Middle Eastern NOCs. I just don't see how such collusion could occur to such a significant extent given the political and federal budget realities among (especially) Middle East producers.

3) It also seems to me that if this price run was the result of deliberate actions, you would have to agree that the producers and intermediaries had *control* of the market. I doubt that anyone has much control over the market (but I'm open to counter claims). At any rate, these colluders certainly understand the simple concept of demand destruction. At some point, as the price climbed above $100, then $120, then $140, these colluders who were controlling the market had to know that they were going to destroy demand. So, the colluders were either extremely naive, or they knowingly acted against their own best *long-term* interest (and as time went by, 'long-term interests' became 'medium-term interests' and finally 'short-term interests'). This of course would not be the first nor the last time that a decision was made which sacrificed future gains for gains in the present. BUT... I still have a very difficult time believing that the colluders were bold enough to push the prices up past $100, then $125, then $140... At some point, these smart guys had to know that their own actions were going to create demand destruction, and the party would end.

4) finally, can you speculate which producers deliberately held back production, and by how much? What do these withholdings of production need to total to? Do you agree that 4.5 mbpd is the right figure?

Please explain in dodo terms for me (and others whose heads are spinning).

I am honestly still trying to wrap my head around your thesis. Thanks again,

-Awake in Seattle


The 'macro' market manipulation as I see it has almost certainly not been based upon with-holding of production, or collusion between producers. However, if it is the case that the Saudis have begun to use the leasing technique then they will do so in tandem with managing their production.

This manipulation has been a purely financial mechanism very much analogous to what Yasuo Hamanaka was up to - undetected for five years - on the copper market, and then for five years after detection. He (Sumitomo) was essentially borrowing money from investment banks, and lending copper in return, and was doing so through that extraordinary hybrid of forward and futures markets - the London Metal Exchange.

In order to manipulate the global crude oil price it is necessary to control the Brent/BFOE complex of contracts and in particular - over time - the Dated Brent/BFOE Platts assessment. At current prices only about $3bn worth of crude oil now comes out of these fields every month. An IOC, like BP, and an investment bank - probably THE investment bank - would have little difficulty in supporting prices if the funds are available, and they most certainly are, now that huge amounts of money have moved into oil and commodities as a safe haven.

The key to understanding all this would be the flow of contracts, and the resulting flows of money and title to oil between the producer(s) and investment bank(s) involved. Undoubtedly, many of the relevant contracts would not be transparent to the market.

I'm not able to get to see those, these days, although the FSA and CFTC between them probably could get to some of them.

I found this quite interesting, especially in light of the admission of belief in peak oil by the author. I'm still wondering how these are reconciled, but perhaps such a discussion is beyond the article's scope.

On KSA being a bank and oil its "currency," one has to wonder (1) how much currency the bank has, and (2) what various currencies the reserves comprise. Only the Saudis know how much oil they have. Not that they are going to run out tomorrow. Nevertheless, we know that peak oil has little to do with how much oil is left, and a lot to do with its location, accessability, and quality. Accordingly, the true worth of KSA's currency reserves is, for all practical purposes, a mystery to outsiders, who must take the word of the Saudis on it. This points to the need for an audit of KSA reserves (and of course those of all other major producers), just as we need an audit of the US Federal Reserve. Such opaque systems might function and make money for a while, but involve huge risks and the danger of precipitating a collapse.

I found this quite interesting, especially in light of the admission of belief in peak oil by the author. I'm still wondering how these are reconciled.

Maybe they are reconciled by a slight of hand. Meaning, the Author throws off the peak oilist by claiming a belief in peak oil, when he actually does not. In this manner we are set up to strongly consider the argument, or at least get a headache considering it as a possibility.

Reality usually is much more simple than the complicated excuses used here to explain away oil price volatility. Fact is, crude oil production has not exceeded 05 totals, which was followed by a rocky plateau and ever increasing prices until the crescendo of 147 in 08 with the market crashing at our feet, and the economy still trying to get up a head of steam.

But we can all read it numerous times, and spin our thoughts around and around until we are completely confused and befuddled, and finally reach the point where we ask, is there really peak oil, or is it a dark, sinister, back room accountant double tricking, banking backlash, hold the oil runaround volitility exercise?

My choice is, when in doubt lean on basic supply and demand dynamics.

But we can all read it numerous times, and spin our thoughts around and around until we are completely confused and befuddled, and finally reach the point where we ask, is there really peak oil, or is it a dark, sinister, back room accountant double tricking, banking backlash, hold the oil runaround volitility exercise?

Thank you! What you're describing--and it describes a lot of the hullabaloo that's been published at this site of late--is "intellectual bankruptcy." Stoneleigh and Ilargi have joined these ranks of late, with their Prechterian tea-leaf readings and conspiracies that elites crashed the economy intentionally during peak oil.

You get a similar feeling halfway through Ruppert's "Rubicon" book. It starts as a nagging insecurity: "Man, I'm not bright enough to understand this stuff!" But then you remember people like Albert Bartlett, or Stephen Hawking, or Richard Dawkins--people who explain complex ideas in such an engaging and accessible way that you actually feel smart! So you slam Ruppert's book closed, realizing--you're being buffaloed.

(One of our chums over at another of the more hysterical sites is floating the idea that the Haiti earthquake was detonated intentionally!)

Maybe conspiracy theories are an attempt to salvage some form of control of our destiny from the general waste--"Well, we're not really yeast, we're Evil." Such theories also absolve us from collective guilt, pinning blame on "powers that be" rather than on our simple reproductive and consumptive habits.

Occam's Razor applied to such woolly theories exposes our embarrassment. We're a bare, forked thing.


I agree that MikeB has written one of the most enlightening comments I have seen for quite awhile. I wish I had thought to write it.

I only found out recently that William of Occam was an early champion of the separation of church and state, which is another one of those logical and simple ideas. One of Occam's precepts was "entities shall not be multiplied unnecessarily". That is a guiding principle of dealing with data.

'The Result of any Transformation imposed on the Experimental Data shall incorporate and be Consistent with all Relevant Data and be maximally non-committal with regard to Unavailable Data"
-- The First Principle of Data Reduction (due to Ables in 1974).


You echo my own thoughts on this - all the talk of oil monetization and leasing has my head spinning!

I find it hard to get away from simple supply and demand and, as long as you include the futures market in that dynamic, there really doesn't seem to be anything else required to explain the price action. The spot and futures prices are neccessarily linked - buying oil for immediate and future delivery will both affect the price.

Of course there are many investors not interested in taking physical delivery and the actions of these investors will eventually net out to zero. What we may have seen during the early days of commodity ETF's was a NET inflow into funds that would have helped drive the price up in 2008 creating something of a bubble but I would have thought that by now an equilibrium between buyers and sellers would have been reached (anyone actually know if this is or isn't the case?). In which case the price (other than very short-term) is once more being dictated primarily by supply and demand of physical.

With OPEC, especially KSA, the only players able to impact supply significantly.

That's how I see it anyway.


This is refreshing and mind-clearing. Thank you MikeB.

Just one further clarification, if you please.

What, exactly is a "conspiracy theory", as you use the term? Surely much of what goes on both locally and globally involves "conspiracies" in the usual meaning of the word (i.e. "breathing together").

9/11 was a obviously a "conspiracy" of some sort -- presumably a few rogue Saudi's conspiring-- but "conspiracy theory", as a sort of pejorative term, seems to be invoked when it is alleged that the government was somehow involved.

Many financial "conspiracies" have gone on for years -- the original Ponzi scheme is one -- and no one calls that a "theory". Is it beyond belief that Goldman Sachs, with or without U.S. Government complicity could run a conspiracy, hidden from us mere mortals, for quite a while before it finally comes to light?

conspiracy theory 

1. a theory that explains an event as being the result of a plot by a covert group or organization; a belief that a particular unexplained event was caused by such a group.

2. the idea that many important political events or economic and social trends are the products of secret plots that are largely unknown to the general public.

Obviously "conspiracy" and "conspiracy theory" have two different meanings. An undercover FBI agent could conspire to infiltrate the Mafia. That would not fit the definition of "conspiracy theory" in either of the above definitions.

Conspiracies are many, an everyday occurance in the affairs of man. But conspiracy theories are mostly BS, dreamed up by small minds who wish to see something deeper and more devious in world events. As Mike suggest Occams Razor should be used in all such cases.

Ron P.

Is it beyond belief that Goldman Sachs, with or without U.S. Government complicity could run a conspiracy, hidden from us mere mortals, for quite a while before it finally comes to light?

Yasuo Hamanaka of Sumitomo manipulated the copper market for five years with the complicity of a few banks, before David Threlkeld blew the whistle and was vilified and mocked for doing so. It took five years before the regulators caught up.

I blew the whistle on systemic manipulation of IPE settlement prices about ten years ago, and lost reputation, income, home, family etc as a result of using the word 'systematic'. Everything I said was true, but it could not be seen to be true, and it was buried, and so was I.

The game has changed, but the problem is that trading by intermediaries has become - to all intents and purposes - acceptable market manipulation.

It appears clear to me that Goldman and BP have been co-operating at high level for a great many years - they had the same chairman for 15 years, and Lord Browne of BP was on the Goldman board for 8 years to 2007 - but what is not clear is the extent of that co-operation. Maybe they exchange Christmas cards


In the article you talk about the essential cooperation of the Saudis for this scheme to work. In the comments you point to BP and Goldman. What then is the Saudi-BP-Goldman collusion required here?

I see folks suggesting you're claiming "conspiracy," and there's a simple defense to that. What Goldman does for its clients and trading partners had damn well better be "conspiracy" or Goldman's not doing its job. They're smart. They presume to know things the world doesn't. For a price they will share that knowledge. And they trade on that knowledge.

