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How electronic trading changed (ruined) crude oil prices



As a local on the New York Mercantile Exchange (Nymex), Dan Dicker traded thousands of contracts a day. He loved the pit, loved the action. He left the floor when Nymex had its IPO and, like other members, walked out a multi-millionaire. But his trading — and global viewpoint — changed and he’s often asked to provide his opinion and analysis across the airwaves, from to But it’s his writing that is most provocative and he doesn’t hold back. We asked him to give us his viewpoint of the brave new energy world.

Futures Magazine: Let’s start by how you got into trading. How did you become a trader? How did you get your start on the Nymex floor?

Dan Dicker: It’s the kind of story that everyone tells ….no one is so focused and decides they want to become an energy trader. I was pre-med at Stony Brook, which is part of the New York State University system and [decided] in my second or third year that I really didn’t want to be a doctor.

My roommate at the time, who has been a longtime friend — and is my business partner now in MercBloc  — was Mark Burnett, went down to where his cousin was [working], which was trading at the brand new New York Mercantile Exchange, which had just introduced heating oil. My father actually suggested I go and take a look at this thing because it was new, and though I was good with numbers, I wasn’t patient about long-term things, and this was kind of quick and exciting. [Mark] and a partner of his at the firm he was working [for] got me a job as a clerk for two locals. I worked for them about nine-10 months before I decided to borrow, I think it was $11,000 from my father to open an account. In those days you could lease a seat for $450 a month.

FM: You traded in unleaded gasoline?

DD: That’s where I spent the lion’s share of my career. I always had positions and intermarket spreads on — like heating oil and gas, cracks and so forth. And I spent a full year in the crude oil options pit when they first introduced those, and those were a lot of fun. But most of my career I was a pit trader in unleaded gasoline —that’s where I spent most of my time.

FM: How did you prep for trading on the floor?

DD: I would be lying if I said I got a sense of the macro side of energy in the early part of my trading years. I was like everyone else and we were consumed with trying to get a sense of where paper was coming and how fiercely it was coming and what the sentiment was of those who were pushing the heavy volume. That was far more important to me than having any macro sense of what was going on in energy in general in a bullish or bearish trend. We did over the course of days tend to deal with biases as the markets moved; that was something  you naturally did but I’d be lying to you if I said I’d spent three hours in the morning doing all sorts of research — I did not. What I did is I saw that there were a whole bunch of guys serious about getting long the market, and the market was going up, and there was a certain macro trend we noticed, that you were better off buying dips than selling rallies, and that went with what the flow sounded like, and how serious they were. At times the best information was knowing who you could ignore.

FM: When did you leave the floor?

DD: I thought I saw sooner than most the guys around me that the electronification of the floor was going to end our exclusive access and once that was ended, we would have to find other advantages than the one we had depended on, at least for me, for 20 years. There was a time I spent first coming off-floor and trading upstairs just above the floor, trying to adjust. Rents were so high I could rent my seats out and not worry about it. I did love [pit] trading.

So in 2005 [when] I started to go off-floor, that’s when I started to view the market in  a far more macro way. And I started to do a hell of a lot more work aside from what the papers were always telling me. I started [to] get a real sense of oil production, and more than that, financial flows into the market, which were and still are the most important variable that no one talks about.

I didn’t leave the floor until after the IPO in 2007. In some ways the floor became a very unhappy place between those who had owned seats and therefore participated full scale in the IPO and the other half of the trading community. That became very acrimonious and difficult to trade because there were a lot of people who realized at that point they had made a mistake early in their career, and the waterfall was about to stop running, and they very much resented those who had a parachute.

FM: That’s very much what happened in Chicago as well.

DD: Exactly. Chicago was even more difficult because the IPO didn’t come off immediately as a success. It was only those who were smart enough or dumb enough or whatever enough to have left it alone for three years while CME stock went to $700 or whatever it was…because the first year and a half was pretty flat.

FM: How did you change your trading once you went upstairs?

