- Money Morning Australia

Derivative Manipulation Hits the Crude Oil Market

Written on 09 May 2012 by MoneyMorning

Derivative Manipulation Hits the Crude Oil Market

Friday, the price of West Texas Intermediate (WTI) crude oil, the benchmark oil contract traded on the NYMEX, fell 4% ($4.14). The one-day decline is the steepest since WTI fell 5.1% ($5.12) on January 3.

The other major benchmark, London-set Brent, also was hit, but less significantly, falling 2.6%. It was the largest Brent decline since a 4.6% dive on December 14.

However, the Brent-WTI spread is now increasing again. As of the close on Friday, the spread as a percentage of the WTI price (the better way of looking at it) stood at 14.9%, the highest differential in more than two weeks.

Two important questions follow.

First, why did this happen? Second, what is that spread again telling us?

The answers will surprise you.

Roll Out the Usual Suspects

As crude oil prices fell, TV pundits immediately paraded the usual suspects. They cited disappointing U.S. job figures, renewed concerns over European debt in general, and the Spanish situation in particular, while so-called “analysts” clamoured over a possible double-dip recession.

These concerns are not new, nor are they revelations.

Plus, the essential reasons why the oil price should be moving in the opposite direction – namely up – haven’t gone anywhere. The constriction produced by supply/demand considerations remain, and the insufficient volume available to meet unexpected demand surges and the geopolitical environment – especially the impending European boycott of Iranian crude oil imports – remain in full force.

The overall market dynamics still point strongly to a rise in oil price.

Yet the overall movement of crude oil futures has remained peculiarly restrained. In fact, WTI has given back 6.1% in the past week, and some 2.7% for the month.

Here’s what’s really happening…

Preparing for the Next Crude Oil Price Rise

The real reason we have witnessed a retreat in crude oil pricing has little to do with the condition of the market or the actual demand for product. It is the result of a classic yo-yo short in anticipation of a major advance in the oil price.

In other words, some very large traders in oil futures contracts – the so-called “paper-barrel” speculators of future actual consignments of oil (or “wet barrels”) – are manipulating a short-term cut in price after establishing a position that will profit with the price going down.

This amounts to a “put” clone resulting in an exaggerated decline in the crude oil pricing level, usually orchestrated on a five-day pricing spread introduced by a sequenced derivative move on the futures contract itself.

The trader profits when the price goes down by exercising the “put” to sell options on the futures contract at a higher strike price than that provided by the market by redeeming the derivative.

Of course, when that happens, the market price will increase. The trader then profits again by having derivatives on the increasing price already in place.

The price is manipulated just like a yo-yo moving up and down. Now the manoeuvre is only doable during periods of lower-than-average futures contract volume and a narrow period in which the price is not likely to spike because of outside developments (for example, natural disasters, a rapid escalation in hostilities, blockage of transit, collapse in production, and so on).

It becomes less useful when the market indicators themselves are decidedly moving up. The approach succeeds by wider market perceptions, not fact. It ends when the actual pricing dynamics take over. In between, a few traders make some bucks by manipulating the margins.

There will be little opportunity for this device to operate again as we move into the summer volatility.

The Iranian Embargo Looms

As for the second question, that widening Brent-WTI spread is signaling a renewed concern about the real market impact coming from the EU-Iranian embargo and the increasing inability of other producers to make up the difference over the long term.

Saudi Arabia has agreed to cover the initial shortfalls to the most highly vulnerable European importers – Greece, Spain, and Italy. But that additional volume will not guarantee price moving forward. And it will also result in both price increases and market dislocations in other regions relying on Saudi exports – Asia especially and, in particular, India.

Spain attempted to secure additional oil from Nigeria but was told the African producer could not cover additional needs resulting from the embargo. Russia may benefit in the near term, but that will certainly increase prices paid by Europe.

All of this is reflected first in Brent because it is the benchmark most impacted by these developments. However, it will be translated into rising WTI prices as well, since the price in the U.S. is still reflective of the price in Europe due to imports.

The increasing spread, therefore, tells what is really going to happen.

Crude oil is going up.

Despite what a few very large short artists will pull off now and then in the hazy funny paper world of exotic derivatives.

Dr. Kent Moors
Contributing Editor, Money Morning

Publisher’s Note: This article originally appeared in Energy & Oil Investor

From the Archives…

Why China’s New Consumer Economy Won’t Give You the Trade of the Decade
2012-05-04 – Kris Sayce

Why China Could Be The Next Destination For the Financial Crisis
2012-05-03 – Merryn Somerset Webb

How Did We Get It So Wrong on Australian Housing?
2012-05-02 – Kris Sayce

This Indicator Shows the Copper Price Could Be Set to Soar
2012-05-01 – Dr. Alex Cowie

How Gold Nanoparticles Will Create A New Kind of Gold Rush
2012-04-30 – Michael Robinson

Already a subscriber to Money Morning... or simply, just like what you're reading? Then show your support and spread the word...
Share this post on...

At Money Morning our aim is simple: to give you intelligent and enjoyable commentary on the most important stock market news and financial information of the day - and tell you how to profit from it. We know the best investments are often the hardest to find. So that's why we sift through mountains of reporting, research and data on your behalf, to present you with only the worthwhile opportunities to invest in. Become a more informed, enlightened and profitable investor today - by taking out your free subscription to Money Morning now.