Anyway, I'm getting several fragments of a broader picture from your article and this discussion, but it's not all fitting together. It will be a big help if you can put together a few sentences in which KSA and BP (or one of its peers) and Goldman (or one of its peers) are described in how they'd interact if they're carrying out the transactions you hypothesize.


The way I see it, Shell first came up quite openly with the oil leasing trading idea/technique, and BP/Goldman (at least) turned this 'open source' technique to a new use.

As you rightly say, if so, then Goldman is doing its job here as a supplier of financial services to BP - at least as market counterparty - and others. The biggest beneficiaries of higher oil prices are producers, not middlemen.

BP and Goldman don't have deep enough pockets for serious support of the market. But they may have had a following wind - as money poured into ETFs - in earlier years as the economy boomed, supply tightened, and - kudos to the guys here - Peak Oil became acceptable in polite circles.

Is KSA involved because they picked up on, or were sold on this trading idea? It's just a thesis, but a very interesting one which may or may not account better for the facts, than others. Another market commentator reckons there might be manipulation not by the KSA, but by the US government through the use of the strategic reserve - which opens up some interesting thoughts down the conspiracy track......

My core competences are legal and financial infrastructure; product design, and market architecture in a world of direct instantaneous connections. The commercial cut and thrust of trading is not my forte, and I do not have the detailed knowledge of the Brent complex as it now is, and of the all pervasive ICE platform, which I would need to attempt detailed answers.

Chris – Been following the discussion and its side shoots from the start. Had not heard of the “scheme” you’ve described as I work far upstream. But it didn’t surprise me greatly. Though designed differently it’s similar to another approach used to monetize in ground reserves that’s been around at least since I started 34 years ago. I suspect you’re familiar with this structure…not very different than approaches used in many aspects of life: collateralization. Seen most private/public utilize the approach. I have X million bbl of oil in the ground. This number is verified (to some degree) by an independent party for the benefit of the capital source. The capital source provides $Y to me. Simple enough collateralization. But there’s almost always a side play to the arrangement: the capital source doesn’t want to expose themselves to future price uncertainty. To acquire the capital I’m required to hedge a certain amount of future production at a set price. Often this generates a third player: someone to guarantee that price. If I just wanted to have a fixed future price I could simple buy enough future contracts to cover the requirement. But a third party might offer me a “floor”. If oil sells above the floor the third party and I split the difference on some previously negotiated basis. I also pay the third party an amount up front. Of course, the third party has to buy future contracts to guarantee their liability. OTH, if the third party has a guaranteed source of oil that satisfies me and my capital source they need not suffer the expense nor risk of the future contract.

In addition to providing an immediate cash infusion for operations I’ve seen this approach used to buy producing fields. Sometimes contributing more than 80% of the purchase price. These “mezzanine banks” (essentially investment companies) will also earn a revenue interest in the production in addition to the interest charged. The structure you describe seems to be some variation of this approach if I’ve followed the tale correctly. In the approach I’ve described all parties have an interest in seeing future oil sales maximize. But I’ve never seen it done on an individual scale that would have any effect on the future price of oil. OTH I can’t estimate the collective effect if a large portion of the reserve base were so contrived. But an oil producer on the magnitude of the KSA is perhaps a whole different game. As a geologist this is as far as I can take my story. I’ll leave it to you and others to integrate what might be different sides of the same coin.

Considering that OPEC by its very nature and purpose is a conspiracy to control the oil market, a theory that they have found a new way to do it is plausible.

No, to be a conspiracy people must conspire, which by definition means to conspire is secret, or covertly. OPEC is simply a cartel, a cartel which makes no secret what its aims are. And those aims are to set the price of oil above a given point. That means that it is not a conspiracy but an open cartel. There is a difference.

And that means it is two steps removed from a conspiracy theory. That is, a theory that parties are conspireing in secret, are did conspire in secret, to commit a crime.

Check it out at

Ron P.

from the Latin conspirare, which has to elements: con - together, and spirare - to breathe. Nothing in the word itself requires secrecy or hidden purpose, but rather a coming together in agreement for a shared purpose...of course that's a different thing than "conspiracy theory", which I find a fairly annoying modern pejorative, attachable to any hypothesis for the purpose of ending discussion.

By definition, OPEC conspires together toward a common purpose, though one which is not particularly public.

From the Latin? We don't speak latin anymore Daxr. As I said, check it out at and find out what the word means today!

The word "conspire" suggest secrecy but does not require it.

con⋅spir⋅a⋅cy  /kənˈspɪrəsi/ –noun, plural -cies.

1. the act of conspiring.
2. an evil, unlawful, treacherous, or surreptitious plan formulated in secret by two or more persons; plot.
3. a combination of persons for a secret, unlawful, or evil purpose: He joined the conspiracy to overthrow the government.
4. Law. an agreement by two or more persons to commit a crime, fraud, or other wrongful act.
5. any concurrence in action; combination in bringing about a given result.

On the other hand "conspiracy theory" does require secrecy!

conspiracy theory 

–noun 1. a theory that explains an event as being the result of a plot by a covert group or organization; a belief that a particular unexplained event was caused by such a group.
2. the idea that many important political events or economic and social trends are the products of secret plots that are largely unknown to the general public.

Daxr, it is just so damn easy to use a dictionary. And if you do you wil find that is exactly how we use the terms today.

Ron P.

secret plots that are largely unknown to the general public

Opaque derivatives trades are precisely largely, even entirely secret from the general public, and even from our nations' economic authorities. There's no contention at all about the fact that the extent of opaque derivatives trades exceeds, in nominal value, the entire wealth of the planet. Yet, in part because the specifics of so many of these trades are unknown, there is real contention about whether or not their continuation - particularly as private deals with no public reporting requirements - puts the world's entire financial future at great risk. On the other hand there's no contention that at present such trades continue to contribute substantially to Goldman's (and its peers') bottom line.

You can't be so afraid of being a "conspiracy theorist" - which is clearly a pejorative label - that you refuse to concede that deals done secretly in fact constitute a substantial portion of current financial activity in this world. You might argue whether these deals constitute "plots" or not. But whether they are "plots" or not is in the eye of the beholder, and really not germane to assessing the facts on the ground. The question is not the coloration of the terms we use, but the reality we're referencing by the larger discourse.

I know, I know - I'm making a different point though. "Conspiring" is acting together toward a shared interest. An oil cartel only exists as a group acting together toward a shared interest.

To label a suggestion that the members of OPEC act together toward a shared interest a "conspiracy theory" is therefore ridiculous, because of course they are, that's why they exist. You don't need a theory that a group is doing secretly what their stated purpose says they do.

@Perk Earl

The price is of course determined by supply and demand. I have never said anything else.

My choice is, when in doubt lean on basic supply and demand dynamics.


Every market - and not just oil - spiked when interest rates hit the zero bound.

We did not experience Peak Oil, Peak Rice, Peak Aluminium and all the other Peaks at the same time.

The fact is that the market prices - ALL of them - lost touch with underlying dynamics of supply and demand because investors came in to the market, and - with the assistance of financial intermediaries - bought, or borrowed, any available commodities as an alternative to dollars earning zero per cent.

@Rice Farmer

I found this quite interesting, especially in light of the admission of belief in peak oil by the author. I'm still wondering how these are reconciled, but perhaps such a discussion is beyond the article's scope.

The reason I included the introduction is to make clear to Oil Drum regulars that I regard the existence of a maximimum level of oil production to be self evident. That is the Peak Oil case is it not?

There are some on this site who appear to see any suggestion that oil prices will not necessarily immediately rocket due to fundamental supply/demand considerations - and civilisation thereupon come to an end - as being heresy. So my suggestion that there is often - due to the dysfunctional architecture of oil markets - a financial component in oil prices makes me a heretic, which I actually don't think I am.

Intermediation of markets ie the advent of middlemen - as happened to the oil market in the 70's - leads to the introduction of players who have an interest in volatility. The introduction of leverage - through credit intermediation by banks, or risk intermediation with derivatives - amplifies that volatility and introduces yet more players with an interest in volatility.

Whether or not the KSA is 'monetising' oil the way in the way I speculate that it could, is a moot point, and just a thesis which may account for oil price moves better than other theses. Certainly, if anyone ever were to take on such a quasi-banking role then transparency would be essential.

One fairly well-known market commentator agrees with my view as to the mechanics of manipulation, but has a different view as to culprit and motive. He takes the view that the US Strategic Reserve was used in late 2008 to flood the market and puncture the bubble. It is only a step from there to build a case that it may have been the US - not just commercial producers - who was complicit in manipulation. He cited geopolitical motives which are plausible, but about which I am not convinced. many would take the view that puncturing bubbles in prices is one of the uses to which the Reserve SHOULD be (transparently) put.

I don't agree with everything in this article but he is on the right track manipulating the oil markets takes a lot of physical oil.

It can be done but by only a few players.

But he goes off the wrong path quite a bit.

The first question you have to ask is how much oil is needed to change the global oil market.

1 million barrels nope 2 nope.

A reasonable minimum big number is 50 million barrels. Thats unleashed or witheld will move the price of oil. 100 million for sure. 100 million is 50 VLCC's and we just happen to have that many and more floating around empty or perhaps full.
You don't need to go into talking about oil in the ground plenty is was might be floating around in tankers.

I'd argue any discussion of and oil bank starts here.

Other parts of the story would be secondary to this.


100 million barrels is de minimis in global terms. A couple of days supply.

