Streetwise Professor

May 10, 2016

Glencore Mucking About in the Dirtiest Market in the World

Filed under: Commodities,Derivatives,Economics,Energy,Regulation — The Professor @ 5:30 pm

The WSJ has an interesting story about Glencore big-footing the Singapore fuel oil market:

In a lightly trod corner of the oil market, Glencore PLC is leaving a big footprint.

During two of the past five quarters, the commodities trader has bought up large volumes of fuel oil at Asia’s main trading hub in Singapore at a time of day when it has an outsize effect on an Asia-wide price benchmark.

Trades made during the daily “Platts window”—the final few minutes of trading—are reported to Platts, an energy-price publisher, which uses the data to calculate a daily benchmark used to price millions of barrels of fuel oil across Asia.

In the first quarter, Glencore bought 20.7 million barrels of Singapore-traded fuel oil in the window—44% of all the Platts-window buying—according to the publisher, which is owned by S&P Global Inc. During that period, fuel-oil prices in Singapore rose 7.5%, according to Platts, outpacing Brent crude oil, up 6.2%, and U.S.-traded crude oil, up 3.5%.

“The fuel-oil bull play has been a fairly regular feature of the market-on-close window for many years,” said John Driscoll, chief strategist at JTD Energy Services in Singapore and a former fuel oil-trader. “Singapore is the world’s largest marine-fuels market and serves as the central pricing hub for petroleum products east of Suez. These conditions tend to favor bullish traders who have the resources and conviction to aggressively bid the window for a sustained period of time.”

The Journal soft-pedals what is going on here:

Some traders, shipbrokers and commodity experts say Glencore’s purchases have hallmarks of a trading gambit sometimes employed in the lightly regulated world of fuel-oil trading. In it, traders buy large quantities of physical fuel oil to benefit a separate position elsewhere, such as in the derivatives market or elsewhere in the physical market.

I’ll be a little more blunt. Yes, this looks for all the world like a manipulative play, along the lines of my 2001 Journal of Business piece “Manipulation of Cash-Settled Futures Contracts.” Buy up large quantities in the physical market to drive up the price of a price marker that is used to determine payoffs in cash-settled OTC swaps. (It’s possible to do something similar on the short side.) This works because the supply curve of the physical is upward sloping. Buy a lot, drive the market up the supply curve thereby elevating the price of the physical. If you are also long a derivative with a payoff increasing in the cash price, even though you lose money on the physical play, you can make even more money on the paper position if that position is big enough.

It’s impossible to know for sure, without knowing Glencore’s OTC book, but it is hard to come up with another reason for buying so much during the window.

Those on the other side of the OTC trade (if it exists) know who their counterparty is. It is interesting to note the “ethos” of this market. Nobody is running to court, and nobody is shouting manipulation. The losers take their lumps, and figure that revenge is the best reward.

Platts reacted with its usual blah, blah, blah:

“The Singapore refined-oil-product markets are highly liquid, attracting dozens of buyers and sellers from across the world, and our assessments of those markets remain robust,” Platts said in a statement. “It’s worth highlighting that our rigorous standards in our oil benchmarks are fully open to public scrutiny, and a result of information provided to us on a level playing field.”

As a transactions-based methodology, Platts windows are not vulnerable to some kinds of manipulation (e.g., of the Lie-bor variety) but they are definitely vulnerable to the large purchases or sales of a big trader looking to move the price to benefit an OTC position. The most that Platts can do is provide more delivery capacity to make the supply curve more elastic, but as I show in the 2001 paper, as long as the supply curve is upward sloping, or the demand curve is downward sloping a trader with a big enough derivatives position and a big enough pocketbook has the incentive and ability to manipulate the price.

Once upon a time, in the 90s in particular, the Brent market was periodically squeezed. Platts (and the industry) responded by broadening the Brent basket to include Forties, Oseberg, and Ekofisk. For a while that seemed to have made squeezes harder. But the continued decline of North Sea production has made the market vulnerable again. Indeed, all the signs suggest that the June Brent contract that went off the board last week was squeezed: it went into a steep backwardation during the last few days of trading, and the market returned to contango as soon as that contract expired.

The fact is that market power problems are endemic in commodity markets. The combination of relatively small and constrained physical markets and big paper markets create the opportunity and the incentive to exercise market power. It looks like that happened in Brent, and looks like it is a chronic problem in Singapore FO, reputed to be one of the dirtiest markets in the world.

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6 Comments »

  1. Their last go at this ended in tears… http://www.reuters.com/article/glencore-outlook-trading-idUSL5N11Z3YY20150930

    Comment by Mlgb — May 11, 2016 @ 8:03 am

  2. Assume you know the strategy and name of the company behind the recent unusual movement in the Brent market that you mention but are just too coy to say without proof. If not, ask offline.

    Comment by DMurrage — May 11, 2016 @ 10:57 am

  3. Do these price excursions from manipulation create significant losses in economic welfare, i.e. basing real decisions on the manipulated price signal?

    Comment by srp — May 11, 2016 @ 4:19 pm

  4. @srp-There are two main sources of deadweight loss. First, there is a distortion in consumption/production. Too much physical supply is attracted to the manipulated market. This could be from diversion of supplies from other markets (thereby resulting in excessive transport costs and perhaps a distortion in the spatial pattern of consumption) or excessive production, or both. Second, manipulation leads to excessive fluctuation in the basis, which reduces the effectiveness of derivatives contracts as a hedge. Furthermore, this reduction in hedging effectiveness may lead to less hedging, with the resultant inefficient allocation of risk.

    The ProfessorComment by The Professor — May 11, 2016 @ 5:44 pm

  5. Both of the “two main sources of deadweight loss” apply to all kind of speculation (not only market manipulation), don’t they?

    Comment by Cable — May 12, 2016 @ 2:30 pm

  6. @Cable-Definitely not. Most speculation is beneficial. Speculators take on risk from those who are more averse to it. Without speculation, there’s no hedging, or at least hedging is greatly reduced. Speculators can help improve the informational efficiency of prices, although this benefit is more equivocal. Some informed trading is rent seeking: incurring a cost (the cost of becoming informed) to extract a transfer from someone with less information. Against that is the possibility that more informative prices improve consumption, production, and investment decisions. That benefit is almost impossible to quantify.

    The ProfessorComment by The Professor — May 12, 2016 @ 5:12 pm

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