DD: When I was on-floor, I would trade scalp spreads and outrights for points, and my daily line would be 1,000s of lots a day, and I would have some positions, but they would be leverages into daily stuff and [were not] really based upon any macro idea. But as I came off the floor, what was clear to me besides not having a major edge in terms of commissions anymore, is that I definitely didn’t have an edge in doing high volume with HFT programs and black boxes. Most of the guys had to learn that the hard way but I didn’t, so the only way I could trade effectively in the oil markets, and still trade effectively in the oil markets, was to take a fairly long-term view on what I think is supposed to happen at very specific targets and stick to that, and have a very specific time periods in those. So instead of scalping spreads for 15 points,  I had to have WTI/Brent spreads and hold two months.  I will have long dated spreads back in the [curve], and I could have those for several months. I could have cross market gas oils, and have those for several months.

I hesitate to be [at] the front end of the curve anymore. I hold further out because it gives me a little more courage to wait it out. I definitely don’t jump on markets. I wait for spots and when I don’t get them I don’t feel that badly. In general, when I have a short-term idea in mind,  instead of buying contracts and sitting on them, I tend to play options against it because as  I spent a year and a half in the options pit,  I tend to be a premium junkie; that’s just my bias. That’s my thing. I used to trade thousands of lots a day, I probably now trade 1000 lots maybe a year, which is enough.

FM: Did you start MercBloc when you left the floor?

DD: I did, it was my idea, and in some ways it worked out very well. It had little to do with futures, but had to do with the circumstance that was created where all of a sudden I was surrounded by another 70 or 80 multi-millionaires who didn’t have this kind of largesse before. The idea was to organize as a group. We would get some white shoe bank, and in MercBloc’s case it was Morgan Stanley, and get a hell of a deal on fees and get some tony wealth management services at a very reasonable price instead of these guys doing it individually. That’s how it started.

FM: So you guys don’t invest?

DD: No, we do not manage money. Everybody at MercBloc has an individual relationship with Morgan Stanley, but we leverage the group’s capital to deliver the kind of fee structure that they can only get if they were worth, say, $500 million apiece. Each of our guys is inside the firm with lowest fee structure that they offer. What we brought to Morgan Stanley, with our relationship, was [more than] $650 million in assets. Then the markets went south and it was difficult to sell services further. In 2008 Lehman died, and frankly at that time we didn’t know if there would be a Morgan, its [stock price] went down to $11.

FM: Let’s get back to the markets. What do you see as the influences on crude oil, natural gas and the products today? What’s your perspective, especially on crude, as it’s still in backwardation.

DD: [Here are] some of the basics about futures that a lot of people don’t know: All the volume and open interest is in front two-three months. You go [to the back months] and there’s nothing. Nymex has close to 2 million in open interest at this point — a new record — but the first three months have about a million of that. I’m sure the first month has 500,000 of that and the second month  300,000. But if you got [past]  the first four or five months, there’s nothing out there.

Now the growth of volume, [which] to me isn’t even arguable, is the growth of those players who have absolutely zero physical interest in oil; they don’t care how it’s used. And their primary way of dealing with that is in the most unsophisticated, unindustrial, unmanageable way, and that is to go in the front month to buy or sell it, because that’s what dumb investors do. Not only do dumb investors do it, dumb investment vehicles do it. And that’s what drives, and has been driving the oil market for sure. WTI particularly, because WTI has lost entirely its connection with global crude oil. It’s now starting to catch up a little, but for the last three years, the price of WTI did not represent any crude oil in the world except Cushing. And yet this is still the nexus of where financial crude maintains to trade.

So you have a market of real players, people with real physical interest for the most part, people who are doing legitimate hedging, people who are trying to manage a spread of risks they have and they are doing it throughout the curve because they have to. Exxon has to plan ahead for the next season — they aren’t farting around for the most part in the front months. If they can get liquidity down say 18-22 months, you bet your life they are taking it. The guys in the back months are what I call the real players and the price in the back months represents the real prices.

You have a backwardation market,  like you have now, where you go out two years and [there’s] $80 crude. You get all the guys who really need to buy the stuff and all the guys who really need to sell it and you put them in a room and shake up until they come out with some number that both of them agree upon….that’s how open outcry works. But once you apply literally tens of thousands of illegitimate — strange word — financial players into the game, you get a skewing of prices that do not represent the fundamental nature, and, in my mind are anti-futures. They skew the mechanism via which price discovery has worked so well up until about 2003 or so.