You are missing the point that I am referring to financial transactions in claims over oil, and the effect these may have in supporting the oil price when backed by billions of dollars of 'free' money. When the financial buying supporting the price pulled out, the price collapsed.

Exactly as the tin price did in 1985.

I don't think you appreciate the effects on the market of producers - who, unlike intermediaries, store oil for free - monetising reserves in the way that appears now to be going on.

100 million barrels is less than 2 days supply(meaning production and its subset,exported supply). that is a valid metric if oil supply(meaning production, et exported supply) is zero. however, if demand exceeds supply by 1 million bpd, that is more than 3 months excess supply. a little over a year ago, the floating storage was estimated at 200-250 million barrels, or 8-9 months (of one million bpd excess supply). recently that number has been estimated at around the 100-125 million barrels. imo, this overhang of 3 plus months (of one million bpd excess supply) will keep oil prices in check.

and, imo, the 2008-2009 price gyrations are a result of only slight imbalances in supply/demand probably amplified by speculation.

maybe we should be looking at supply as exported supply and at imports as imported demand.

excuse the request for a remedial lesson on extraction, transport, and storage, but is the infrastructure in KSA (or for that matter most of OPEC), associated with the aforementioned tasks, owned by KSA? If not, how are the agreements made? Through annual negotiated contracts, or longer term? Just curious.

No Chris your missing the point it takes very very little oil on the margin to set the market price.

I was being nice.

First and foremost this concept that its only a few days supply and thus not import is simply stupid. 100 million barrels would fill almost half of the US's storage and is about a 10 day supply of US imports or 25% of the market. It would supply china for 20 days.

If China quit buying oil for 20 days what do you think happens to oil prices ?

All of these forward contract schemes cannot pump oil out of the ground any faster they are all eventually limited to the real production rate and thus eventually price is set by supply and demand.

Crude stored in tankers and on shore is a fundamentally different beast and can be unloaded in volume in a matter of weeks smashing real oil producers.

The next question is where does this oil really come from well it does not really need some dramatic changes in supply and demand to make it happen the seasonal variation in demand which fluctuates by several million barrels a day over the year is more than enough to provide the seasonal spare capacity to generate a few 100 million barrels of stored oil. The arbitrage play is effectively natural if your willing to store as there is always a built in period of supply in excess of demand on a seasonal basis.

What you do need to be sure of is that no oil producer has significant spare capacity and can flood the market leaving you sitting on a bunch of over priced crude.

Obviously this crude can be leased just like production can be leased forward its just one of the financial games that can be played on top of a decent supply of crude. Indeed to keep this supply large enough to move markets your going to be front running end customers buying crude forward via a number of methods.

In fact the number one way to make serious money without losses is to front run your own customers so if you want to pick a financial scheme to go with oil prices I'd argue that proving this is not happening is your first step.

And last but not least there is and extensive spot market for crude and most crude is not exchanged on the markets. For financial games to actually work to control the price you need liquidity in crude to temper the much larger spot market.

Does this arrangement eventually blow up well yes. In this case its the spot market that will eventually force the issue as real consumers run low on supplies and resort to spot purchases. This sends the futures market into backwardation and spot prices zooming.

This oil used to provide liquidity to support financial games becomes a simple hoard sold to the highest bidder. Thus even when the trade blows up it blows up to one that generates even higher profit. Not a bad ending.

Underneath it all of course lies the fundamentals which make hoarding oil a win win situation. First of course is that net exports need to have fallen far enough that tankers are in oversupply making it cheap enough to lease them for storage. Next you need to be pretty certain that real oil producers simply cannot surge production in any meangingful way. I'd argue both these conditions have been met. The inability of the Saudi's to control prices is fairly obvious. And tanker rates are public info.

And last but not least this does suggest that if the current situation unravels that its to a simpler shortage and hoarding market which historically results in a rapid increase in prices.

When it blows is and open issue but once it does it goes with a bang.

Hi Memmel,

If I understand CC correctly, he is saying that the Brent/BFOE contracts effectively set the WTI;
and that the Brent is set by Platts with reference to a pretty small number of contracts.

CC (ex ICE manager) says the WTI tracks the Brent via "massive arbitrage", I can only take his word for it.

Platts are trusted to find a price which balances supply/demand, but are also in a position to collude with producers to adjust the supply side of the equation.

Major producers can sell forward full production capacity, and then buy some random percentage back, and thereby leave as many or as few contracts for actual eventual delivery onto the market as they want (as per my hazy understanding of forward contracts), essentially after seeing the other players cards.

The manipulation theory makes sense in that it explains how the arrival and departure of cheap credit impacted the oil price (while supply tightening was also afoot), and also how important players would logically and feasibly have been futhering thier own interests.

This would all be completely different of course if all produced oil was offered in a rolling auction after being produced, to buyers immediate delivery.

CC's theory would be a Popperian scientific theory if it could be shown to be false, I amn't qualified to suggest some way it might. Chris - ?

(or have I misunderstood ..?) ..

Look thats all secondary to the spot market.

The vast majority of oil is not sold via the futures market. They are used to index the real oil trades i.e you sell some real oil at X quality at say 2 dollars below Brent of WTI of 10 dollars higher depends on the grade of oil.

The spot sets the real price as its where all the real oil volume is you can play games all day long in the futures markets and it won't do a damn thing to the price of oil.

Now with that said if the market is well supplied oil prices can collapse in a hurry the sensitivity of the market is towards the lowest price. Sell a cargo on the spot market and get no bid lower your price.

Oil like all commodities are very sensitive to price collapse on oversupply. Enter the futures market which allows commodity sellers to lock in a price using the liquidity supplied by speculators.

Those mean nasty speculators provide the cash that allows real producers to hedge against price drops.

If the price eventually goes higher than what the producer hedged at the speculator makes the profit instead of the producer. Thus its a pact in exchange for loss of potential profit a speculator thats going long on oil makes a profit. Now this speculator can be a real customer or a cash speculator does not matter.

I'm simplifying but the point is the futures markets are there to allow the commodity producer to protect against price collapse. I'd argue that their role in protecting a consumer against price increases is secondary.

Well producers are of course going to hedge into the futures market and also sell on the spot market at a price that makes a profit for them if at all possible.

They have to of course compete against other producers but the marginal supply generally sets the price i.e prices are set on the margin. If they drop too low then less oil is offered for sale.

Now what speculators in the futures market can do on occasion is drive down the price of oil not drive it up if the market is well supplied and enough producers are willing to sell at a spot price thats low.

They can screw the marginal producer over big time. A perfect example of this is of course Natural Gas in the US where plenty of marginal producers are selling at a loss even right now.

Depending on how they hedged buying futures they are doing ok to very poor.

The only time you can play financial games to drive the price up is when the real oil market is very tight. If theres plenty of physical commodity around and you try to drive the price up using financial games only then your sure to get wiped out eventually. The spot market will get well supplied spot prices sink and there goes the futures market.

You simply cannot drive it higher than what producers are willing to sell for for long in a well supplied market.

Now if the markets actually tight then the sky is the limit commodities in general exhibit such price swings and this is where a real commodity buyer become willing to enter the futures market to protect against scarcity. But also this is where the money from financial speculators flood in.

Now the market is highly sensitive at this point if a surge in real supply actually happens then it can collapse fast. For most commodities the market generally surges production as fast as possible and we get your typical roller coaster ride or spike.

Whats important to understand is it takes a very small increase to turn the market at this point producers are making money beyond imagination consumers are desperately hedging the market is demanding more supply if it comes then wham. But only a physical real change can sooth the market and force it to back off.

More often then not it undershoots badly on the low side then back up again.

The future markets certainly dampen the volatility with the key exception of at the extremes. There they tend to make the highs higher and the lows lower as the financial side bets are unwound.

Thus they work till they don't. This is why this concept of 70-80 dollar oil being a good price is fascinating as its difficult to keep commodities stable but overpriced. 70-80 is a good price for even the most marginal producers and should ensure all oil that can be pumped will be pumped i.e its high.

The problem is of course to prevent a spike you need physical oil i.e your constantly adding physical oil and probably playing games in the futures market. Its certainly doable over a 3-6 and perhaps 12 month time span but its a interesting concept. My opinion is its highly unstable.

I guess the problem I have is the assumption being made by most is that the price is being artificially inflated while I've been looking at it from the other viewpoint that the price of oil is being systematically pulled down. 70-80 makes all the sense in the world if the market is really fundamentally short yet every effort is being made to avert another spike in prices.

OPC is not trying to keep prices high they are trying to keep them low but high enough to ensure anyone that can produce oil will.

And its not just OPEC of course everyone in the game is generally working to keep a ceiling on prices. As long as the volatility is there and the contango its doable. We have lost our contango but the volatility is still around.

If you know that prices are suppressed then its safe to push them down as you know they will pop up again. I.e you can play the lows just as if they where true contango. For example the price of oil right now as I right is hovering around 74 while the high was over 83. This give a price spread of 83-74= 9 a barrel. If your certain that the price will bounce back over 80 then this volatility is just as good as a static contango. You can be confident they will pop back up again. This means of course you can aggressively buy for storage at the lows and sell at the highs.

The result of course is a crapload of oil sitting in storage.

Over the long run it does not matter if the market is fundamentally tight then every low gets more and more buyers and you see steadily higher lows and faster rebounds. Eventually you get more and more new highs. After a while everyone piles in on the dips and the volatility is lost. To push price down you have to let more and more out of storage as you buy into the futures market for delivery to replace storage you tighten the market even more.

