James Bianco, a respected fixed income analyst at Arbor Research, was so kind as to pass along his observations about the retreat in oil prices from his morning research note. “Is This Why Crude Oil Is Getting Slammed?”:
The Financial Times – Oil trading company files for bankruptcy Access
SemGroup, the US physical oil trader, on Tuesday filed for bankruptcy as it acknowledged trading losses of more than $3.2bn in different energy markets after betting this year that crude oil prices would fall. Its collapse came as oil prices plunged to their lowest levels since early June. West Texas Intermediate crude oil fell to an intraday low of $125.63 a barrel, down $5 on the day. Traders sold oil futures as news emerged that tropical storm Dolly was set to miss oil and natural gas installations in the US Gulf of Mexico. Oil traders said SemGroup could have exacerbated the spike in oil prices this month, when the market experienced unprecedented swings of more than $10 a barrel, as the company was buying back some previous bets on lower prices. The bankruptcy of SemGroup, which describes itself as the fourteenth largest US private held company, affects approximately $3.1bn of debt, according to court filings. Oil company BP is the largest creditor, with almost $160m.
Reuters – Huge oil trading loss sinks energy trader SemGroup
SemGroup took a $2.4 billion loss on July 16 after it transferred its New York Mercantile Exchange oil futures trading account to Barclays Plc, converting what they called “loss contingencies” into an actual loss. Included in the NYMEX loss was $290 million owed to SemGroup by a trading company owned by co-founder and former chief executive Thomas Kivisto, who was placed on administrative leave on July 17. Securities legislation limits publicly traded company executives from extensive dealings with their firms, but experts said privately held companies have more flexibility. . . . SemGroup, ranked the No. 12 private U.S. company by Forbes.com in a 2007 article, also took $850 million in losses on July 17 when its over-the-counter hedging program was marked to market. It listed liabilities of $7.53 billion in its bankruptcy filing, including $3.1 billion of total debt $2 billion of secured debt and $594 million in unsecured notes. SemGroup’s financial difficulties were disclosed by its publicly traded affiliate SemGroup Energy Partners LP last week, when it warned that a liquidity crisis at its parent could lead to bankruptcy.
Comment – This story reminds us of the May 2006 parabolic rally and collapse in copper. Back then it was the short position held by China and Dwight Anderson’s Ospraie Management that was forced to cover and when they did, copper prices collapsed.
The Financial Times – (May 7, 2006) Bears seek cover as copper’s rise extends
China’s State Reserve Bureau and Ospraie Management, a $4bn commodities-focused hedge fund, both had large short positions that they covered within the past two months, are China’s State Reserve Bureau and Ospraie Management, the $4bn US commodities-focused hedge fund according to copper market participants familiar with the matter. When investors exit a short position, they repurchase stakes they previously borrowed and sold, and the repurchasing can add substantial upward pressure to the investment. For instance, China reportedly exited half of its large short copper position last autumn, fuelling a sharp price rise. Several market participants believe the SRB has closed out the remainder of its short position in the past few weeks. Ospraie, meanwhile, was believed to be short about 12,000 contracts of copper, or about 300,000 tonnes. “They have been covering that position in the last few weeks as the pain just became too much,” said one market participant. Another trader said Ospraie is believed to have closed out its short position at about $6,750 a tonne after being bearish on copper’s price starting around $3,000.
This time around, it is crude oil that rallied enough to force SemGroup to take a $3.2 billion loss. As the chart below shows, the current correction is approaching the biggest correction in crude oil since February.
It could be argued that $3.2 billion is not that much money in the cash crude oil market. That is true. But often these are not the only firms “caught.” But, it is often the case that stories like this that lead to market reversals often do not involve that much money relative to the size of the underlying market.
As we note in the next block, an ambiguous SEC-ruling designed to rein in the shorting of 19 financial stocks, all that were easy to borrow (see this comment), is at first blush just a tiny sliver of the U.S. domestic equity market. However, as S3 Matching says below, this rule caused almost all shorting to stop and was the catalyst for the sharp stock market rally last week.
Whether SemGroup’s forced cover is the catalyst for one of the biggest recent corrections in crude oil can be debated. But the fact that this correction started literally hours after SemGroup were forced to cover (July 16/17) seems to be more than mere coincidence.