To me what’s important that if you’re looking for legitimate price, what oil is fundamentally worth, you need to go out at least 20-22 months. The further out you go, the more legitimate it gets — because you are chasing away all the guys who either due to lack of credit or lack of good sense, aren’t out there. So that to me is basically my thesis in crude oil, and that’s been since 2005, and is to me the main focus of my book [ “Oil’s Endless Bid,” John Wiley, 2011]. How this market has changed from what I call legitimate players to this sort of anti-futures kind of construct, which it will be unfortunately defended by everyone in the industry, particularly the exchanges. For every buyer there’s a seller, for legit prices, buying is good, liquidity is great…all these nonsensical [statements], to increase volume and get more commissions out of it. So for the financial industry, the oil game is wonderful, [but]for me it’s very much anti- consumer, anti -fundamentals and anti-fair price.

FM: Do you think that will change?

DD: No. We want Exxon and BP to tell us what the stuff is worth again, what [it really costs] to go 3.5 miles deep in [to the] Gulf of Mexico to get a barrel of oil out. That’s been lost. And the instant proof of that would be natural gas, which is localized and you can’t fake it. If there is too much supply, the price goes to zero; if there’s not enough, it goes to 14, and there’s no in between.

FM: Why do you believe supply and demand aren’t the key drivers for oil prices? Is it these financial players?

DD: Yes….but their reasons could be legitimate. They could be looking for a diversifier for stock assets. They could be worried that Obama’s going to put boots on the ground in Syria. But none of that goes to the fundamental nature of oil supply: Where it is, what oil companies [pay] to get it and what consumers are willing to pay. The things that [now]play first [are] how much money is being driven here, how long is it going to be driven here, is a bubble being created and who will be first  guy out of the port hole? These aren’t the same as “I am an oil producer with 75,000 barrels of crude in the 4th Q of 2014-2015 and I need to legitimately hedge those over that time period.” On the other side is “I am a refiner in the in midcom who needs to have some idea what my base price is going to be going to in the first quarter of 2015 …so I have to buy a couple futures as a risk hedge.” And between those guys and hundreds like them you get a legitimate price. [But today] if someone says [John] Kerry is going to get Obama to put boots on the ground in Syria, I’ll buy 3,000 lots in October….that’s anti-futures.

FM: But hasn’t a speculative component always been there, at least in commodities? Hasn’t that been always built into the price?

DD: The answer is yes, but the difference was in 2003 the electronic access swamped by many orders of magnitude those legitimate components that until then had a fundamental logic in those prices. Now you’ve got a footprint of players who dominate it that have zero [connection] to oil. That includes funds, investment banks, and the Asia payment machines.

FM: What is the speculative premium?

DD: I know exactly what the speculative premium is.  It runs all the way through the [back month] prices. It gets less the further you go back.  So [today] CL closed at over $109. I show Oct. 2017, in four years at $83. So that’s $26 [differential]. There’s a speculative premium even in the back somewhere because it’s showing up. What the hell Syria could have to do with October 2017,  I don’t know. My belief is with a backwardation like this, where from October 13 to 14, you have a $14 [differential], that’s premium — at least $25. There were some years, like when we had [the] Libyan war and the stock market wasn’t as good as it is now, they drove it to the moon, particularly Brent, where the speculative premium was $40.

FM: What’s your favorite trade?

DD: Best trade is buy long-dated oil futures because they don’t reflect financial input. If you believe you won’t see the financial fallout of 2008, these are best investments in the world. No special premium, or little, and doesn’t take into account theories like peak oil, but just [inputs] the expense of what it takes to get crude oil out of the ground. Crude oil today is 107,  and is at 92 far out. This is the finest investment in the entire world….to me that is a risk-reward basis for years. I always have far back that I’m long, usually out 18 months, sometimes more than 24, and it continues to pay off.

FM: Why do you think ETFs are a bad investment? Do you mean commodity ETFs?

DD: Commodity-based ETFs, futures-based to be specific. They try to solve non-existent problems. [Trading futures is the ] perfect long and short, but ETFs, when funds change them and instead of being a delivery product, they put it in a structured note with no delivery date, it runs into issues and robs investors. It gets worse when a market is in contango — it has rollover problems, has other problems, and then [there are] the standard exchange fees and getting in and out. You can track the [differential to crude] for years with ETFs. For example, the USO [is supposed to be a] crude oil proxy; [but] for years crude oil was up 55%, and the ETF was up 15%; other days crude is flat, and ETF is up 15%. As a proxy for prices [ETFs] are very bad. And as a vehicle for customers — [they] are not going to be getting the kind of gains they should get. [Investors] want to be long oil, not long an ETF.