Thus this attempt to set a "fair" price for oil where every producer makes a profit eventually blows up as its simply a price control/shortage game. Like all attempts at price control they eventually fail. This is because the profit margin of the producer is not the issue its increasing the price to the point that demand meets supply thats the issue. The price must increase to lower demand nothing can stop this from happening.

As and aside the inverse is currently happening in the housing market the market is over supplied with houses and everything under the sun is being done to keep the price from collapsing this will eventually fail. In both cases when the attempt to control prices fails you are more than likely going to see a serious overshoot.

In the case of oil the simply fact we had a price spike and collapse in the past will make it much harder to drive prices down as demand is resistant.

For housing the same but opposite the fact it was bubbles while supply was really ample makes it very hard to even increase prices once supply is actually balanced you need to go to tight conditions to actually get it to finally go up i.e overshoot.

As far as a collapse in oil prices well so far at least I just don't see that happening if OPEC is not withholding supply to support prices then they always can so if I'm wrong then at bet they get their fair price. If I'm right then it blows higher. Only a significant increment of non-OPEC oil could actually drop prices and I don't see that happening. As time goes on if Saudi can act as a swing producer then they need less and less support from the rest of OPEC to set a price. If its a bit more complex game and the real oil supply simply is not there then nothing can be done to prevent and eventual spike.

Commentators have suggested that perhaps $50.00 of that price is accounted for by supply and demand, while the balance is purely financially related.

To me this is not a very convincing argument. Unknown commentators guessing at something for which they have no supporting evidence.

Well lifting costs for the marginal barrel are fairly well known. The pricest oil on the market comes from the tar sands and deep water GOM whatever their production costs sits the marginal minimum price.

In general numbers such as 60 dollar a barrel or so to cover costs are common. 40 a barrel is very common. Depending on the price X amount of marginal production would be done at a loss. At 40 a barrel we probably would still produce the tar sands but not expand some of the deep water projects not that they won't be produced at a loss. So on a fundamental basis 40-60 for a barrel of oil is a very sensible number.

I'll say I buy into the argument even 30 depending on demand is easily sensible as most of todays production was produced profitably at 30 a barrel. Given the time thats elapsed since this happened and all the financial stuff inbetween you need to correct for inflation but we have been deflationary for a while so 30 is probably doable depending on demand.

Thus the current price is by no means supported by fundamental production costs its way beyond whats needed to generate handsome profits for most oil producers.

This leaves two choices.

1.) The OPEC cartel and other games such as outlined in this paper is responsible for inflating oil prices by playing games on the supply side.

2.) Even after the economic crash we are still fundamentally short on the supply side and prices are rising. This is indicative of a fairly robust fall in net exports either via demand growth in producing countries falling supply or probably both.

Now these are not fully exclusive and I'd argue at the moment there is a bit of mixing as I posted above but its based on seasonal flux in demand not extensive real spare capacity.

However I should add that if its purely one i.e financial games eventually they will unwind and collapse at some price point someone will get greedy and over supply the market esp given rising prices should dampen consumption thus sooner or later cartels will fail and this would cause a chain reaction collapsing prices below the fundamental support levels.

This is important is its also doable without a long term fundamental oversupply of oil. A short term burst timed when the market is fragile works.

I might as well explain what I think underlay the price swings in the 2008 its not that complicated.

First of course KSA was unable to expand production to temper oil prices i.e they were at capacity. Since they could not increase daily production they had to do something else. Well it turns out there is another way to smash a market even if you don't have any real spare capacity.

What you do is start witholding production from the market and storing oil probably using your fleet of 60 VLCC's production going to market then goes on leased ships. This sends the price of oil up strongly but more importantly it send tanker rates shooting to the moon as your taking more and more tankers of the market even as prices are soaring. So the key fingerprint is a sharp rise in tanker rates plus sharply rising prices.

At some point you simply unload assume you have filled 60 VLCC's and you throw them all on the spot market for oil you rapidly swamp the basically just in time market with oil. Sending prices for oil and tanker rates plummeting.

If such a move is timed to happen when the financial market just happened to be facing armaggedon by the strangest of changes ( not)

Then you get a massive drop as financial plays are also unwound.
KSA also has or rather had extensive product storage so such a surge need not only be oil but also distillates. Thus flooding the product markets at the same time.

Now on the demand side the sharp increase in prices would have artificially dropped demand below real production capacity as supply equals demand. The initial flood of oil would have easily overrun demand for 140 dollar oil and coupled with the financial crises that followed real demand could have easily dropped below supply leaving a significant glut on the market with even a 1mbd differenatial.

At this point the hurricane and real oil bank using floating storage come into play and the rest is history if you will.

I suspect that everything got seriously out of hand with lots of unintended consequences I seriously doubt the Saudi's expected investment banks to get into the oil business at the level they are today for example. So I don't think everything went as planned but it was dealt with.

With this sort of scenario you can readily see large changes in the price of oil without large changes in supply or demand a gap of 1-2mbd is more than enough to support prices from 140-30 with just a bit of manipulation of the timing of delivery and assumptions about the finanical changes that are historical. In deed you can actually pull it off with a difference as low as 500kbd just depending on when you start storing oil. And if you dig around a bit you see evidence that smaller variants of such a game of withold and surge where attempted earlier before the "big one" was tried. This suggests that when the sledgehammer was applied it was 1-2mbd of oil taking out of production and stored to at least 100million barrels or more.

This also explains why the market responded as if oil production had suddenly collapsed well from the market perspective it had.

I thought we had turned a shark fin like production curve at the time as thats all that fit the data. Now the picture is a lot more muddled but with the data I have the timing was probably based on and underlying sharp increase in decline rates. So we did but not quite as sharp as the market was signaling.

This fits well with the big picture as a sharp increase in the decline rates would put us well past peak as even the rosiest realized that production simply could not be brought online fast enough to increase production to new highs.

Peak oil was well in the past but more importantly the decline rate had accelerated to the point that it was the peak for sure using any sane model for bringing new production online. Thus once this decline rate hit a certain threshold we had to crash our global economy.

And of course and underlying real acceleration of physical decline rates even with the games played on top supports our current price levels very well. Thus everything fits.

Going forward what you want to watch is tanker rates and the price of oil if we see the price rising strongly and tanker rates having a tough time keeping up with rising bunker fuel costs then we know its the big one if you will and the market is fundamentally short.

If tanker rates scream higher with oil prices then its another round of the game and expect a spike.

A very strange answer to my comment!

"At some point you simply unload assume you have filled 60 VLCC's and you throw them all on the spot market for oil you rapidly swamp the basically just in time market with oil. Sending prices for oil and tanker rates plummeting."

Your reply is strangely worded. Are you suggesting the Saudis did this. Some evidence please. Withholding and then throwing 60 tankers of oil on the spot market all at once is not something one can keep quiet. Also, I can't quite see the motivation for Saudi to try and trash the oil price.

But in the increasingly divisive debate on the cause of the quadrupling of oil prices since 2000, Brown has support from the US and least some Opec members, notably Saudia Arabia, the largest oil producer. Under diplomatic pressure from America and Europe, Saudi Arabia increased production in May by 300,000 barrels a day, to 9.45m barrels a day. Oil minister Ali al-Naimi has said he will increase production by 2%, to 200,000 barrels a day, next month.

More here.

By august prices where falling so a significant quantity of oil entered the market. I'm not saying all these reports are correct obviously I don't think it was real production increases but plenty of claims of increased production followed by falling prices which I'm willing to take as the truth in the sense that more oil was really put on the market and prices really did decline. Now where did this oil come from all of a sudden despite prices having been way over any historical comfort zone for over a year ? No way was it a production surge sorry. And since I'm claiming its tankers you have to look at the various tanker indexes.

Using this it looks like we had a test store and surge in Dec-Jan of 2008 which did not do all that much to prices thus later on a bigger hammer was used. Who knows the exact amount of oil that was stored and released but its seems fairly obvious looking at the tanker indexes and oil prices that a sort of test was carried out.

This was May-June 2008 by Aug prices where declining.

Given they had failed to act all the way up all I'm saying is that this was probably oil that was stored and it took a while to build enough to surge.

Nobody really believed them for good reason they where probably producing maxed out most of the last several years. Thats why cut and store was the only option.

Its a one shot deal assuming its true then we can readily assume plenty of people with lots of money know it.

Small wonder very wealthy speculators have had not problem storing 100 million barrels of oil or more post 2008.

Its got to be a sure bet. I'd argue the truth is really not that hidden movements of hundreds of millions of barrels of oil is not something thats easy to hide.

Of course at some point once physical pressure was released financial games took on a much larger role as large positions where liquidated.

A history lesson on what happens when the market becomes well supplied with just a small production increase.

Notice who I credit with and excellent understanding of the truth.

Back then it was and unexpected number of North Sea fields coming online that helped start a financial storm.

First you have to have the physical oil next you have to have a financial issue. In our case it was the imminent collapse of the entire financial system not just one company in a bad position.

It took about two years before prices recovered in that particular case the period around the low was about one year or so.

Thus a combo of a fairly small physical oversupply coupled with a financial squeeze can readily depress prices for about 6-12 months.

Don't read to much into the source of this link the commentary is actually pretty good :)

Another factor that was part of the price of oil was also the recession through the period by 1993 however outside the US was where the issues where.

A trifecta that fits quite well with whats happened recently.

I'd argue for the historical data its probably the best fit out there to recent history.

Also had basically a double dip a bit later in 1998.

More good stuff from Simmons I'm in basic agreement with.

Whats important to understand is a disruption of oil prices for 6-12 months from a combination of recession, financial squeezes/problems and recession is the norm not the exception its happened time and time again. It takes a bit for the situation to clear but eventually it does. By any measure the oil market got hit with the largest sledgehammer possible in late 2008 but prices had alread rebounded by summer of 2009.

