Time for an Oil Change
By Chris Cook, for Trend
“What goes around, comes around” - a recent meeting in Tehran between two of the founders of the Iran Oil Bourse project perhaps opens the way to a new energy market beginning.
A Middle East Petroleum Exchange?
In 2000 – as former Director of Compliance & Market Supervision of the International Petroleum Exchange (IPE) - I became aware of routine manipulation of the Brent Crude Oil futures contract settlement price. I reported this to the exchange; its UK regulator (the Financial Services Authority) and UK Treasury. My complaint (subsequently validated) was 'whitewashed' and my career, home and family life was destroyed.
Following this, a UK colleague and I wrote a letter in June 2001 to Iran's Central Bank Governor Mohsen Nourbakhsh (now sadly deceased) pointing out the ongoing take-over of the global oil market pricing platform by Wall Street investment bank after formation of the Intercontinental Exchange. I recommended the foundation of a Middle East Petroleum Exchange and benchmark price. The proposal – which arose out of many years' work at IPE on a Middle East pricing benchmark - met with the approval of Oil Minister Bijan Zangeneh and was then taken forward as what became known as the Iran Oil Bourse initiative.
It is worth pointing out here that a myth has been circulated (mainly by gold enthusiasts) that the Oil Bourse constituted an attack on the US dollar. However, I can state categorically that the currency in which oil would be priced was never a consideration, since while Iran had raised the possibility of pricing oil in Euros several times at OPEC meetings, this was always vetoed by Saudi Arabia and their allies.
Iran Oil Bourse
In May 2004, my colleagues and I made a presentation with our partners (Tehran Stock Exchange Services Company) at Iran's Central Bank and we were commissioned to carry out a feasibility study, which was completed by August 2004. This was a radical document in terms of proposed market structure and instruments, reflecting as it did the need for a new networked global market platform and instruments for financial rather than physical energy. Such a network and instruments will link providers of liquidity such as exchanges and will enable energy development financing and operational funding to be raised simply but effectively.
Although our report was used to enable a new conventional exchange– the Iran Oil Bourse - to be authorised, my colleagues and I remain unpaid to this day, since this was the simplest way for those opposed to more market transparency to prevent progress. So throughout the deeply corrupt Ahmadinejad regime, no further progress on our proposal for a financial energy bourse at Kish Island was made.
Meanwhile a conventional bourse for marketing physical energy as a commodity was funded by powerful financial interests and has been developed as Irenex. The proposal for Iran's oil and gas to be marketed through Irenex - rather than via Natftiran Intertrade Company (NICO) - is as contentious within Iran's corridors of power as the Iran Petroleum Contract and for the same reasons. Heated criticism and accusations are therefore flying around in respect of both subjects between Reformist and Resistance factions in the current volatile pre-election atmosphere.
Oil Market Financialisation - 2001 to 2008
My gloomy forecast in June 2001 proved justified as the global oil market became dominated by the Intercontinental Exchange (ICE) and the Brent oil futures contract evolved – as new grades of oil were added to maintain liquidity - into the Brent, Forties, Oseberg, Ekofisk (BFOE) complex of physical and derivatives contracts. This complex has become the vehicle for the greatest market manipulation the world has ever seen, or probably ever will see: theBig Long.
Between 2001 and 2008, crude oil ceased to be a commodity and became an asset class, as investors entered the market through new breeds of Index Funds and Exchange Traded Funds (ETFs). This 'passive' fund participation enabled producers - through use of the deceptive financial structures and instruments developed by Enron – to fund themselves via opaque prepayment for what has been described as Dark Inventory. In other words, the owners of stocks of oil may sell the economic interest in oil via prepayment by investors, and act as the custodian of oil pending delivery.
A financial bubble in oil was therefore created which reached $147/barrel in July 2008, only to collapse and then re-inflate as this massive manipulation entered a new phase when President Obama – who was the servant of US banks rather than oil companies- came to office in 2009. The departure of the financial market in oil from the reality of physical use for transport, heat and so on may be understood by the fact that the oil price rose from $80 to $147, fell to $35 and rose again to $80/barrel within a two year period during which underlying demand for physical oil varied by less than 3%.
Oil Market Financialisation 2009 to 2014 - the Big Long-
Beginning in 2009, the US deployed Saudi finance capital to re-inflate the oil market price and support it above $80/barrel. In exchange the Saudis ensured that US fuel prices – particularly gasoline – did not reach levels at which Obama's re-election chances in 2012 would be endangered.
This was a smart strategy by Obama's administration, and most OPEC members were blinded by greed as dollars rolled in with massive surpluses being invested in US Treasury Bills and other US $ denominated financial assets. As a result of this massive inflow of Petrodollar finance capital, the US was able to finance the rapid expansion of US shale oil production. This wave of largely debt financed investment saw some 5m barrels per day of US shale oil production mobilised within three years, while demand for oil products fell drastically, as renewable energy and energy efficiency measures became profitable.