FM: What about the actual physical commodity trading firms, especially now that the banks are stepping aside? They control many different aspects, not just drilling, but shipping, selling, etc. They’ve grown dramatically in last several years. How could that change the marketplace?

DD: You’ve pointed out exactly where the futures markets are going. With the banks, it was a credit issue, and the banks don’t need the hassle anymore and they don’t have the advantage they once had. And part of that is due to their own sword, the electronification of the market. But places like Glencore and Vitol, particularly Glencore, they were a trading company. They were J Aron before, they weren’t a bank. Marc Rich and Glencore, they were a trading company. They bought assets because they learned the game from the investment banks, particularly Morgan Stanley, which was the first that was allowed to buy physical assets. These guys aren’t oil companies because they make more money trading. Because the whole object of holding assets was no longer about  selling oil; the object of holding assets was to gain insight into the futures market. This is what it is!

Ask John Shapiro [former commodities chief] at Morgan why they bought all those crazy storage units for their trades —  because if a trade went bad they didn’t have to sell it into the market, they could dump it into [a] tank. And they could squeeze somebody else out. They were doing storage, and they were doing transport; they had a bunch of local guys who were telling them, ‘oh my god, everyone’s looking for storage.” It was an extra unit of access, of knowledge, to edge the knowledge they already had to network onto the floor. They already were paper drivers, they already had access to the legitimate hedge guys and commercial guys and trade guys who were doing the paper on the floor and they had additional access to knowing what was going on, to a certain degree, in the cash market.

Goldman Sachs is doing it in the aluminum market. Do they really want to stockpile aluminum? No. They want to know where the price is going — and have a great stream of information of just how much needs to go in and out of storage every month. They have great insight into knowing where the futures is going to go.

And this is why I own Glencore stock, despite the fact it’s been awful, because they are the future in this. They are taking this to the limit. They don’t want to have a couple of mines, they want to own all copper. They are going from one mining company to the next, slowly putting it together, whatever it takes. But again, [despite] all of this, Glencore [stock] trades like mining companies — no doubt about it — it’s been trading poorly for the most part the last year-and-a-half because it’s being lumped into the category of mining company. But it’s no mining company, it’s a trading company. They buy mines so they know where the hell copper is going to go. The money they make trading dwarfs what they do with the mining assets. And that’s the way they want it.

FM: So is buying Glencore a good idea right now?

DD: I’ve often gone on TV and spoken about this and touted Glencore. But they trade like a mining company, so for the last year-and-a-half they’ve gone down, so I look dumb. I’ve got a lot of money [in] Glencore shares so far, and if it turns out okay, [which is] my belief , [I’m] betting on the next model for profitable trading in the futures markets.

FM: Any other stocks, whether trading companies, energy companies?

DD: That’s what I do for the TheStreet, that’s what I do for RealMoney, that’s what I do for…mostly the stocks I look at, they are futures based in a lot of ways. I use the futures as a prism [through which] a good energy stock will look like. That does tend to change. These become mid-term plays, they last several weeks and then sometimes the trend may swap or switch.

Recently (and I’m coming into this late in the trade, started in April, so it’s a little long in the tooth but it seemed to work for so long), buying or looking to get domestic midcap E&Ps that were focused to crude and NGL, and the more focused I could get into domestic E&Ps to crude and NGLs, the more opportunity I thought there was. This wasn’t magic. I saw the Brent/WTI spread come in and there was going to be a catch-up to be made in domestic crude prices and that meant that if you were pulling that stuff out of the ground and you were getting $80 one month, $100 two months later, you likely were going to have a better quarter. It wasn’t magic.

FM: How much importance do you put on what’s happening in Syria and Middle East now?

DD: Syria produces 350,000 barrels of oil a day. Natural gas is obviously a local priced market so when we talk about natural gas, normally we’re talking about domestic natural gas, which will not be affected in the slightest by what’s happening in the Middle East.