Everyone fixates on the low and the high whats important is the time scale the period of falling prices before a strong rebound was one of the shortest in history. Physical crude of course played a factor as it had to have but I'd argue given the time period over which prices moved financial factors dominated a good bit of it with crude taking secondary role. It was large amounts of crude moving around but not huge amounts of continuous supply.

Many people that know the history of the market well assume this is a repeat of whats happened in the past. Its close that for sure close enough I can use past examples that have similar factors. However its not a repeat and for fundamentals whats important is time. This time around the nature of the factors and the relatively short period of time we had low oil prices in my opinion signals that no long term production change was behind the price changes.

Everything is short term one off events. I'm not convinced we will see a repeat of any past events going forward.

When I saw the title "Oil Bank", I thought it was more likely to be written by you than someone else, but thanks for your thoughts here.

I do not have much disagreement with what you have said, except that I perhaps think it more strongly than you that the Saudis are (unsucessfully) targeting the price of oil. There was have been upticks in OPEC oil exports as the price reaches about $85 and a downticks when it falls below $75 - although admittedly I think the oil output figures I and everyone else throw around here are a little less certain and precise than we like to think.

On a side note I don't think OPEC will let oil go below $70 if at all possible, and perhaps because of US help in Yemen, they are trying to hold a top line at about $85 for now - by which I mean the first half of 2010.

Having said all that, any desatbilzation of either the US dollar or US financial system will set oil once again on a wild ride. Since I don't believe lasting energy price deflation is possible, the risk of the price doubling in less than one year is about the same as it falling 25% - or in simple terms, very much skewed to the upside.

As I have said before, we will know by the end of 2010 for sure whether some of our ideas about inflation, deflation, the oil bank, and similar topics turn out to be right. We now live in interesting times.

Thanks Chris for this enlighting post.
I think your ideas go well in line with the revenue optimization derived from Hotelling's rule. This is the same principle a (monopolic) drug dealer follows in order to maximize his income, or like a farmer who wants to get as much milk as possible from his cows without killing them.

So we see that the economy of a finite resource supplied by a monopoly (or cartel) is fundamentally different from the current free market paradigm (which is self-regulated by market's "unvisible hand"), which does not take account supply and which cannot apply for cartels (which inhibit free market competition).

And it is sad to see that so far only few people realize this.


Thanks for sharing your ideas with us. If this manipulation is taking place, how would one go about finding more evidence of what is or is not going on? Wouldn't somehow their hand somehow be tipped to the public?


I am putting forward a thesis which may or may not account for oil price movements, and the actions of market participants, better than other theses. That is for Oil Drum readers, and everyone else, to consider in the light of their own expertise, and knowledge.

If they have a better explanation, they may outline it in the same way I have, and thereby put their head above the parapet to be shot at.

The thesis of the more fundamentalist 'Peak Oil' adherents is that supply and demand considerations ALONE caused price movements. I disagree with this absolutist view - at least in the dramatic spike in 2008.

While supply and demand considerations definitely underpinned and sustained the upward trend prior to that, I feel that it is beyond the bounds of possibility that Peak Oil, Peak Rice, Peak Aluminium etc were all reached at the same time - and so I think that another explanation, involving financialisation of oil, accounted for the 2008 Spike and subsequent crash and retrenchment in commodities.

The thesis of populist US politicians and the instinct of the general public is that it was the funds wot dunnit, via futures exchanges. Naturally this is a thesis that suits financial intermediaries and producers. But anyone who actually understands how the market works understands that funds - whether ETFs (who are blameless) or hedge funds (who are not, being interested in volatility, if not price) - are categorically unable to secure supply and therefore cannot be responsible for any manipulation. Having said that, the funds could, and did, IMHO, unwittingly fund the true culprits, whoever they were and are.

As for evidence - not easy, particularly if only a few people are in the know, and there is nothing in writing.

First, and above all is 'cui bono': here it is producers first, second and third. Producers have a long track record, and if they can support prices, they will.

Secondly, purely circumstantial evidence includes the Saudi abandonment of WTI in favour of ASCI - which if my thesis is correct was because WTI was causing them far too much in friction costs to middlemen.

More interesting is Craig Pirrong's recent study, in particular

Pirrong discovered different findings for Brent. “During the period from Sept. 1, 2008 to July 17, 2009, the correlation became negative: .5536 to be exact,” Pirrong said. “This is diametrically opposed to the behavior of Brent spreads prior to the financial crisis, and is not what one would expect to observe if Brent spreads were reflecting world-wide supply-demand fundamentals.”

I think that this demonstrates that Brent/BFOE behaviour during that pricing interlude of collapse and retrenchment was financially, not fundamentally driven. The question is, was it the Brent/BFOE prices before Sept 1 2008 and after July 17 2009 which reflected world-wide supply-demand fundamentals, or did they briefly revert to fundamentals during the period?

But to conclude, I think that in our current - intermediated - market architecture there is no "true" market price, and that one can only understand the market price in terms of the 'bid' and 'offer' boundaries where destruction of production and destruction of demand kicks in.

I think that this demonstrates that Brent/BFOE behaviour during that pricing interlude of collapse and retrenchment was financially, not fundamentally driven.

Chris, no doubt finances had a lot to do with it but this could only cause short term swings. Short term swings are nearly always caused by speculation, or other types of financial manipulation, but long term trends are always caused by the fundamentals. Chris, the economy collapsed for Christ sake! We went into a worldwide recession. A worldwide recession caused primarily by high oil prices and the collapse of oil prices was nothing but the feedback caused by the recession. Those are fundamentals if fundamentals ever existed.

Ron P.


I agree totally that long term swings are fundamentally driven, and I say as much.

As for causality - that's a very interesting discussion.

I think that energy price shocks can and do precipitate recessions, but that there is something more fundamental than a recession going on. Over two thirds of money created in the US and UK, and a large proportion in many other countries, is based upon land value, through the creation of mortgage-backed loans by banks.

This created property bubbles on a colossal scale, and I think that it is likely that it was the oil price rise that proved to be the straw that broke the US public's back.

Did the oil price 'cause' this continuing credit crunch? I don't think so. Did it precipitate it? Almost certainly.

Chris, Jeff Rubin explains it much better than I ever could.

Jeff Rubin At ‘The Business of Climate Change’

Only a very small portion of the video is about climate change, it is mostly about oil prices and the effect they have had, and will have, on the economy. The part about the oil shock causing the recent worldwide recession begins at 16:35 into the video. He asks: "Why was the recession in Japan twice as deep as in the U.S.? Why was the recession in Germany 50 percent deeper than in the U.S.? And why did Germany and Japan go into recession before Cleveland went into recession if it was all about sub-prime mortgages?"

Anyway this is best video I have watched in the past decade. It explains a lot... a lot that most people do not understand.

Ron P.

@Ron P

I've seen that video. Most impressive.

I thought one of his best points was that the most cosmic energy waste (and source for savings) is in the producer nations, which I've been saying for some time. That's why COP15 reminded me of cripples fighting over a crutch, since it was about developed and less developed consumer nations fighting it out over cuts, when the low hanging fruit is among the OPEC membership.

He reinforced the case that energy shocks are a cause of recession. Germany, having very stable property prices, due to a rental culture, and Japan, having a bombed out property sector, are among the most insulated from the property bubble so the recessionary effect of energy was most visible.

You say 'was' in relation to the recession. What's happening now is not a recession.

In the US, UK and many other economies, I think that we are only at the end of the beginning of what could easily - particularly with the application of Voodoo economices - degenerate into a depression. At the moment, we have a bubble in financial assets. The real economy is stagnant at best, with a real danger of depression. IMHO the only solutions conventionally are continuing QE until massive investment in productive assets - renewable energy and energy savings, plus conversion and reconfiguration of the built environment - rectifies the economy. Unconventionally, a debt/equity swap - which has been touched upon by Nassim Taleb and Willem Buiter - might work.

You say 'was' in relation to the recession. What's happening now is not a recession.

I think you meant to put a question mark after that last sentence. Yes, what's happening right now is definitely a recession, and I expect it to turn into another Great Depression within five years or less. But I was quoting Jeff Rubin. I don't think that he meant to imply that the recession was in the past. He meant it like "Why did the recession hit Japan twice as hard? That is, the initial onslaught of the recession is in the past even though it is still raging.

Ron P.

I wouldn't attribute the bulk of the problems for Germany/Japan to energy (at least not the domestic cost of it). Remember both nations are major exporters, particularly in the hard hit automobile sector. Admittedly fuel costs were/are part of the reason for the dramatic decline, but much more it is about the credit collapse, which would have happened even if energy was not a problem.

As short term dollar interest rates fell to zero - “the zero bound” - investors switched their dollars into other assets, and particularly commodities, which also carry zero income, but which at least have intrinsic value, unlike the dollar or indeed any other 'fiat' currency. We therefore saw simultaneous spikes in the oil markets, agricultural markets and metals markets which had nothing whatever to do with underlying supply and demand.

These rises in price continued until the destruction of demand created surpluses beyond global storage capacity, and prices thereupon collapsed as the bubble of leverage funded by investors deflated. The oil price collapsed to about $35 per barrel, and since short term interest rates remained at 0% the conditions were ripe for a repeat.

This is wrong on so many accounts that it is hard to start discussing it.
But here go a couple of points:

Your timings are totally mixed up:
The short term dollar interest rates DID NOT fall to zero before the raise in commodities prices, and as such cant be the reason for that price increase.