As a result, the US achieved a crucial geopolitical goal of making themselves independent of Saudi Arabian oil reserves. In mid 2014 – as I had forecast in Tehran in late 2011 – the oil price collapsed to $45 to $50/barrel when the US dollar liquidity tap (QE) was turned off by the Federal Reserve Bank.
If there is one thing that the history of commodity markets demonstrates it is that if producers can support the market price then they will. Because a relatively small amount of Brent/BFOE oil sets the global benchmark price, it is straightforward for the price to be supported by finance capital such as funds. I have termed the substantial 'long' fund position in crude oil necessary to support the price the Big Long.
Oil Market Now
The oil market is currently in a dangerously fragile equilibrium and price range with the price supported by Saudi capital which is maintained opaquely in specialist energy funds and with liquidity provided by the European Central Bank's € QE. On the supply side any rise in price above $50 per barrel sees shale oil producers selling their production forward, enabling the necessary debt finance to produce shale oil profitably. This financial combination essentially acts to create an additional US Strategic Petroleum Reserve (SPR) which operates on autopilot to cap the global market price.
On the demand 'Buy-side' China is essentially acting as a global oil buyer of last resort, preferring to hold oil reserves over dollar reserves. China is therefore building new oil storage to accommodate this SPR at a phenomenal rate of construction. While China appears to be content to allow the Saudis to maintain the price in the organised market above $50/barrel my understanding is that surplus 'marginal' oil being quietly sold (much of it by cheating OPEC members) is selling on the fringes of the market to independent refiners at between $24 and $28 per barrel.
Meanwhile, OPEC's cuts are almost entirely cosmetic and the global oil market glut has continued to build although summer heat will see increased (wasteful) use in the Middle East. It is not a matter of if OPEC members cheat: it is only a matter of how they do so, and Saudi Arabia appears to have brought cheating to a fine art with Wall Street assistance.
Saudi Arabia's energy strategy is to secure demand for their oil through ownership of, or long term relationships with refiners. In the US Saudi Arabia had 50% ownership (now 100%) of Motiva which owned several major refineries, and the Colonial pipeline connection enables oil products from refined Saudi crude oil to be delivered into New York Harbour, which in turn enables manipulate of US oil product benchmark prices.
Meanwhile, one of the major US Strategic Petroleum Reserve facilities at Big Hill (close to the Motiva refinery at Port Arthur) became surplus to requirements. The US has been able to use this reserve – simply by selling and repurchasing ('lending') oil inventory in exchange for a sale and repurchase of Treasury Bills – to enable Saudi Arabia to bypass OPEC commitments through 'pre-cheating' through opaque use of this Dark Inventory. It is essentially a swap for the value of energy over time against the value of dollars over time
The outcome of this colossal market deception has been to create a two tier market between the insiders who are aware of the true ownership of oil, and the majority of outsiders who are not. This disparity ('asymmetry') in market information has enabled fortunes to be made by those aware of the market reality.
However, while it is likely that a Clinton (Wall Street) administration would have continued this deception, it appears that the Saudis are now left to manage the market without active US participation, and in my view, the market price is dangerously fragile, with market risk concentrated in 'too big to fail' clearing houses.
What is to be Done?
I have long believed that the solution to the oil market lies, strangely enough, in the creation of global physical and financial markets in natural gas. Unlike oil (of which there are innumerable varieties), natural gas is pretty much the same everywhere once it has been processed. Again unlike oil, which is relatively cheap to transport, it is extremely costly to transport natural gas thousands of kilometres to market, whether it is pumped via pipeline or compressed into Liquid Natural Gas and then shipped and decompressed.
This is why Iran developed under Zangeneh a policy of substituting natural gas for oil both as fuel (for heat/cooling, power and transport) and feedstock for petrochemicals. Other Persian Gulf nations have increasingly been following Iran's lead, and that is why our proposal for reactivating the Kish Bourse does not involve contentious oil or oil products. It is instead for natural gas pricing and trading via regional 'Balancing Point' pricing similar to the UK balancing point natural gas contract in respect of which I was responsible at IPE for introducing the financial contract in 1995.
An Important Meeting
My Tehran-based colleague who was one of the driving forces behind the Bourse project, recently met Zangeneh's knowledgable adviser who was responsible for commissioning the initial Iran Oil Bourse study which we carried out. This adviser is now in charge of the difficult task of updating Iran's market architecture to reflect President Donald Trump's evolving and ever-changing America First policies.
My simple message to Zanganeh is this. Instead of pricing oil and gas in dollars, collaborate with other producers and consumers to price dollars and oil in gas. Russia and Iran possess more than half of global gas reserves, while China is the world's greatest consumer of gas. It is therefore completely possible for these three nations to collaborate (as the investment banks did almost 20 years ago to create the Intercontinental Exchange) to reach the basis of what could be a new global energy settlement.
Such a collaboration may commence with the creation of the first (Caspian) hub in a new global financial market network in gas, as I have advocated for almost a decade and extend to new hub in the Persian Gulf.
Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and a commentator.