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Sorry to be dense, but why would covering a short position cause prices to fall? Seems like they would instead rise as the position was bought in.
Can someone more knowledgeable than myself explain this?
They probably tried to cover two weeks ago, temporarily pushing prices higher, worsening their position. Once they couldn’t do this further, then they stopped further buying, reducing demand, causing prices to fall (as we have seen in the past few days). Then again, I may be wrong.
Thanks for posting this, yves. Very intersting.
Just be sure nobody tells John McCain and bursts his bubble!!!
Sorry to be dense, but why would covering a short position cause prices to fall? Seems like they would instead rise as the position was bought in.
Other market participants will be aware of their predicament and deliberately move the market against the hapless trapped firm in order to force a liquidation. Once they succeed, they can take off their own positions.
This is why keeping positions private is very important.
Also, exact same pattern in open interest is in evidence in both implosions to this point. I’d anticipate open interest to continue to decline in oil even beyond its current relatively low levels, and the energy sector to cool off quite a bit.
If the analogue continues to play out, we should see a collapse in short-term oil prices followed by a rapid recovery. It fits cleanly with fundamentals too, as net exports continue to decline and incremental production costs rise.
I remember some greybearded copper analysts talking about how it was preposterously rich at $2.00/lb in December ’05. The wringing of Ospraie occurred around $3.90/lb. While it got as low as $2.50, it’s been remarkably stable at about $3.80 since then.
http://www.kitcometals.com/charts/copper_historical_large.html#5years
I’m adding to my positions in canroys with big reserves here, but they’re not dropping much in comparison to the commodity, unfortunately.
I think they shot Shorty and then they took his gun.
Some of you might remember a chart I posted with daily open interest on NYMEX futures and the front-month price imposed over it. This was in a discussion on a Hausman article I believe. I’ll be posting another update of that in a bit.
Track XLF vs USO. They have traded as opposites since the financial storm began in August. I think this has a lot more to do with that, than this firm collapsing, although I’m sure this hasn’t helped.
Here’s the chart of NYMEX Futures open interest in crude with price/bbl up until yesterday when August contracts were assigned.
http://img293.imageshack.us/img293/1899/crudeoichart072208bk7.png
It’s a big chart so you might have to make your browser window bigger.
That’s a great chart, mr. sparkle. Most interesting to me is the persistent decay in interest in the CLZ08 contract. Could you add CLZ09-12 open interest to future charts as well?
I’m hoping for a price just below $100 that persists or drifts upward slowly for awhile, and a significant further drop in open interest. It’d be a wonderful opportunity.
The WTI/Brent correlation is another interesting data point to watch. WTI should always be priced higher than Brent due to superior product yield, but this flips sometimes. It flipped pretty sharply during the early ’07 correction.
http://www.dallasfed.org/research/energy/images/en0701c3.gif
It’s inverted sharply and suddenly again, from a $4 premium at the $147 peak to $2-3 cheaper during this fall. That’s suggestive of fireworks in the WTI market.
Sorry for spamming the blog. It’s a topic near and dear to my heart.
Just to add…althought the DOE numbers are only US, if we are going to be in the triple digit crude range, we should not be seeing higher-than-average builds in diesel inventory like we have over the past few weeks.
imo, this is a negtive signal for oil prices — Given that refiners are drowning in gasoline supplies (which btw, according to the DOE numbers, are 30% higher than the 5-year average) — they literally have no place to put it — refiners HAVE to move diesel because its the only product that is keeping their margins (cracks) from imploding completely.
The fact that they are not moving diesel suggests slowing BRIC/EM demand?
Also, lets not forget that natgas is off almost 30% from its all time high made in early July. I wonder if SEM has anything to do with blowing that trade apart??
For some reason, I’m thinking Hunt Brothers and silver?
As we note in the next block, an ambiguous SEC-ruling designed to rein in the shorting of 19 financial stocks, all that were easy to borrow (see this comment), is at first blush just a tiny sliver of the U.S. domestic equity market. However, as S3 Matching says below, this rule caused almost all shorting to stop and was the catalyst for the sharp stock market rally last week.
Sorry if I’m being stupid, but where can I find this ‘next block’ ‘this comment’ and/or ‘s3 matching says below?’ I’m trying to find the clear references but am failing. Help please.
So this is how speculators don’t affect the price of oil.