Billionaire boys’ club for oil

The Asylum book cover

The Asylum: The Renegades who Hijacked the World's Oil Market by Leah McGrath Goodman, 398pp, hardcover $27.99.

The trading floor with coke, hookers and fistfights is gone, but speculation has only gotten worse in the era of peak oil.

Before screen trading took over a few years ago, the world’s oil price was set in the pits of the New York Mercantile Exchange.

Editor’s rating: three stars

NYMEX began as a refuge for scrappy ethnic guys from the Bronx and Staten Island who were not welcome in the WASPy club of Wall Street. The commodities exchange offered these renegades a chance to get rich trading futures in potatoes from Maine and Idaho. (Potatoes? Apparently there was gold in them thar spuds.)

Then, the pit bosses hit on the idea of trading futures in crude oil, as Leah McGrath Goodman explains in The Asylum: The Renegades who Hijacked the World’s Oil Market.

This financial innovation enabled NYMEX’s crew of City College grads and high school dropouts to make enough  money to arouse the envy of their Ivy League rivals. And it helped a commodities market led by an Orthodox Jew to thumb its nose at the world’s most powerful oil sheiks. Not to mention Big Oil.

Goodman tells the story of the many colorful personalities who grew NYMEX in gossipy detail that any reader but the most ardent financial-market geek will want to skip. A Cliff Notes version focusing on the effect of trading on the world market for crude would’ve been more useful.

Because that’s the real story.

Over-the-counter and over the top

In the end, screen trading closed the NYMEX pits in 2008. But starting years earlier, with the advent of the so-called over-the-counter (OTC) market, NYMEX handled only a small percentage of all trades in crude.

While NYMEX traders got away with stunning monkeyshines — from nearly every form of insider trading ever known to making markets on Quaaludes and New Jersey cheese steaks — at least on paper, their exchange was subject to regulation, which did lead to the occasional slap on the wrist from the Commodity Futures Trading Commission.

By contrast, the OTC was by law exempt from federal oversight, creating a gray market where anonymous traders could place bets on a disappearing commodity with almost no money down and artificially manipulate prices to their own advantage, the public be damned.

This is basically the oil market we have today and after crude hit $147 a barrel in 2008, Washington had a mandate to get speculators under control. But after two years of trying, “Congress still didn’t know what to do about it,” writes Goodman.

Rather than close the loopholes and apply practical solutions, the lawmakers were advancing wild proposals to kick speculators out of the market or limit trading activities in ways that didn’t take seriously the realities of Wall Street. If one thing could be known about the oil traders, it was that they would never stop trading. Blocking them from the market would only lead to the creation of new markets elsewhere — likely farther away and even harder to control.

So, even if the Fed or the Senate and House finance committees had taken serious steps to control fraud in markets under some form of US control — which they didn’t — speculators would just find another offshore, online way to trade that would cut Washington out.

And that’s essentially how the rise of screen trading seems to spell the end of financial regulation, unless it’s done on an international level.

But in nearly all stories about crude these days, the problem is not really too many speculators. It’s not enough oil supply.

Speculation just noise on the signal of peak oil

When supply gets tight, prices become  more volatile, which opens a window to speculators, who don’t care if oil is high or low, but just that it keeps going up and down. Because they profit from the spread, speculators hate stable prices. So, not only will they trade long, trade short and trade every which way but loose to profit from volatility; if they have enough money to spend, speculators will also create artificial market volatility to benefit themselves.

There really is only one solution, according to former NYMEX vice president John D’Agostino, sounding more like a peak oiler than a commodities trader. He told Goodman that “oil traders are interchangeable,”

They don’t have any real power; they’re just riding the wave of America’s oil addiction. Other people will come in to replace them. And that goes for the rest of the colossus surrounding the oil market, from the politicians to the regulators on down. It won’t stop unless we stop using so much oil.

What a good point to remember. Most people will do what everyone else does, especially if the cash is flowing, the cars are fly and the nightlife is hot. Only a few will have enough sense that something’s not right and then conclude that they can no longer cooperate with a system whose future seems poor and whose effect on society is harmful.

Ethical action in a world of precious oil

The mental place where a small minority feels compelled to do something differently is where we can find anything like an ethics of oil.

Barring an apocalyptic collapse of society, there’s certainly plenty of money to be made in the coming years off the buying and selling of an increasingly scarce commodity that’s vital to the global economy.

Which side will you be on. Will you try to profit from the peak? Or will you be someone who helps the world go beyond oil?

— Erik Curren

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  1. Auntiegrav says

    Thanks again, Eric. I just finished “British Petroleum and the Redline Agreement” by Edwin Black. If the NYMEX isn’t confusing enough, then the state of Middle East oil agreements should finish off any unicorns still keeping the magic in your brain going.
    These stories about corruption, rich vs poor, overconsumption, etc…all come down to basic understanding of how systems work and are moderated. “Limits to Growth” covers a lot of the mechanisms, but we need to remember that the key to Supply/Demand is that both the supply and the demand sides require PEOPLE to demand or supply the commodities. It is easy to blame the rich for being rich, or the crooks for taking advantage of the system, but the pivot point is at the cash register. The rich get richer because the poor buy their stuff. If we want to modulate the flow of money to the rich, or the pollution of the forests and air, or the behavior of criminals in the money-based decision process, then the place to do that is at the cash register, where people make their decisions on what they are going to buy ‘right now’. That means sales taxes to pay for ALL of the overhead costs of government and civilization and ‘free’ trade support (military, CIA, police). The feedback needs to be immediate and effective in order to work. Education or coercion which isn’t immediately apparent at the purchase point will not work. Threats of prison for criminals, or hidden income taxes, or painting a bicycle green do not matter to the human looking at the discounted price of goods from China or factory petrofarms. The price of the oil wars won’t be paid until the debt comes due, but people are still buying gas every day and increasing the demand for more wars ‘sometime in the future’, which they are hoping they won’t see.

    • says

      Auntiegrav — You’re right that it’s confusing! I think Goodman tried to humanize it with all the discussion of various colorful personalities on the trading floor, but in the end, we’re talking about complex financial transactions done lightning fast without much transparency. There’s probably not much that government or anyone else can do to change the way that oil markets work. So I think your route is the only way we can make a difference, which is for consumers to reduce our demand for oil. I’ve always liked James Hansen’s proposal for a carbon fee and dividend (basically, a carbon consumption tax). It would also be more than fair to internalize costs of oil starting with the budget for the US military’s Central Command and going down from there. Bottom line, though politicians will usually say the opposite, the price of dirty energy needs to go UP, not DOWN.

    • says

      Scott, That’s a very good question. In the long run, I think the world will see an end to economic growth and the start of a steady-state or even a shrinking economy. In the short run, some people do seem to think they can make a quick buck off of oil price volatility, especially traders in the OTC market. I certainly wouldn’t have the stomach for that kind of investing, but it seems to give an adrenalin-rush to the kind of commodities trader found in Goodman’s book.

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