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Oil Below $80? Just Close the Enron Loophole

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July 08, 2008 – Comments (7) | RELATED TICKERS: OIH , DBC , XOM

On 30 Dec 07 my call was for $175 oil. I expected the run up due: 70% to expectation of war with Iran, 10% Enron loophole, 10% due to increased demand, 10% declining dollar. I now believe oil over $80 is +80% Enron Loophole. If you are long oil, or commodities, you might want to understand the Enron Loophole, very, very well. The Disciplined Investor has a Pod cast with Michael Greenberger, professor of law at Maryland University and former CFTC Director of the Division of Trading & Markets. The Podcast is an hour, but I listened to it 3 times, to ensure I was picking up everything. I will wager you a REC, this POD cast is worth listening to for ALL STOCKMARKET investors. If the Loophole is closed oil will drop like a rock. TDI Podcast 63: OIL-OIL-Enron Loophole-OIL-OIL

June 29, 2008

ENRON Loophole MSNBC


 

The Smartest Guys in the Room - California and Traders (Full Movie is on Google Video)
 

FYI - The Enron Loophole

by Vinny Catalano posted on: June 13, 2008


“Michael Greenberger, professor of law at Maryland University and former CFTC Director of the Division of Trading & Markets (1997 – 1999). Professor Greenberger argued that the “Enron Loophole” provision in the CFMA produced a change in the supervision of certain commodities (energy, for example) that had been in place since 1922 thereby enabling Enron to engage in their trading practices (with led to the electricity crisis in California in 2001) and the development of “dark markets” (Intercontinental Commodities Exchange in Atlanta, for example) enabling unlimited positions and limited transparency to be established by speculators. All outside the purview of the US regulatory bodies such as the CFTC.

Currently, an attempt to eliminate the “Enron Loophole” has been attached to the massive farm bill (amendment by Sen. Carl Levin) that was passed with a veto proof majority and has been threatened with a veto by President Bush for stated reasons that are suspect, at best.
 

At last week’s congressional hearing, several experts testified to what the fair value of oil might be – a subject that I wrote about last week, without knowledge of the actual testimony. It was interesting to hear that my rather simplistic calculation of where the fair value of oil might be (approx. $80) matched very closely to several expert witnesses’ estimates, as well as the more sophisticated analysis conducted by Exxon Mobil and Shell Oil.

Hearing on Energy Price Manipulation - Greenberger Testimony
 


 

The Real TRUTH Behind The OIL PRICES
 


 

Oil speculation and oil prices
 

 

Here is the Trailer to Smartest Guy in the Room

7 Comments – Post Your Own

#1) On July 09, 2008 at 12:10 AM, FleaBagger (28.17) wrote:

Manipulation in California was caused by overregulation (their "deregulation" somehow made the law longer and more complex), and the price controls. It's true: government mandated monopoly is actually bad for the market! Who knew! As for the "loophole," another word for it is "capitalism." Yes, congress and the silver spoon socialists in the mainstream media would love to close that loophole, but I don't see the benefit lasting more than a week or two.

We could mandate $80 oil and subsidize it or steal it or whatever we need to do, but that doesn't mean that it will still cost just $80 to produce. Shortages would be rampant. I prefer my energy market run by money, rather than crusaders, regulators and PhD-wielding eggheads. And yes, even if that money is in the hands of speculators, or Enron, pt. 2 - or whatever scare term you want to use to refer to the free market. 

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#2) On July 09, 2008 at 1:36 AM, AnomaLee (28.75) wrote:

I just read an article a few weeks ago about the loophole between the exchanges and how the traders are escaping regulation. I agree it exists and I'd rather chase the money trail  of a drug cartel if I were investigating this situation.

However, I wouldn't dub this the 'Enron loophole' and if I did I personally wouldn't view it as a pejorative for today's traders.  Despite the exploitation by Enron there there was real a supply and demand issue with the state of California. Enron maximized that situation to a level that hurt many people of California, and they still haven't done much in response to the fundamental problems. 

Today, there is a real supply and demand issue, but on a much larger scale and the solution isn't as easy as deterring a few traders. Personally, these traders are accelerating the search for solutions. If crude prices were to trade at a 60% discount to today's prices it would just temporarily relieve a long-term problem. However, I wouldn't be surprised to see the post-WWII 'baby boomer' generation do what they've done all along - postpone the problem.

