Secrets of Bank Involvement in Oil Revealed

The World’s GambleLet’s look at the energy market to gain a better perspective.The energy sector represents around 17-18 percent of the high yield bond market valued at around $2 trillion.

Over the last few years, energy producers have raised more than a whopping half a trillion dollars in new bonds and loans with next to zero borrowing costs – courtesy of the Fed.

This low-borrowing cost environment, along with deregulation, has been the goose that laid the golden egg for every single energy producer. Because of this easy money, however, energy producers have become more leveraged than ever; leveraging themselves at much higher oil prices.

But with oil suddenly dropping so sharply, many of these energy producers are now at serious risk of going under.

In a recent report by Goldman Sachs, nearly $1 trillion of investments in future oil projects are at risk:

Via Bloomberg:

“In a stunning analysis this week, Goldman Sachs found almost $1 trillion in investments in future oil projects at risk. They looked at 400 of the world’s largest new oil and gas fields — excluding U.S. shale — and found projects representing $930 billion of future investment that are no longer profitable with Brent crude at $70. In the U.S., the shale-oil party isn’t over yet, but zombies are beginning to crash it.”

It’s no wonder the costs of borrowing for energy producers have skyrocketed over the last six months.

According to the Bank of America Merrill Lynch, yields on junk-rated energy bonds has nearly doubled since June, from 5.7 percent to a more-than-five-year high of 9.5 percent last week.

That’s because many of the companies are already on the brink of default, and unable to make even the interest payments on their loans.

For example, Connacher Oil and Gas has around $1 billion in debt and has recently hired BMO as an advisor to review its “liquidity and capital structure.”

Southern Pacific just hired RBC to help raise money and advise on quarterly interest payments it can’t make on C$432 million of bonds.

If oil continues in this low price environment, many producers will have a hard time meeting their debt obligations – meaning many of them could default on their loans. This alone will cause a wave of financial and corporate destruction. Not to mention the loss of hundreds of thousands of jobs across North America.

But that’s not even the biggest problem.

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A Zero Sums Game

It would be absurd to think that as oil prices fall, oil production will just stop.

The big players in the oil industry have experienced oil’s boom and bust, many times over. The biggest of them – such as Exxon Mobil and Chevron – survive through the downturns because they are involved in all aspects of energy production such as drilling, refining, and other downstream operations. These guys are hedged because as oil prices fall, other aspects of their business improve.

Other big players in the industry hedge their oil production against falling prices.

For example, Calgary-based EnCana Corp. has already hedged more than 30,000 barrels a day of expected oil production between July and December of this year at an average WTI price of US$97.34 a barrel.

Cenovus Energy Inc. has hedged more than 14,000 barrels a day of expected 2015 production at an average Brent price of CAD$113.64.

Many companies may be able to escape this downturn in oil prices with cash flows largely intact because they have locked in future sales at much higher prices.

Locked and Loaded

Oil companies often hedge themselves against the volatility of oil prices by taking up a position in the oil futures market, selling short enough oil futures contracts in the futures market to cover the quantity of oil to be produced.

A futures contract gives the buyer of the contract the right and obligation to buy oil at the price at which he buys the futures contract.

Conversely, the contract gives the seller of the contract the right and obligation to sell the underlying commodity at the price at which he sells the futures contract.

But if oil companies are the sellers, who are the buyers?

Too Big to Fail

There’s really only one group of investors that can soak up the amount of global oil futures contracts: the Big Banks.

Since many oil producers having locked in prices as high as $90-$100 per barrel for 2015, the losers of oil’s drop will be those on the other end of the contract – the banks who have to buy oil for $100 when oil is at $55.

Combine these losses – where the bets are often leveraged – with the potential defaults of the energy sector’s junk debt, and we could witness a domino effect in the overall high-yield, highly-leveraged, debt market as a whole.

But will that be allowed to happen?

First of all, consider that oil futures sold in the paper market are really never settled with physical delivery.