"spikes in the oil markets and agricultural markets [...] which had nothing whatever to do with underlying supply and demand"
This is preposterous!
You clearly did not study the realities of these markets, say, between 2005 and 2008...

"until the destruction of demand created surpluses beyond global storage capacity"
Boy, you sure did not even try to look up those facts, you just invent them!
Something easy and simple in graphical format:
Does storage seem to be at record levels during the 2008 oil price "spike"?

These forceful statements, being totally wrong, bring into question every other "fact" you state (some of which I cant immediately classify as correct or incorrect but that, anyway, in light of this I cant trust...).


I wrote 'fell to' when I should have said 'fell towards'.

It's true that short term interest rates were falling dramatically throughout 2008 towards the zero bound late that year, and since. It is this fall which IMHO motivated many investors to switch into commodities in whatever way they could, whether by physically buying them, by investing in funds, or otherwise.

You clearly did not study the realities of these markets, say, between 2005 and 2008...

I am not referring to what happened in that period and certainly did not study those markets. I am referring to the spikes across commodity markets in 2008 and - more to the point - to the subsequent collapses in price. I do not see how these collapses reflect fundamental flows of physical market supply and demand, rather than the results of financial distortions created by panicked - and risk averse - investors looking for a bolt-hole for their money.

You may disagree.

On the storage point, I stand corrected. The rapid breakdown in prices clearly had other - financial - causes. If you think that this brings into question everything else I say, then that is your privilege.

The storage data you introduce illustrates very well the smoothness of the underlying flows in the global market in oil and oil products. The oil market price can and should be - as it has been previously - relatively stable.

That it is anything but stable, and the sheer scale and rapidity of the swings in price, is in my opinion the result of the entirely dysfunctional market architecture which we now suffer.

Mr. Cook

I do not understand the inner workings of the oil market well enough to know if the $147 price came about due to financial manipulation behind the scenes. However I do follow several other markets and I know of one market where supplies declined for in excess of 6 years to lower trending prices. This inclines me to believe that you are be on to something.

Another area of market manipulation is official statistics. OPEC reserve figures increasing in response to a change in Production Quota determining factors. In some markets Official US Govt Statistics are clearly manipulated to move the markets.

Mr. (or Ms.) SMN

Misstating reserves is not market manipulation. Quota manipulation perhaps but that is an entirely different subject. Anyway five OPEC countries are totally ignoring the quota system. Five OPEC countries, Angola, Ecuador, Iraq, Nigeria and Venezuela produced more in December 2009 than during their peak month of July 2008.

In some markets Official US Govt Statistics are clearly manipulated to move the markets.

Well unless you state which official US Govt statistics you are talking about, and which markets, there is no way that I, or anyone else for that matter, can argue with you. But remember, projections of future production and estimates of reserves are not statistics. Statistics are used to make projections and estimates of reserves but guesses are not hard data and therefore cannot be classified as statistics.

Ron P.

There's plenty of "evidence" that statistics are being manipulated:

The Wall Street Journal devoted a half page to Boskin’s list of offenders. Politicians are interfering with the Gross Domestic Product calculations in France and Venezuela. They have toyed with the inflation rate in Argentina. In the U.S., the Obama administration has taken the phony numbers game “to a new level.” Here, Boskin is writing of the current adminstration’s calculations of jobs “created or saved” from its stimulus bill.

I find it hard to beleive that Govts. are the only ones playing with numbers. Whether the goal is market or quota manipulation seems to matter little. It's still "cooking the books", by by the same people that insist on an open and free market (when it acheives their goals). Over/understating assets, GDP, employment figures, etc., all spoil the soup in the end. Perception is reality.

Just a thought from one who is truly unqualified in this respect....

Ghung, of course the inflation numbers, like core inflation, are bogus. Core inflation does not include energy or food. That is inflation statistics that have very little to do with actual inflation. And the unemployment numbers are not much better. Those who have quit looking are simply not counted anymore. But the government is not lying here. They clearly state that core inflation does not include food or energy. And they clearly state that the unemployment numbers do not include people no longer looking for work. Perhaps they hope you won't notice but they are not lying.

But you miss my point entirely. What markets are these data meant to manipulate? My bone of contention is in the claim that markets are manipulated. I simply do not believe it. Markets may go up or down for a few hours, or even a few days, on inflation or jobs news. But in the long run only supply and demand control the markets. Jobs of course affect the market, but only the true employment rate. Fudged statistics do not buy food or cars, only real people do.

Ron P.

"...I am not qualified to enter into discussion on that subject..."
Don't feel bad about it...nobody on this site is qualified.

nobody on this site is qualified.

Does that mean you know everyone on the site, and you have personal knowledge than none is qualified (because you are qualified to make the determination)? Or are you just sort of sarcastically pointing out the obvious problems inherent in trying to sort out causes and effects of complex phenomena?

It is so hard to make out the meanings of cryptic comments on electronic media -- it's hard enough to understand a native speaker of one's own language when one is in the same room with the other person.

Total layman's view.

Shrinking EROEI precipitates Financialization Gone Wild, AKA Hubba Bubba Big Bubbles.

Financialization fails to take the place of energy driven growth and in fact boosts consumption to artificial high.

Peak Oil Production primarily manifesting itself in the form of Diesel shortages, (The life blood of Commerce and absolutely the life blood of consumer capitalism) Yanks the carpet out from under the whole party, removing any hope of profit from a system operating on extremely tight margins. Popping Bubbles.

Central banks, Nation States, Finance industries throw as much money as possible at it and still can't overcome this real constraint. Finance, investment, banking, economics being the biggest and most well attended game on the playground means lots of "theories" about whats reality in hopes of finding the right button to push to make it better.

Meanwhile Diesel is still at record highs and climbing steadily, eating away at a global system 100% dependent on cheap Diesel. OH! Look over there...a big bad bankster! Yoink!!! (rug getting pulled out from under feet).


A very interesting post to me, as I have - marginally, faintly, ignorantly - tried to argue that the high oil prices we saw in the recent past (in dollars, of course, not so much in other countries/currencies, though that is a whole other ball of wax) were not primarily, as first cause, say, a symptom of ‘peak oil’ but of market manipulation, of whatever kind. Co-causes, particularly the behavior of actors in the field, well what a snarl..who knows... So thx Chris Cook, grist for the mill (oops, that is another commodity.)

Financialization fails to take the place of energy driven growth and in fact boosts consumption to artificial high.

Yes, this.

I am just simple but if I read right here is what I gather with some extra comments of my own that I have gathered.
1) Money is electrons in someones bank account that digitally displays a number(credits or debits) to the owner.
2) The world would have an entirely different economy if there was wasn't any cheap energy avaialble.In the case of oil everything we do not manufacturer or produce in our immediate backyard would not be avaialble as how would you get these items to your door step. Without energy there is no economy.
3) It would appear that we as a world are stuck with one source of energy for transportation = oil for a number of decades. The world has not identified the next cheap source and hence it is not in a position to transition to what ever that new source is!.And transition will take a long time once alternative is found.
4) If the price of oil remains cheaper than the next source of energy =$/joules than it remains king.
5) The world is at only Peak Cheap Oil, probably 2006! Human history since 1900 indicates cumulatively we as a species produced our 1 Trillionth barrel in 2006. We are now exploring and exploiting more and more of the more expensive oils like Oil Sands and Oil Shales and Off Shore where we know there are 10 Trillion bbls.Maybe more.
6)The energy in the ground is like what Fort Knox's gold bullion once was to the USA dollar many decades ago.It is the back up to a currency or currencies. I guess now can be referred to as Black Gold.
7)Relatively speaking I think almost all nations with an economy have debt.! Saudi Arabia needs $x number of dollars to serve debt as all other nations and $y number of dollars to run economy and $z number of dollars to produce a bbl therefore they will need X+Y+Z per bbl. And there you have $75/bbl relatively speaking to the current US $ valuation. That is that electron figure again the credit and the debit thing.
8) Well that Black Gold sure doesn't smell like money but is essential to an economy therefore must be money!

I think the question as to whether the price run up in 2008 was due to market fundamentals and geology or market manipulation and treachery is that such manipulation wouldn't work as well in a non peak market. If we are at or near peak, then we don't have a swing producer who can easily pump more to moderate price spikes (though we may still have actors who can pump less to moderate price collapses).

Knowing that there is no swing producer and that the margin between supply and demand is tight, big players may engage in shenanigans that cause prices to spike, having purchased futures so that this spike would give them financial benefits. So big players buying and later dumping futures would be a piece of evidence for market manipulations.

But the market manipulations wouldn't work as well without the peak market background. It's similar to our election fiasco in 2000. Bush couldn't have stolen the election if Gore had won by a wide margin. But lacking that margin, market (or electoral) manipulations can make a big difference. The butterfly ballots weren't a scheme to steal the election, just a screw up. Disenfranchising people with arrest or misdemeaner records as though they were felons is a scheme to steal an election. These screw ups or schemes wouldn't be noticed if not for the tight election.

The lack of a swing producer (a peak market condition) forces markets to react to manipulations and screw ups. If a hurricane knocks out production in the Gulf of Mexico, its no problem if Alaska or Saudia Arabia have an equal amount of production they can easily bring to the market. But when they don't, prices can spike greatly in response to such events.


Thanks for the post, Chris, and the neutral way you respond to sometimes un-neutral critiques. Good job! Most of the posters on TOD would agree that fundamentals are not enough to explain the particulars of oil price spikes and variability. When I read these sorts of posts I realize how complicated the situation can be - to the point of despair with respect to explaining it to the average person on the street. Jeez, it's tough enough explaining resource peaking and quality of energy without delving into financial markets, futures, forward contracts, and derivatives.