No matter what we do here China is still adding 9 million cars on their roads every year. In ten years they will have more drivers than the United States. This doesn't include the demand and supply strains caused from other BRIC nations or other oil producing nations. So, no matter what we do to manipulate trading today if we don't begin adjusting now I can assure you that it won't matter what regulations are in place around 2015 and crude oil is over $225 and we're still dependent on foreign oil.

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#3) On July 09, 2008 at 10:03 AM, camistocks (< 20) wrote:

Hey, c,mon, I said for several weeks that the oil market is driven by speculators at the moment. It was absolutely clear that it would correct (over the short term, which is a couple of months). I expect a drop to $100, maybe even $80.

However it is absolutely clear, at least to me that oil/gas will rise much higher over the long term, due to demand from developing countries. Unless they develop the air car or an efficient car fueld by electricity.

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#4) On July 09, 2008 at 3:57 PM, abitare (49.18) wrote:

ALCON,

Thanks for the replies. 

FleaBagger and Anomllee,

Watch the Movie and/or listen to the Podcast. I think you are both missing the full picture.  

"Manipulation in California was caused by overregulation"

Watch the movie or read the book Smartest Guy in the Room then check back, you do not have the full picture. You have the Enron propaganda they were spewing. 

"whatever scare term you want to use to refer to the free market."

Only a fool would thing 30 -40x leverage is a "free market". Or a 7% cash reserve, with NO severe consequence of loss is a "free market". The Managers of BSC made millions in Jan 07. Their  shareholders got cleaned out a few months. Listen to the Podcast and check back.

There is no such thing as a "free market", people are always trying to cheat that is why you need regulation.  

"No matter what we do here China is still adding 9 million cars on their roads every year."

NOPE! How much do you want to wager this is going to drop significantly? China is having price control problems and shortages, their stock market has fallen 50%. Do you really think people are buying cars? Unemployment is coming.

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#5) On July 09, 2008 at 4:35 PM, madcowmonkey (< 20) wrote:

I am looking at oil taking a bigger hit in August, but I am a confused monkey and I always feel that my opinion gets stomped by people that can really back up their opinion. I wouldn't doubt the camistock thesis, since I am agreeing with the speculators causing slight/medium increase. I think many people will be losing money on oil in the future. I can see it in caps posts everyday. Look for it to drop in August is my call.

I kind of like the enronloohole tag:)

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#6) On August 01, 2008 at 11:16 AM, agchris02 (< 20) wrote:

Ahhh socialist and academia always scream the loudest when things hit small snags (or in this case, a slightly bigger one).  Free markets work people. 

As to the critique that "only a fool" would think 30-40x leverage is a free market....I don't think you understand how leverage works.  It's not "free" money, you have to find a lender, or someone else to take on the risk.  Let's say you're already leveraged out 10x, and you come to me wanting to buy my oil future contracts....I'm NOT going to sell them to you if I don't have money in my pocket.  The true problem here is regulation, over regulation, and government bailouts -- it's the same thing that's happening in the mortgage industry.  

I mean if Bear Stearns wants to fun cetain speculators who want to leverage their accounts to the hilt, well by all means let them, but know the potential consequences....o wait, Bear Stearns ate those consequences.  Likewise, if you're a bank and issue a 30yr ARM on 100 new homes in a new subdivision, to a builder with no track record of sucess, and the homes don's sell; or if you give a $1m mortgage to Bob, whose annual income is $30K,  and then you do this a million times, well likewise you deserve to eat it -- EVEN IF THAT MEANS YOUR INVESTORS EAT IT TOO.  Regulation of industry, government bailouts, and subsidies only serve to mask a companies flawed business models and encourage risk taking in idiotic situations.  

Now then, if you have a group of investors who cook the books so they can increase leverage, and lie to investors, and to the authorities, so they can trade higher on margin -- of if they illegal market futures, or if they use inside knowledge to capture a market return....well that's not free markets, that's a felony and you should be sent to prison.  