Leave a Comment

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.

If you would prefer to email the editor, you can do so by sending an email to moneymorning@moneymorning.com.au

Comments are closed.

FREE INVESTMENT REPORT: The Top 5 Oversold Blue-Chip Stocks in Australia

These five Aussie stocks all have something very powerful in common…and it could see them bounce up in the coming weeks and months. For all the details download this report right now.

PLUS you'll get Money Morning every weekday...absolutely free.

Enter your email address below and hit the 'Claim My Free Report' button now.

Privacy Statement
We will collect and handle your personal information in accordance with our Privacy Policy.
You can cancel your subscription at any time

Diggers and Drillers

A 3-Point Plan to Re-Engage with the Aussie Mining Boom

This new video reveals a way for Aussie share investors like you to RE-ENGAGE with the next phase of the mining boom…while valuations are still dirt-cheap…

The plan centres round three specific stocks.

To find out what they are, click here.

Australian Small-Cap Investigator

The Australian wildcatter
exploring oil's 'final frontier'

The US Geological Survey says this area contains up to 71 billion barrels of oil.

Only a few explorers have secured licences to drill.

One of them is a daring little Aussie firm that begins drilling 'in early 2014'.

According to small-cap analysts Tim Dohrmann it's impossible to speculate just how high this one could go. Find out why here.

World War D

Couldn’t make it to our
‘War Summit’?

Don’t sweat it. Click here for the next best thing…

World War D was the most important meeting of minds of the decade so far. What came out of it will almost certainly force you to reshape your investment plan for the rest of the decade. There's no way to go back in time and get inside the Savoy Ballroom of the Grand Hyatt.

But you can do the next best thing…
to find out what it is, click here.

  • ^NDX3534.532+1.446 - +0.04%
  • ^FTSE6625.25+41.08 - +0.62%
  • ^AORD5444.800+32.200 - +0.59%
  • ^AXJO5454.200+33.900 - +0.63%
  • AUDUSD=X0.9331
  • USDJPY=X102.585

Graphic Ad 1 – Blue Chip Stocks Report

Revolutionary Tech Investor

This report is about TECH MOON-SHOTS

Four of them, to be precise.

It's an early-days project. But one biotech aiming for the cancer moon-shot is already up - get this - 497.14% since tipped.

For four more tech moon-shots, click here.

Gowdie Family Wealth

The worst mistake you can make when handing wealth on to your kids

This brand new investor briefing shows you what your family’s in for if you don’t take care to leave your wealth to them in exactly the right way.

And it shows you precisely how to prevent infighting, recklessness and misunderstanding over money.

Read it here.

The Money For Life Letter

Holden. Toyota. Qantas. BUST

Do you really expect the share market to boom in times like these? That's why Nick Hubble says the best thing you can do right now is invest for safety and income.

This brand new video shows you how you can get predictable, reliable and rock solid cash flow no matter what happens in the wider economy.

You could lock in up to $20,000 a year - and that's just the start. See how here.

Sound Money. Sound Investments. [bullish prediction]

Greg Canavan's first bullish prediction in four years

Greg Canavan
doesn't make forecasts like this often.

When he does, it's because he’s found something that could make you money for years to come.

Read more here.

Is the Australian Housing Boom Really Back?

The Denning Report

2014 Predicted

Dan Denning accurately forecast 2013's flight from
bonds to stocks, the commodities crash and the
Aussie dollar top…to the exact week

In this brand new forecast report, he shares his
three critical predictions for 2014…

More Recommended Reading Below...

The Pursuit of Happiness & The Daily Reckoning

  • The Pursuit of Happiness
  • The Daily Reckoning Australia

Done properly, a retirement business can not only help fill a retiree’s time and replace their work [Read More...]

Free speech is no longer really a right at all. Governments, vested interests, and lobby groups are [Read More...]

Australian house prices are going to remain high. Perhaps finally, when the last baby boomer retires [Read More...]

Make sure that the changes you make to your financial plan are from a credible source. Otherwise the [Read More...]

It was day two of the World War D conference, and the final session was starting. We were closing th [Read More...]

The US dollar has value because the government levies $3 trillion in tax liabilities annually and ac [Read More...]

The best course of action is to focus on generating wealth and investments outside of the government [Read More...]

Since the US Federal Reserve’s relief efforts began, total world debt has gone up by $30 trillion, w [Read More...]

A one size fits all strategy or rollover to your own self managed super fund with the ability to tai [Read More...]

Services will boom according to the Reserve Bank of Australia. Sales assistants and tour guides are [Read More...]


"I think you're fantastic! I love to read what you write...you're so interesting and amusing and I've learned so much" -
Money Morning reader, Chris Gadd

"You guys are brilliant. I feel more relaxed about the future than ever simply because I know what is going on rather than floundering around with smoke screens and mirrors from the government and mainstream" -
Money Morning reader, Helen Carter

"Wow what can I say? I was an economically confused moron until I read your newsletter and even though I've been a subscriber for a short period I can now see how easy it is to understand, if you use common sense and can have the spin translated into everyday language. Thanks for an entertaining read." -
Money Morning reader, John

"Keep up the good independent and well thought out articles offering a view that often debunks mainstream myths." -
Money Morning reader, Craig

"I do admire your straight talking and simple analysis of the situation, I think of you as the Jeremy Clarkson of finance." -
Money Morning reader, Jeffery