[Crude oil] is the global market affected financially a hell of a lot more, so again the nervousness of another Middle East conflict will translate itself in there. Again the supplies that come out of Syria are not significant, [they’re] 4/10 of a percent of global supply. They’re not swing barrels; the Saudi’s easily can cover what is lost or not lost to a degree like they did in Libya and then in  Egypt.

But again, fundamentals don’t mean anything. When we get to a market like this, where the stock market is on the ropes, where the bond market is in panic mode, and everyone is looking for a diversifier as some sort of hard asset and gold has not been its normal stellar self in 2013 like it’s been for the past 17 years, to me that’s the biggest driver of oil and continues to lead crude. And all the risks to crude remain on the upside because as money tries to find some toehold somewhere, while all others look under pressure and under fire, I have to believe that crude has nowhere to go but up. That’s a purely financial analysis.

Now I can go on TV and tell them about all oil at risk:  The major risk to the closing Suez canal, the kind of contagion that you might get with boots on the ground, what’s going to happen with Iran, which is the strongest supporter of Assad in the region, and the Russians are clearly supporters as well. And I can tell them because that is what people believe the oil market is about and most oil people believe it too, those have legitimate needs. But if you’re asking me to address a group of people who are trained, who understand what moves markets, to me what is far more important is that the stock market, all of its good gains are in the air, the bond market doesn’t know where it wants to be and gold is not delivering as it has for many years. That means one thing, and one thing only, that except for some sort of money people who want to [be] in as some sort of hard asset, I’m saying that all the risks if you are a trader remain to the upside. That means if you are long you are less likely to reach $4 than if you are short. That’s not saying it can’t go down, but to me all the risks are to the upside. Unless the financial wheels come off, vis á vis 2007, a type of Fed tapering to a degree that the credit market sees again, then the oil market will take  a dive as it did then.

FM: How will Fed tapering affect the energy markets as well as the stock markets?

DD: Investment in the oil markets obviously had been done with cheap money. Part of what’s been driving current prices is Fed easing as it’s been driving all assets higher. The degree to when the parachute comes out and how fast has been the question about stimulus and federal money printing. That’s always the question. Right now I’m confident that cutting back from $80 billion to $45 billion is not the kind of easing that will cause oil markets to collapse. However, if it comes fast and furious with little economy catch-up with it, it [can] seize up the credit market as it did four years ago and six years ago, and we’ll have the same results — a cratering of all assets.

FM: What about U.S. energy independence? Is it realistic?

DD: Part of the theatre of the absurd has been in U.S. energy independence, that is logical and probably is inevitable, but not in a way most people would think. The way I view it is that there’s been an incredibly insanely wasted opportunity in natural gas, and that has come thru with glee and bad judgment of all parties through the government,  environmentalists and particularly those who look to exploit it, those midcap, independent E&P companies who shall remain nameless who went on a lease spree and drilled 40 wells in every square mile in six months and flooded the marketplace, and now are forced to try and cap wells. They’ve already destroyed certain areas like the Haynesville , and they’re flaring gas in the Bakken so they can reach tight crude. It’s a travesty, it’s an outrage. In the process we’ve allowed this incredible natural resource to be mismanaged at all levels, [it’s] worthy of a book, which is why I’m writing it.

You couldn’t make this stuff up. It’s outrageous what goes on. They literally drained  Haynesville  dry in three years when it could have lasted 40 or 50 years. And then natural  gas cratered when it went down to $1.70. The people on the land didn’t get rich, the  companies that drilled there are broke and we are not an iota closer [to being] a natural gas driven economy as opposed to a crude oil economy, which we should already be on top of. There’s not one thing you can’t do with natural gas that you can do with crude oil that’s safer, cleaner more efficient and cheaper — not one thing!

FM: We spoke with T. Boone Pickens two years ago and he was pushing natural gas for trucks but the bill got stalled in Congress.

DD: Boone’s got money on it! I don’t have a dime on it and I see how stupid it is. And he’s so right on this. I’ve talked to him; he’s had it with these guys.

FM: Has the shale revolution become a bubble?