Perhaps the thing I hate most about critiques about "speculators ruining the market," is the ignorance of one small fact -- each transaction takes a "buyer" and a "seller."  Yes, there's a lot of speculation that the price of oil is going to keep going up, thus driving the price up.  But do you really think ANY hedge fund is capable of cornering the OIL MARKET?

The United States alone produces over FIVE MILLION BARRELS a day (http://www.eia.doe.gov/basics/quickoil.html). At just $100/barrel that works out to $500,000,000.00 PER DAY.  To buy up all the oil produced in the United States, in an attempt to manipulate the price over a thirty day period a hedge fund would have to outlay over $15b -- and that's just in the United States.  Yet that makes up less than 1/3 of the total oil used in the US -- on any given day, over 10m more barrells are imported.  You would be looking at, at minimum, a $50b outlay to try to corner the market -- in just the US, over just a month period.  Given the world wide nature of oil, and the numerous sources of oil, your costs likely would greatly exceed this.  

But, let's take your "fear" to the extreme.  Hedge Fund "Evil Fund," run by "Bob," decides to try to manipulate the market.  He does so by taking his $5B hedge fund and levering it up 100times, and proceeds to buy 6month option contracts on oil as fast as he can, starting at $100.00, and the price quickly skyrockets, up to $200.00.  Bob now owns $500b of option contracts for oil six months from now.......Now what does Bob do....particularly with the spot price of oil being $100.00?  I bet his options expire out of the money six months from now....ouch.  I seriously doubt Bob is capable of buying up, and taking delivery of, $500b of oil, thus he must use options, and when the expire out of the money....well Bob's bankrupt and his investors might string him up by his neck.  The way "speculators" make money is the same way any option purchaser does, and that's based off the future price (go read some about the spot price of oil.)  If I buy 100 options at $200/barrel, for delivery six months from now, but the price is only $100 six months from now, my options expire worthless.  I watched oil speculators lose their shirts doing this in the early 80's growing up in West Texas.  (Remember when the price of oil dropped to $12/barrel?  Well all those guys who kept buying options in the future at $25-$30 lost EVERYTHING when the spot price of oil was $12).

The GREATEST SINGLE INDICATOR that the price of oil is not being manipulated as people think is that the oil reserves and supplies are not increasing.  To manipulate price, there MUST be hoarding of some form, a stoaring of inventory -- much like DeBeers does with diamonds.  Any non-politically motivated economist with half a brain can tell you this.  If there is no hoarding going on, in a free market, supply and demand will ultimately control.  Yes, there may be irrational spikes here in there in option markets, but at delivery time, and consumption time, not so much.

I am done ranting on this topic for now.  When I watch idiots like  Greenberger make the rant he has....well I want to make him sit back down in ECON 101.  Why do you think the price of oil has dropped the most it ever has (in dollars) over the past few weeks?  How about because, for the first time in something like 20 years, people in the US are DRIVING LESS, therefore DEMANDING LESS OIL.  Demand for oil in the US has dropped, and virtually immediately, the price for oil dropped.....what a strange coincedence. 

Side note:  NOT regulating electronic markets does create oppurtunities for unethical behavior, insane risks, insider trading, and the like....but as to wholesale price manipulaton of something like "oil," especially with the way spot delivery works, and the supply of oil works, 

Ok, Im done ranting on someone else's blog.  I might write a piece this afternoon or tomorrow over the concept of supply, demand, and free markets.  Sheesh.  (sorry for any spelling errors, Im not editing this as I have work to do :P) 

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#7) On August 01, 2008 at 11:57 AM, agchris02 (< 20) wrote:

Ahhh socialist and academia always scream the loudest when things hit small snags (or in this case, a slightly bigger one).  Free markets work people. 

As to the critique that "only a fool" would think 30-40x leverage is a free market....I don't think you understand how leverage works.  It's not "free" money, you have to find a lender, or someone else to take on the risk.  Let's say you're already leveraged out 10x, and you come to me wanting to buy my oil future contracts....I'm NOT going to sell them to you if I don't have money in my pocket.  The true problem here is regulation, over regulation, and government bailouts -- it's the same thing that's happening in the mortgage industry.  

