HardAssetsInvestor

Written by Dave Nadig  |

June 17, 2011

CFTC Vs. Arcadia: Not So Simple

Details

The CFTC case against oil speculators isn't a slam dunk, and isn't as simple as the media would have you believe.

Fundamentally, investments in commodities futures are bets on the future of the commodity's price. Every once in a while, somebody gets the bright idea to make it less of a guess—to try and push a commodity's price around while making corresponding investments in futures. Often—as in the case of the notorious "Mr. Copper"; the Hunt brothers' attempt to corner silver; and Malaysia's move to corner tin—the attempt ends in large losses. Even when it looks like someone has beaten the system, they then have to also escape government investigations and intervention.

On May 24, 2011, the U.S. Commodity Futures Trading Commission filed a complaint in the U.S. District Court for the Southern District of New York. In the complaint, the CFTC alleges that Parnon Energy, Arcadia Petroleum, Arcadia Energy (Suisse) SA and employees Nicholas Wildgoose and James Dyer participated in a scheme to manipulate the market for light sweet crude oil from late 2007 through April 2008. Parnon Energy and Arcadia Petroleum are both subsidiaries of Farahead Holdings Ltd., a closely held company incorporated in Cyprus and owners of the world's largest oil-tanker lines.

Light sweet crude futures (also known as "West Texas Intermediate," NYMEX and ICE: WTI) expire three business days before the 25th of the month before the delivery date. Like most commodities, few investors actually end up having to deal with the actual black stuff, having exited their position before expiry. If you still hold a WTI contract after it expires, then you are obligated to purchase the oil at the price of the future. The next three business days are for agreeing on a delivery date within the next month, and for physical suppliers and short holders to get their barrels in a row. At that point, if you need crude in the U.S., you'll likely have to buy it on the physical market in Cushing, Okla., where a number of important pipelines cross. That window of time is called “the cash window.”

The market for crude was tight in 2008, volatility was skyrocketing and all eyes were on Cushing:

If these allegations are true, Wildgoose and Dyer took advantage of uncertainties in the market by making the supply of crude seem even tighter than it was, and then shorting crude just before releasing that crude supply, alleviating fears. The pair bought up and hoarded two-thirds of the expected physical supply of sweet light crude in Cushing before dumping it at the end of the cash window. They made a tense market worry, and then made the market relax, and invested to take advantage on both ends.

The CFTC's complaint alleges that Wildgoose and Dyer, on behalf of Arcadia and Parnon, went through this cycle twice (in January and March; credit issues stopped them in February) before learning in April that their actions were under investigation by the CFTC. Though their physical positions lost over $15 million over the course of the scheme, the derivative positions brought in over $50 million, for a tidy net of roughly $35 million.