DD: I believe there is. Natural gas is $3.45 a MMbtu, and crude is  $105 [a barrel]. Which one are you going to take out of the ground? That’s the bottom line. I’m going where the money is; my shareholders need money. [The] problem with natural gas has been the mismanagement of it. We’ve got to find a way to get this stuff out of the ground, like DeBeers gets diamonds out. The way the copper miners have finally figured out you shouldn’t mine everything you can, you think that’s a good idea. It’s been incredible — you would think low prices would fix everything but they’ve hurt everyone. Fair prices fix everything.

FM: How does China play into the energy market? One EIA report said they could be the world’s largest net importer by this year. We’re talking crude oil.

DD: The Chinese clearly have shown a capacity for signing whatever deal is cheapest. And it’s clear the Chinese have thrown their lot in with the sour crudes inside the Middle East crude, and the darker the better. I don’t believe while they come and spend money for Canadian assets…I believe [their] game rests with whatever pipelines are being built through Turkey and Iran. I believe ultimately that’s where their supplies will come from. Chinese have all the money, and they’re covering every base.

FM: You’re not a big supporter of peak oil, it’s more of a psychological driver you’ve said…

DD: No doubt [oil’s] a limited resource, so that’s where you start. Meanwhile, every guesstimation to run out has turned out to be wrong and I expect it to be wrong for several decades to come, and that puts the environmentalists in a very bad spot. I shouldn’t say the environmentalists— maybe it puts us all in a bad spot.

FM: Let’s talk the drop in WTI/Brent spread to single digits from $40.

DD: I think actually WTI went over Brent for a day. It’s about two things, and one is fundamental and the other is financial. The first thing is fundamental: WTI is worth more than Brent to any refiner. The historical premium of WTI to Brent is $3-$5. [At least] it was until 2007. When the WTI/Brent spread turned over in 2008 and 2009, it killed more of my friends than any spread I’ve ever seen because they had lived the previous 15 years where WTI was worth more than Brent. And when they saw Brent went $3-$5 over  WTI,  they thought it was the greatest gift God had ever bestowed upon them. Then when it went to $7, they doubled down,  and when it went $15 they might have taken a shot, but when it went to $23 or $26, goodbye. I didn’t see anyone who made money on that. So the fundamental rationale for WTI finally catching up with Brent despite the fact there are some transport issues makes sense, but there isn’t a refiner on the planet who wouldn’t take WTI over Brent.

Here’s the financial side of it: There wasn’t a trader on the planet who was long the spread. I don’t think it’s over, but clearly it’s been [fading]. I had a friend who was trading at Morgan Stanley, say ‘if I ever tell you I’m trading one lot of WTI/Brent, come over and pluck my eyes out.’ It caused more pain to more professional traders than I’ve ever seen in my life.

Futures Mag

6 Comments on "How electronic trading changed (ruined) crude oil prices"

  1. bobinget on Thu, 26th Sep 2013 5:17 pm 

    THis interview is one of the most truthful, educational
    and accurate piece I’ve read in months.
    Since it’s worth the price of a good ebook (on the subject) send $14 or $15 to Peak in thanks for republishing here.

  2. GregT on Thu, 26th Sep 2013 9:14 pm 

    This interview exposes exactly why free market capitalism was a bad idea right from the start.

    The Earth’s finite natural ‘resources’ are a one shot deal, once they have been consumed, many are gone, forever. Those resources do not belong to anyone, and for people to ‘exploit’ them as quickly as they can, just to turn a ‘profit’ is immoral.

    We are leaving a planet behind, for all future generations, that has been completely decimated. A small percentage of our population, has turned the natural environment into their own personal assets, numbers on computer legers, and totally unnecessary and unneeded toys. To think that we consider these people to be successful, is very telling of our society.

    Our entire society is sick with corruption, greed, selfishness, and gluttony. I find it very sad, that our children, and their children will be the ones to suffer for our ignorance.

  3. mo on Thu, 26th Sep 2013 11:28 pm 

    Look at it this way scarcity will cause a population implosion. Maybe there’s hope for the planet after all

  4. BillT on Fri, 27th Sep 2013 1:44 am 

    Hope for the planet, maybe. Hope for humanity, nope!

  5. GregT on Fri, 27th Sep 2013 3:28 am 

    The Earth, has all of the time in the world.

    We, on the other hand, do not.

    Will we figure this out in time? Not likely.

  6. mo on Fri, 27th Sep 2013 1:28 pm 

    Who says we are meant to survive anyway. The arrow for all species points to extinction.

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