I mean if Bear Stearns wants to fun cetain speculators who want to leverage their accounts to the hilt, well by all means let them, but know the potential consequences....o wait, Bear Stearns ate those consequences.  Likewise, if you're a bank and issue a 30yr ARM on 100 new homes in a new subdivision, to a builder with no track record of sucess, and the homes don's sell; or if you give a $1m mortgage to Bob, whose annual income is $30K,  and then you do this a million times, well likewise you deserve to eat it -- EVEN IF THAT MEANS YOUR INVESTORS EAT IT TOO.  Regulation of industry, government bailouts, and subsidies only serve to mask a companies flawed business models and encourage risk taking in idiotic situations.  

Now then, if you have a group of investors who cook the books so they can increase leverage, and lie to investors, and to the authorities, so they can trade higher on margin -- of if they illegal market futures, or if they use inside knowledge to capture a market return....well that's not free markets, that's a felony and you should be sent to prison.  

Perhaps the thing I hate most about critiques about "speculators ruining the market," is the ignorance of one small fact -- each transaction takes a "buyer" and a "seller."  Yes, there's a lot of speculation that the price of oil is going to keep going up, thus driving the price up.  But do you really think ANY hedge fund is capable of cornering the OIL MARKET?

The United States alone produces over FIVE MILLION BARRELS a day (http://www.eia.doe.gov/basics/quickoil.html). At just $100/barrel that works out to $500,000,000.00 PER DAY.  To buy up all the oil produced in the United States, in an attempt to manipulate the price over a thirty day period a hedge fund would have to outlay over $15b -- and that's just in the United States.  Yet that makes up less than 1/3 of the total oil used in the US -- on any given day, over 10m more barrells are imported.  You would be looking at, at minimum, a $50b outlay to try to corner the market -- in just the US, over just a month period.  Given the world wide nature of oil, and the numerous sources of oil, your costs likely would greatly exceed this.  

But, let's take your "fear" to the extreme.  Hedge Fund "Evil Fund," run by "Bob," decides to try to manipulate the market.  He does so by taking his $5B hedge fund and levering it up 100times, and proceeds to buy 6month option contracts on oil as fast as he can, starting at $100.00, and the price quickly skyrockets, up to $200.00.  Bob now owns $500b of option contracts for oil six months from now.......Now what does Bob do....particularly with the spot price of oil being $100.00?  I bet his options expire out of the money six months from now....ouch.  I seriously doubt Bob is capable of buying up, and taking delivery of, $500b of oil, thus he must use options, and when the expire out of the money....well Bob's bankrupt and his investors might string him up by his neck.  The way "speculators" make money is the same way any option purchaser does, and that's based off the future price (go read some about the spot price of oil.)  If I buy 100 options at $200/barrel, for delivery six months from now, but the price is only $100 six months from now, my options expire worthless.  I watched oil speculators lose their shirts doing this in the early 80's growing up in West Texas.  (Remember when the price of oil dropped to $12/barrel?  Well all those guys who kept buying options in the future at $25-$30 lost EVERYTHING when the spot price of oil was $12).

The GREATEST SINGLE INDICATOR that the price of oil is not being manipulated as people think is that the oil reserves and supplies are not increasing.  To manipulate price, there MUST be hoarding of some form, a stoaring of inventory -- much like DeBeers does with diamonds.  Any non-politically motivated economist with half a brain can tell you this.  If there is no hoarding going on, in a free market, supply and demand will ultimately control.  Yes, there may be irrational spikes here in there in option markets, but at delivery time, and consumption time, not so much.

I am done ranting on this topic for now.  When I watch idiots like  Greenberger make the rant he has....well I want to make him sit back down in ECON 101.  Why do you think the price of oil has dropped the most it ever has (in dollars) over the past few weeks?  How about because, for the first time in something like 20 years, people in the US are DRIVING LESS, therefore DEMANDING LESS OIL.  Demand for oil in the US has dropped, and virtually immediately, the price for oil dropped.....what a strange coincedence. 

Side note:  NOT regulating electronic markets does create oppurtunities for unethical behavior, insane risks, insider trading, and the like....but as to wholesale price manipulaton of something like "oil," especially with the way spot delivery works, and the supply of oil works, 

Ok, Im done ranting on someone else's blog.  I might write a piece this afternoon or tomorrow over the concept of supply, demand, and free markets.  Sheesh.  (sorry for any spelling errors, Im not editing this as I have work to do :P) 

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