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Page added on May 28, 2011

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CFTC vs. Arcadia et al.: a government agency roils the oil market with a big action


This is one of the biggest actions the CFTC has taken in the crude market in recent years. When traders dismiss these allegations as nothing more than normal trading activity, they’re ignoring a simple fact: the CFTC apparently doesn’t think so.

Based on the defiant media statement that Arcadia released after the suit was filed, this dispute is either going to go to trial–“Rather than consent to the resolution of the matter based on allegations that are unjustified and untrue, we accepted that the matter would be adjudicated in the courts,” Arcadia said–or it’s going to be settled for a lot of money. This won’t be a repeat of the $1 million fine that Marathon paid to the CFTC in 2007 on charges of manipulating the market (in a year it made close to $4 billion), accusations that appeared flimsy at the time.

But consider that the Marathon case, according to several sources, set off deep soul-searching among corporate lawyers and compliance officials into some trading practices. On at least two separate occasions back then, I floated the idea–once to a leading commodities attorney and the other time to a trading executive–that the Marathon case was unimportant, and that the relatively paltry fine was proof of that. The ferocity of their response in dismissing my theory was stunning. Their argument was that the investigation, and concurrent investigations directed at other companies, took up trader time, took up other staff time, resulted in big legal bills, and most definitely was not unimportant.

Many traders’ mocking view on this case is interesting. But it may be corporate compliance staff’s opinion of it that will determine if it affects trading activity.

The issue of position limits looks like a red herring. The NYMEX does have position limits, but they are for a contract’s front month only, and are in effect for three trading days prior to a contract’s expiration.

If we assume the trading practices laid out in the lawsuit to be accurate (without rendering an opinion on their legality), it looks like Arcadia/Parnon would never have been in violation of any NYMEX limits. The length the companies held was at the physical delivery point of Cushing, Oklahoma, and it appears to have been acquired in the Over The Counter market, so there’s no NYMEX role there. The spread trading that went on concurrent to the physical activity was for trading months that were not expiring for several weeks. So the NYMEX internal position limits would not have kicked in.

The NYMEX also has less-specific accountability limits. But as one source noted, they are only invoked by the exchange if it believes a particular position has the potential to disrupt the market. According to the CFTC suit, the big, market-moving position held by Arcadia/Parnon was in the physical WTI market, not on the NYMEX or IntercontinentalExchange, and the traders sought to use that position to have the month-to-month spreads go along for a profitable ride.

As far as the possibility of CFTC-imposed position limits having an impact, Commissioner Bart Chilton cleared that up earlier this week. “They wouldn’t be under the position limits since they’re an end-user,” Chilton told Platts on the sidelines of a House Agriculture subcommittee hearing. “It wouldn’t have changed that circumstance.” The reference to end-user appears to be a nod toward Parnon’s extensive holdings of physical storage at the NYMEX delivery point of Cushing, Oklahoma. (Those physical holdings may also have qualified Parnon for a hedgers’ exemption from accountability limits or position limits on NYMEX, if it became an issue.)

The position limits issue remains very much alive, at least for some members of the US Senate, even if implementation remains stalled at the CFTC. On Thursday, CFTC chairman Gary Gensler met with several US senators over the issue. Following the meeting, Oregon Democrat Ron Wyden said of the delay, “There’s no sense of urgency. We think this should have been addressed a long time ago.” Asked about the Arcadia/Parnon case, Sen. Bernie Sanders (Independent-Vermont) said that Arcadia/Parnon action took took too long, Americans want to stop manipulation now, and not that of 2008.

In reading the complaint, one thing that jumps out in reviewing Arcadia/Parnon’s actions (again, assuming the basic facts of its trading to not be in dispute) is just how hard it would be to repeat that trade again. The difference? There were about 15 to 17 million barrels of oil held in storage in Cushing back in the first half of 2008. That’s one of the reasons the price was moving higher on its way to an all-time high in early July 2008. Now, there’s close to 40 million barrels in storage, and another 15 million sitting empty. Its growth has been fed by higher production from Canada, the Bakken Shale in North Dakota and other states, and the construction of lots of tankage to put that oil. The allegation is that Arcadia/Parnon tried to “trick” the market into thinking there was less oil than there really was, despite the fact that EIA announces a Cushing inventory figure each week. Now, there’s no argument: there’s a lot of oil at Cushing. You want to own a big enough chunk of it to drive the market, you better have a lot of capital.

Based on one passage, it seems that the traders did not use the NYMEX as their means to acquire the oil. The acquisition was done in a fairly short period, between Jan. 8 and Jan. 16 of 2008. “Can we get this issue resolved pls. time is of the essence here, we need to trade cash with 3rd parties tomorrow as part of the feb/mar wti strategy,” Wildgoose writes in an email to an Arcadia officer, according to the lawsuit. The reference to “cash” can be interpreted to mean the trades went on in the OTC market.

One question, and this is sheer speculation: did Arcadia/Parnon want the industry to know it was acquiring such a large position? Based on the lawsuit, it wanted the market to think the tanks were drying up, so maybe not. But if you want to take a large position and do it anonymously, the place to do it is on the NYMEX. In the “old days,” when trading was done by open outcry, floor brokers could see that broker A was buying a lot of oil, and since broker A usually handles the needs of oil company B, that meant oil company B had a play on. Since that trading is now almost completely virtual, that market intelligence is no longer available. But if the company bought a lot of February oil in the cash market, its activities might have been noticed, which would have undercut trying to persuade that there was growing tightness in Cushing.

The lawsuit has an, ahem, colorful quote by Wildgoose about how much money there was to be made through this trading program. Platts has chosen to use a more family-oriented term in its reporting. But you are free to peruse the lawsuit and find it yourself. We won’t identify the page.


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