NYMEX No Future For Crude Oil Futures

According to Leah McGrath Goodman’s well-researched book “The Asylum: The Renegades Who Hijacked the World’s Oil Market”, the start of Nymex oil trading was in major part due to traders who stumbled upon oil futures after screwing up Maine potato futures. Their trading “industry” or gambling party had been built on predicting the Maine potato harvest, and—much more importantly—trying to manipulate potato prices, to the point that regulators were finally forced to act. They shut down the potato futures market in 1976, after repeated defaults on physical deliveries of more than 25 000 tons of potatoes. As Goodman explains, the traders were forced to cast around for something else to trade. Then-Chairman of the Nymex, Michael Marks tried to boost futures trading in boneless beef and plywood, but that didn’t work. In 1978 however, Marks hit on the right thing and introduced heating oil futures – which was the jackpot gusher that led to 30 years of good times.

The oil scares following the Iranian revolution of 1979 led to an explosion of business interest and the original small market of heating oil futures begat natural gas futures, and then hit another jackpot with the creation of futures based on the price of West Texas Intermediate crude, now the US and Western hemisphere benchmark for a barrel of oil. The CFTC regulatory agency, at the time small and understaffed, nodded-through each new extension of instruments traded – and the number of market participants. The first big exemption the CFTC gave for widening market participants, allowing large multiple trades for a single financial player, went to Goldman Sachs in 1991. Others soon piled in.

Marks was soon dumped by the traders after he opened up the oil market, and by the early 1990s traders and their clients rode the frenzy in oil, right up to and over the precipice as speculative money, freed by exemptions, flooded in. Whenever the US Congress held an inquiry into “possible oil price manipulation”, they were each time ritually warned by the incumbent Nymex president about the dangers of  “substituting the judgment of Congress for the judgment of trained financial investment professionals.”

Futures to Full-metal Financialization

The Nymex was bought out by  the Chicago Mercantile Exchange Group in 2008, which shut down its recently-started screen trading and shifted it to the OTC (over the counter) market for very short-term trades, as the Nymex became a brand name for a large range of financial futures and options, still including crude oil. By yet another irony in a long list of them, the OTC trading arena started out “gray” and very lightly regulated and became more so, while the Nymex, trading smaller volumes of oil as measured by lots traded each day, became a more-frequent target of regulatory attention. The former “pits” where human physical traders used open outcry trading, wearing strange-colored jackets or clown-like uniforms, in a daily show of frenzy were replaced by a small number of more-sober trading professionals, executing trades on laptops. As one finance journalist put it, its possible to feel nostalgic for the previous amoral furor of the pits where undereducated, drug-taking, frenzied greedheads who would “rip your heart out for a nickel,” have disappeared and gone from the scene. At least they were human.

The point underlined by Goodman and other finance journalists and energy writers is that the Nymex morph from “hustling potatoes to rigging oil prices” took place in a certain era and ambiance. To be sure, each new scare on the global oil upstream was seamlessly transferred after suitable distortion and exaggeration, to pushing up oil prices. On occasions of course, to “spook the speculators” prices could be talked down by the daily maximum limit able to alert the regulators, for action after months of delay and usually very small fines for wrongdoing by the slightly-strengthened, more vigilant CFTC.

The hinge period and game-changer was oil price rigging during the peak oil scare of around 2005-2008.

For Nymex oil traders, this was a “strange and complex theme” because it above all suggested oil demand would top-out, stagnate or decline. Which meant a threat of lower prices unless production fell even faster than demand.  The feeling was that peak oil would be bad for everybody, to be sure because there was no decent alternative for oil, but above all for traders because there was no reliable way of knowing exactly when the planet had reached the oil tipping point. In the meantime, guesses on peak oil could be used by brokers, bankers or traders to shout down prices, as much as gouging them up. The price volatility would be fine, for traders, but the uncertainty about oil would not be.

More finance-technical factors also played a leading role in the period of around 2005-2008. This was reflected by the vastly-rising amount and complexity of “bets on oil”. Via derivatives, the bets could easily throw in and include interest rates, government debt, currency values, mortgage buying and defaults, car sales, job data and any number of other “meaningful derived and related” instruments.

To be sure, there were and still are “oil fundamentals” including geopolitical risk, as well as supply-demand, stocks, oil tanker shipping demand and costs, and so on, but this was swamped by the high ground. In the 2005-08 hinge period, the US was fighting wars in two Middle East nations and drilling for oil in ever more hazardous ocean depths, the shale gas and oil revolutions were beginning, and at least until 2008, “unlimited growth” of Chinese and Indian oil demand looked plausible.

This was a Complex Paradigm. Even as late as 2011, as explained by Erika Olson in her book “Zero-Sum Game: The Rise of the World’s Largest Derivatives Exchange”, recent-past Nymex chiefs including James Newsome were always ready to opine that they thought that oil prices would tend to run away on the upside due to peak oil, when it wasn’t due to China. The complex paradigm was responded to by reformed “ex-coke head” traders by ever-more-complex financialized assets and tradable instruments.

These are by nature arcane themselves. However, when they are looked at the right way, from the right distance under the right light, with or without the coke they can seem like they reflected “the right market price for oil”.

The Rigged-out Market

By mid-2008 the Nymex was fully and totally rigged-out. Goldman Sachs had “goosed prices” to the limit, although with no surprise GS never admitted that it “goosed prices”. Any multi-hundred-million dollar fines it paid for the Sem Group affair and subsequent or related affairs, or unrelated affairs, were “with no admission of wrongdoing”.

Oil prices on the Nymex in 2008 hit $147 a barrel.

Ironically therefore, the end-result of full-blown financialization as also shown by for example the Man Group blowout at end-2011, and serial CFTC and FERC legal pursuit of the so-called “energy market maker banks” with ever-rising fines levied, is that the Nymex oil market of today is structurally rigged. The Nymex is unable to reflect “the right price” for oil.  For the moment the market playfield tilt is upward, oil has to be expensive because it is such a noble fluid and supplies are so limited. Peak oil has come and gone, but it left an oily dirt line around the empty bath.

This can be put another way. The complexity paradigm, triggered or favored by Peak Oil, led to ultra-opaque Nymex oil pricing with a general bias to extreme-high oil prices. The market size paradigm then baked-in the scum line around the bath. Bets riding on the traded price, today and every day, are so immense that daily price variation in percentage points can only move by fractions – usually upward – except under market disaster and financial panic conditions.

The bottom line is the market is “rigged out”. Probably the only thing which can make oil prices fall like they did in 2008-2009 (by about 73.5% or $147 to $39 from peak to trough) will be a repeat global stock market collapse. Nothing else.

By Andrew McKillop

Market Oracle