Taking on Big Oil

 | Nov 08, 2013 | 11:41 AM EST
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It's been a busy year for the regulators and the legal groups at major banks and hedge funds as recent fines for JPMorgan Chase (JPM), SAC's Steve Cohen and others have been occurring with increasing frequency. The feds might have been slow to come around, but they are finally showing some teeth against manipulations and outright fraud in the capital markets after being virtually silent during and after the financial crisis of 2008.

That newfound regulatory zeal has come to the commodity markets too, with allegations of manipulations by Goldman Sachs (GS) in aluminum markets and by JPMorgan in electricity markets.

That's why a lawsuit brought by four traders from my old home at the New York Mercantile Exchange seems so well-timed. Former Nymex board member Kevin McDonnell and three floor traders allege collusion by BP (BP), Shell (RDS.A), Statoil (STO) and the privately traded Vitol Group to manipulate physical Brent crude trades in order to fix reported prices by Platts, the industry's recognized price benchmark.

Here's the background you need to know to understand what's going on. Brent crude had taken over for West Texas Intermediate crude after the financial crisis for benchmarking the global oil prices that everyone outside of the U.S. pays. But the daily production output from the North Sea is only between 1.2 million and 1.4 million barrels per day. That doesn't seem like much to price the world's supply, considering that it's closer to 90 million barrels a day, but that's how the crazy financial pricing system has evolved. The issue is that only a handful of producers control what comes out of the North Sea, including the four defendants named in the lawsuit.

It's not hard to imagine that when a small group of oil producers have huge levers into the pricing of world crude, that you're going to get allegations of manipulations all the time, and the Brent market has been subject to those allegations since the 1980s.

Is this case different? One thing is clear: The four traders in question were on the wrong side of trades in the Brent market during the last three years, most likely in the insane explosion of Brent crude prices compared to WTI, and they are trying to recoup the many millions of dollars they lost. Not one of these traders has motivations stemming from fixing whatever price-fixing they believe is happening; they just want their money back.

But on the other side is compelling evidence in the complaint from four veteran crude traders who know how the system works. When they lay out the physical trades that took place and the pricing that was translated through Platts, you get a picture that's more than a little suspicious -- if you have the experience to understand the alleged manipulations.

Imagine the temptation to withhold or misprice just a few cargoes, amounting to only several thousand barrels, that could move prices for several million barrels in your favor that are being held either financially or physically. To imagine it didn't happen would be to expect a lot from these massive trading groups.

Proving it is another matter. But the outcome of the case isn't the point. The point to me is, again, a clear example of how the commodity system, with physical control of commodity assets priced through financial vehicles like swaps and futures, is a scourge that cannot assure anyone of legitimate prices.

And that isn't limited to crude -- it includes the price you pay for your gasoline at the pumps, your breakfast cereal and your aluminum soda can.

I'll be rooting for the vindication of my old colleagues at the Nymex.

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