The important point I took from your post is that the market price for oil is a product of a dysfunctional (non equilibrium and supply-constrained) market and that financial manipulations and 'animal spirits' (as in easily spooked and stampeding species) are acting as synergestic variables. These are the hallmarks of nonlinear systems hovering around a bifurcation, right? Previously uninfluential variables assume greater importance in the folded region of the response surface.

As to your contentions regarding who should be tarred and feathered, it seems as though there are data that might be marshalled to support your thesis. Another post from you, I hope.


Thanks for the supportive response.

Dysfunctional sums up the current market architecture very well, but I regret that as to the ouctome, my maths is a bit rusty these days!

A few quick comments:

1. I would say one thesis of the article regarding money supply is proven and mathematical. Various studies show high correlations between money supply and oil prices. Some I have seen range from about 56% to 87%.

2. The U.S. is headed for absolute bankruptcy (due to politicans who refuse to break it to the public that 1/3 of the retired population can not live on Govt. health care and social security... public employee pension liabilties that are out of control and unfunded... 1/2 of workers are now on govt. payrolls and earning more than the private sector workers... massive deficits and social spending that often created disincentives to work...That's 57 trillion in liablities. If you went around a passed that debt out
to each household that would be $500,000 per household (imagine if that were passed out today to each household in America).

3. The U.S. will face massive inflation as other countries do not need to fund us forever and/or use us to consume for the world forever. Our borrowing power will run low and interest rates will rise and than the Govt. will print money to monetize the debt. The money supply will be out of control and especially effect prices of commodities purchased on the world markets, especially oil.

4. To the conspiracy issue: George Bush made a statement against interest in 08 which tells the whole story. He said, paraphrasing, I cann't ask the Saudis to pump more oil if they don't have it. That is not something to be taken lightly because he would not have wanted a statement like that to further increase prices. The way he said it and the fact it was against interest tells the story. Last year Obama, candidate, said we cann't use our National reserve of oil because what would we do when gas gets to $8 a gallon.

or follow the money...the oil companies aren't spending 1/2 billion to a $ billion to put rigs in the middle of the ocean and soon possibly in arctic waters (even more $) because they can get oil out of land based rigs that cost 2 1/2 million.

5. Yes, investors do effect the oil market because it is my understanding that present prices are generally based on futures prices. Although that may seem circular, there is not a very liquid market for present oil transactions, so companies look to the futures market as a barometer for current pricing. That said, especially given peak oil, it is excellent when investors bid up the price of oil because the sooner it goes up, the sooner the Govts of the world will finally publicly recognize the peak oil issue and the public will become more aware. Then action can begin to begin the societal adustment process.

6. The recent financial crisis may have partly been triggered by high oil prices but that was going to happen anyway. Go out and give enough no income check loans and by definition you have to create a bubble. The vast majority of defaults were by people who lied on their applications. If oil prices hadn't triggered it, it would have happened within a few years anyway. The real peak oil wave will likely be bigger and won't subside quickly.

(Footnote: Likely too busy to respond to comments but I will read)

The vast majority of defaults were by people who lied on their applications.

That's just factually wrong. What's your source?

There's no way residential real estate could keep going up for ever, in economies where incomes weren't rising in parallel, without reaching a point where people in the course of relatively normal, honest transactions would make bets on what they can afford based on the presumed future values of the properties, rather than on present income. There is just no other way to rationalize purchasing a dwelling traditionally appropriate to your relative income level and social status. When those bets - inevitably - go wrong, because the bubble begins to deflate, then millions of relatively normal, honest mortgage holders end up in default. Which has happened.

But if the event had been that prices had risen forever, the buyers could have covered their mortgage obligations by taking additional mortgages against the future value of their homes. Within that assumption, their actions were reasonable and honorable. When even the investment bankers are claiming to have believed the home prices would ramp up eternally, you can't go pointing fingers at mere home buyers, claiming they should have been smarter than Wall Street on this.

Prime mortgages have, in aggregate, suffered greater losses than junk mortgages. And the tremendous losses in commercial real estate, which have run in the same direction as the losses in residential markets (and are currently accelerating) are not in the least explained by "people who lied on their applications."

I agree with many of your statements above but you are pointing the blame in the totaly wrong place (as many would like you to believe). Almost nobody in finance would ever guarantee prices would go up "forever" without a decline. The blame lies mostly with Govt. Agencies that made the loans available (although Wall Street did take advantage of the opportunity the Govt. gave them and packaged and resold the loans but that is what they have been doing for decades, at least as far back as 1981 and likely longer,..taking loans and reselling them- with good loans for two decades and later with the available good and bad (that is what Wall Street does, acting as the middle man between buyers and selles and securitization).

My sources for above as requested;

First read Barron's article (didn't keep) that said 70%! of defaults were on no income check loans.

Search "liar loans" and "crisis" ...For instance, Alan Zibel AP Business Writer (a good liberal source) August 18,2009 Freddie Mac and Fannie May (the govt. agencies that caused the comment) lost 3.1 billion between April and June 2009, half of these came from liar loans. The article also says that additional liar loans could run 100 billion in addition to the subprime loans.

Neither subprime (high risk by definition) nor "no income check" loans" should ever have been made available either at all or in large amounts.

(As a footnote, I couldn't believe I saw an FHLIB govt. no income loan ad about TWO weeks ago). People take no income check loans (and pay extra for them) because by definition they cann't prove their income (either they don't have the income to begin with or they aren't showing it because they are cheating on their taxes).

(an interesting footnote: China requires 40% down on mortgages and I bet they don't allow no income check. In the U.S. many were 0% down, 10% etc. I never would have thought I would cite China as a model of prudent capitalism.)

I agree with many of your statements above but you are pointing the blame in the totaly wrong place (as many would like you to believe). Almost nobody in finance would ever guarantee prices would go up "forever" without a decline. The blame lies mostly with Govt. Agencies that made the loans available (although Wall Street did take advantage of the opportunity the Govt. gave them and packaged and resold the loans but that is what they have been doing for decades, at least as far back as 1981 and likely longer,..taking loans and reselling them- with good loans for two decades and later with the available good and bad (that is what Wall Street does, acting as the middle man between buyers and selles and securitization).

My sources for above as requested;

First read Barron's article (didn't keep) that said 70%! of defaults were on no income check loans.

Search "liar loans" and "crisis" ...For instance, Alan Zibel AP Business Writer (a good liberal source) August 18,2009 Freddie Mac and Fannie May (the govt. agencies that caused the comment) lost 3.1 billion between April and June 2009, half of these came from liar loans. The article also says that additional liar loans could run 100 billion in addition to the subprime loans.

Neither subprime (high risk by definition) nor "no income check" loans" should ever have been made available either at all or in large amounts.

(As a footnote, I couldn't believe I saw an FHLIB govt. no income loan ad about TWO weeks ago). People take no income check loans (and pay extra for them) because by definition they cann't prove their income (either they don't have the income to begin with or they aren't showing it because they are cheating on their taxes).

(an interesting footnote: China requires 40% down on mortgages and I bet they don't allow no income check. In the U.S. many were 0% down, 10% etc. I never would have thought I would cite China as a model of prudent capitalism.)

IMHO the "fault" is the fact that the participants in the homebuilding/financing/buying process are human.
We all want more

The buyers wants more (than he can affort)
The broker wants more transactions at larger dollar amounts
The appraiser wants more business
The bank wants more fees and income from originating and servicing mortgages
The securitization desk wants more mortgages to securitize so they get paid more
FNMA/FHR/GNMA want a bigger mortgage portfolio so their stock goes up, and the pay of the people who work there goes up
Politicians want more votes so they are not going to go against what people want (which is "more")
Voters want politicians who promise "more"

WE are the problem


Hi Chris.

Great article, I'm glad it's getting attention. Max Keiser is becoming an invaluable asset - as he has no difficulty with peak oil. He recently interviewed Gail Tverberg. The peak resource message is starting to creep out into the light, so to speak.

Your arguments regarding Saudia being swing producer and pegging oil to the dollar mirror my own. The ramifications of this are profound; the dollar is a proxy for crude at this time and all other commerce activities bend around the dollar/crude axis.

The reach of this turning is beyond the scope of a comment, but the outcome that matters most is the end of the 'Short- dollar' trade where the buck is sold short and the proceeds used to buy higher yielding issues in both dollar denominations and in other currencies. Investments in stocks, developing countries and in gold are short- dollar trades. This trade has been an attempted defacto dollar devaluation. It has been the policy centerpiece of the Federal Reserve and the Administration. The Saudis have ended the dollar short or carry trade by acting and selling crude at a price that does not rise beyond a certain point. As you point out, a small amount of crude on the Brent market can effect the marginal price, particularly as demand is constrained by recession. It makes sense that the Saudis would want to receive something of value in exchange for their oil.

Keep in mind, the world wasn't in recession in 2004 which is why Saudia could not maintain a dollar peg below $30 during that time. Super- cheap oil in vast quantities during the 90's stimulated voracious demand which was manifesting itself in the early 2000's.

By fixing the crude price, Saudia puts value to the dollar. I can finger Saudia because they have spare capacity and the rest - particularly non- OPEC producers - are running out. The other OPEC producers are probably pumping flat out. 75 million barrels of oil a day is still a lot of oil. The other swing 'producers' or 'Pseudo- Swings' are those who store oil offshore in tankers. This probably includes the Saudis who might need to change delivery schedule to keep the price from sagging at any given time.

We had this discussion elsewhere here on TOD.

The end of the short- dollar trade means the policy irrelevance of Fed Chair Bernnake.

