Trading firm sued by government regulators over oil price manipulation

May 27, 2011

Gas ProblemsEarlier this month, President Obama responded to increasing public outcry over high gas prices by vowing to crackdown on any oil speculators that are fraudulently manipulating prices for their own benefit.

Earlier this week, the U.S. Commodity Futures Trading Commission, the government agency that regulates futures and option markets, looked to be following through.

On Tuesday, the CFTC filed suit against Parnon Energy and subsidiary Arcadia Petroleum, along with two of its employees.

The complaint claims that the defendants retained millions of barrels of oil beyond monthly commodities trading deadlines to create the impression in the market that those supplies were to be used, not traded, thereby fooling the market into believing there was a substantial shortage.

In reality, Parnon only buys and sells oil supplies for profit.  It does not produce or consume it commercially.

After it declined to sell off its oil stocks before the monthly trade deadline, prices increased because of the widespread belief that supply was very short.  The move also cost the firm $15 million.

To those of you that are still following this, congratulations.  However, it’s going to get more complicated, so hopefully you can still keep up.

So although Parnon lost $15 million from not selling before the trade deadline, it gained $50 million from short selling calendar spreads.

“Short selling” here is the practice of selling a commodity only to buy it back a specified time period later.  To profit from this practice, the seller hopes that the price of the asset will decrease between the time of the sale and the later repurchase.

“Calendar spreads” refer to the time period of the short sale.  Here, it’s a monthly spread, so short sale is contracted as such that the sale occurs at the price one month, and repurchase occurs the next month.

By retaining their stocks of oil, Parnon created the illusion of a low supply, causing prices to increase.

The firm then sold off its oil stocks, switching the market perception from a low supply to a surplus, causing a substantial drop in prices.

Because of market manipulation, Parnon netted $35 million dollars from the transactions.

It’s actually far more complicated than that, but I don’t have the space or patience to explain it more fully, and for this discussion, it’s beside the point.

While these suits are not entirely uncommon, the fact that Parnon actually intends to litigate the case is (they’re usually settled almost immediately).

The firm claims that the CFTC doesn’t have a case, despite the many incriminating emails referenced in the complaint and the implicating circumstantial evidence.

This may just be chest-beating by Parnon, but it may also suggest that the CFTC has traditionally had stronger evidence in past suits.

If it’s the latter, the CFTC is feeling more emboldened, not only due to Obama’s vows of crackdowns, but also because of the broad new powers the CFTC was granted by last year’s Dodd-Frank financial reform act.

If so, which recent statements from CFTC officials suggest, we can expect to see a much more active CFTC from now on.

Let’s hope, though, that all these efforts have some downward impact on consumer gas prices.

UPDATE: A derivatives trader has just filed suit against the firms, claiming he was harmed by their activities.