I find it fascinating to think that Saudi Arabia may – through the use of the new financial oil leasing techniques I refer to – now be acting to all intents and purposes like a Central Bank aiming to keep an oil currency pegged within a range against the dollar.

It is hard to analyze all the reasons why his confirmation for a second term as Fed chairman is now in doubt; Bernanke's incompetence is both wide and deep. But, this policy failure does not help his cause. At bottom, Bernanke's confirmation does not matter; he is irrelevant. Ali al- Naimi makes US monetary policy, now.

What's next? The 'closest crisis' is the chain of ongoing sovereign defaults in the Eurozone. Greece is first in line at the edge of the pit with Portugal, Spain, Ireland and 'Others' queued up behind. Germany and the ECB have no choice but to bail out Greeece and the rest - the alternative is a massive deflationary collapse in Greece - and the others - and the ultimate end of the Euro. The ECB must create a massive flood of euros to refloat Greece and its brethren in default. What happens to oil priced in euros?

The dollar priced in euros will thence become massively hard and impossible to come by. If Bernanke is done for, dollar swaps by the Fed overseas would be poison. Without access to cheap dollars, how will Europe afford fuel? Can Saudia take a chance and hold a euro/crude peg? The answer is no because well- capitalized currency traders would arbitrage between oil, dollars and euros. If Saudia doesn't hold a peg, oil prices will fall in dollars and Europe will have a severe energy crisis on its hands. Petrol prices could double and double again. The effect would be China in miniature: central bank euros would rush into the oil 'asset' The price spike would have a massively defationary effect on the overall euro economy.

IF the eurozone shuts off the printing press, the deflationary collapse from debt overhangs would restart. Europe is between the devil and the deep blue sea. It's where the upper and lower bounds meet somewhere in the middle.

Meanwhile, back at the ranch, the resultingly massive super- hard dollar will amp US deflation and pound the economy like the hammer of Thor. This time, the Fed will have to redirect its money spigot away from its banker/finance pals and put cash into the pockets of citizens. Look for lots of volatility, teetering stocks, super high bond prices and lots of soothing bromides from the establishment.

More later ...

Hi Steve

Thanks for the supportive, and top quality comment, not for the first time.... I was beginning to get a bit depressed....

I'm still pondering the implications of this - particularly in the light of your input - and also the startling thought from another commentator that the US strategic reserve could possibly be 'monetised' as well.

We are living in the Ironic Universe; an example is the observation that some of the major producers such as Saudia and Iraq are living Peak Oil while the major consuming nations - US and China - are behaving like the 'See No Evil' monkey, denying everything.

Consequently, the Saudi oil minister has accumulated great economic power. The monetizing process exists because of the rise of the 'swing producer'. Saudia's spare capacity gives them the power to move the oil market. Everyone who is savvy in the energy markets wants to be swing producer. This is behind the tankerage oil, IMO and is also behind Iraqi oil minister Husayn al-Shahristani's announcement of 12 million barrels- per- day 'future' production. Shahristani is becoming Mr. Virtual Spare Capacity Wannabe before he's even pumped one drop of new oil out of the ground.

Strategic Reserve also becomes spare capacity which can be used to swing the oil market. Of course, when everyone is swing producer, nobody is and the situation reverts back to the condition that existed prior to 2008. An observation that can be gleaned from the past year is that volatility is more damaging in effects on economies than already damaging high prices by themselves. Limiting volatility sugar coats the prices. A swing producer removes some of the volatility enabling them to command an implied volatility premium.

Until he-she-it cannot, anymore.

Iraq announcing spare capacity dashes the hopes that Iraqi oil would be dumped on the market and stimulate US commercial growth. Iraq clearly understands Peak Oil and is waiting for Saudia's spare capacity to evaporate. Ditto with Brazil. Brazil would only sell enough of its oil to maneuver the markets. The wild card in these countries - as Jeffrey Brown points out - is their own domestic consumption. Saudia's spare capacity is being devoured by its own expanding auto fleet and the rising 'oil cost' to produce new oil. Saudia is in the EROEI trap along with its producing peers.

Heaven help us if Iraq becomes the world's swing producer. Al- Naimi at least resembles a sane person.

The US can become its own swing producer by embracing conservation and enacting an oil import fee. This would indeed be deflationary but the issue now is choosing one's own poison. We cannot escape deflation: the FACT the swing producer phenomenon exists is proof.

Ironically, the US has spent a trillion dollars so that Shahristani can claim the ability to put his foot on the neck of the US economy - except that al- Naimi already has his foot there. Watch the two clowns jostle for position; this would be hilarious if not so tragic. There will always be a foot on neck until the US develops an energy policy that emphasizes conservation. We would then be able to monetize our energy savings. This would be a form of cash dollar spare capacity. Fuel prices would still be deflationary, but the country could gain an offsetting monetary advantage to support the inevitable transition.

An identical situation is taking place in housing; people who walk away from large mortgages find they have a lot more money at the end of each month, cash that they can save or spend as they please. If this country can move away from its gigantic oil bill, it would certainly have both an improved current account balance and ordinary folks would have more funds in their pockets. This is already taking place in an impromptu manner. US driving miles and fuel consumption overall are declining. This needs to be supported by (tax) policy. Monetizing our 'virtual' spare capacity would mean that many could enrich themselves by conservation. Novel idea, no? All that would be needed is a finance mechanism to distribute the funds appropriately.

Somebody in charge over here needs to admit that our so- called 'business partners overseas' are playing political and economic hardball; that there is new set of rules that they understand completely and we choose to do so not at all. With the economy and politics both broken and the establishment in denial there needs to be some real leadership changes. Not "change we can BELIEVE in" but real change without caveats. Unfortunately, the political choices of today, both in the US are limited to either (a) of (b): Bill Clinton or Ronald Reagan. Tony Blair or Margaret Thatcher. Tweedle Dee or Tweedle Dumb.

So tragic ...

One of the little problems that the vast majority of OECD governments--from the local to regional to national level--are facing is that their tax revenues are heavily dependent on consumption related spending, which of course means energy consumption too, and in fact most government budgets assume a resumption in the rate of increase in overall consumption.

Most OECD governments are headed toward a cliff, it's just that some are closer than others.

So much to chew on here as usual.
An import tax. Putting money in the pockets of consumers. Conservation as monetization.

An idea which has been floated around here before is a large tax credit, in the form of a rebate check, in conjunction with an offsetting hefty gasoline tax. I would leave distilites out of it for now. And yes I know it's been political suicide so far.

The benefits would include it encourages conservation, it can be used to fund transitional costs for an individual's transportation needs (very tough to do OTW for middle/lower income post crash), it could be made to be revenue neutral or slightly positive to fund light rail projects.

Downside. It targets the (more discretionary) P/U truck drivers, which will likely be seen as culture war.

Couple of questions on the imported crude tax. Buying the defacto military subsidization you say we spent the better part of a trillion dollars just to potentially have Shahristani's foot on our neck....I can see it from a couple of different angles. If the tax 'revenue' is directed at an increased foreign military presence then it seems counter. However if it creates a deterrence to such adventures then so much the better IMHO. I can see it encourages domestic production and if we favor 'burn-everybody's-first-but-much-much-slower', maybe a blanket approach to discretionary consumption has merit.

Anyway I wholeheartedly agree that conservation/efficientcy is the best oil bank we have, and our most likely course given severely diminished options. Thanks for your continued thought provoking insights.

Chris this is an interesting post, but I find the description of Oil Leasing Contracts to be a bit opaque.

Cui bono --- Who benefits? is, indeed, a good place to start the analysis.

For most people, myself included, the ins and outs of futures contracts, oil leasing contracts and other derivatives is nothing short of stupefying and mind numbing. On the other hand, what oil leasing does is fairly easy to understand. An oil leasing contract puts money in the hands of a producer with proven reserves (either in the ground or in storage facilities) -- now. Presumably, eventually, the leasing contract will be satisfied by future oil production. I think this concept is fairly easy to understand.

There are some fairly straightforward, honest reasons why a producer might want to enter into this type of a contract. For example, these contracts provide funds for investments in oil infrastructure. The fixed price in specified in the oil lease guarantees the return on investment and lowers costs of borrowing.

However, I think the main thrust of this article is to explain some of the game playing that is normally glossed over when this sort of product is discussed. One game is to manipulate prices to increase total revenues. The easy to way to manipulate prices to decrease supply below the free demand/supply equilibrium level.

From a producer's point of view one of the main disadvantages of decreasing supply is an the immediate loss of revenue. At $80/Bbl a 1 million Bbl/D drop in output costs $80 million per day or $2.4 billion per month. If the producer needs to reduce supply by 1 or 2 million Bbl/day for a month in order to produce a satisfying jump in prices, the costs quickly add up. These costs are a serious disadvantage for producers trying to game the market.

Oil leasing contracts provide a way for a large producer, trying to game the system, to get around this disadvantage. If the producer sells the 1 to 2 million barrels of oil produciton per day for a month using oil leasing contracts, it receives the revenue immediately even while it either reduces production or diverts production away from the market into storage. The reduced supply of oil drives prices up. The higher prices can then be used to create oil lease contracts further into the future that are set at the new higher price. The best part from the producer's viewpoint is that, with very low interest rates, this strategy costs very little.

Note that the higher prices provided by this game are in addition to increases in price generated by supply shortages. Using this game current marginal costs (probably around $60/Bbl) for tar sands production) can be increased to the current monopoly levels of $75-80/Bbl. The game 'only' increases returns by $15/Bbl, but, hey, $15/Bbl on 80+ million barrels per day is a significant amount of money and a significant reason to play games with futures contracts.