Now consider the following…

Secrets of Big Bank Involvement in Oil 

Over the past weeks, I have talked about why the price of oil may have been manipulated down in the short term as a result of geopolitical strategies.

I have also debunked much of the media myths about why oil prices are falling; from a supply glut, to an attack on fracking by the Saudis.

In short, the demand for oil has never been greater; thus, the talks of too much supply do not warrant a 40% drop in oil price. (And by demand, I mean actual world consumption, not some paid analyst generated percentage.)

Secondly, if the Saudis were attacking the American shale economy, why would the U.S. continue to sell arms to them?

For example, why would the US Defense Security Cooperation Agency (DSCA) clear yet another major potential sale to Saudi Arabia in August?

If a nation was attacking your economy, would you sell weapons to it?

What has been happening to oil is orchestration at its finest.

Think about it in this simple way:

If you are in control of the world’s reserve currency, but slowly losing that status as a result of devaluation and competition from other nations (see When Nations Unite Against the West: The BRICS Development Bank), what would you do to protect yourself?

You buy assets. Because real hard assets protect you from monetary inflation.

With the banks now holding record amounts of highly leveraged paper from the Fed, why would they not use that paper to buy hard assets?

Bankers may be greedy, but they’re not stupid.

The price of hard physical assets is the true representation of inflation. Therefore, if you control these hard assets in large quantities, you could also control their price. This, in turn, means you can maintain control of your currency against monetary inflation.

And that is exactly what the banks have done.

The True World Power

Last month, the U.S. Senate’s Permanent Subcommittee on Investigations published a 403-page report on how Wall Street’s biggest banks, such as Goldman Sachs, Morgan Stanley, and JP Morgan, have gained ownership of a massive amount of commodities, food, and energy resources.

The report stated that, “the current level of bank involvement with critical raw materials, power generation, and the food supply appears to be unprecedented in U.S. history”

For example:

“…Until recently, Morgan Stanley controlled over 55 million barrels of oil storage capacity, 100 oil tankers, and 6,000 miles of pipeline. JPMorgan built a copper inventory that peaked at $2.7 billion, and, at one point, included at least 213,000 metric tons of copper, comprising nearly 60% of the available physical copper on the world’s premier copper trading exchange, the LME.

In 2012, Goldman owned 1.5 million metric tons of aluminum worth $3 billion, about 25% of the entire U.S. annual consumption. Goldman also owned warehouses which, in 2014, controlled 85% of the LME aluminum storage business in the United States.” – Wall Street Bank Involvement with Physical Commodities, United States Senate Permanent Subcommittee on Investigations

From pipelines to power plants, from agriculture to jet fuel, these too-big-to-fail banks have amassed – and may have manipulated the prices – of some of the world’s most important resources.

The above examples clearly show just how much influence the Big Banks have over our commodities through a “wide range of risky physical commodity activities which included, at times, producing, transporting, storing, processing, supplying, or trading energy, industrial metals, or agricultural commodities.”

With practically an unlimited supply of cheap capital from the Federal Reserve, the Big Banks have turned into much more than lenders and facilitators. They have become direct commerce competitors with an unfair monetary advantage: free money from the Fed.

Of course, that’s not their only advantage.

According to the report, the Big Banks are engaging in risky activities (such as ownership in power plants and coal mining), mixing banking and commerce, affecting prices, and gaining significant trading advantages.

Just think about how easily it would be for JP Morgan to manipulate the price of copper, when they – at one point – controlled 60% of the available physical copper on the world’s premier copper trading exchange, the LME.

How easy would it be for Goldman to control the price of aluminum when they owned warehouses – at one point – that controlled 85% of the LME aluminum storage business in the United States?

And if they could so easily control such vast quantities of hard assets,

how easy would it be for them to profit from going either short or long on these commodities?

Always a Winner

But even still, if for some reason the bankers’ bets didn’t work out, they still wouldn’t lose.

That’s because these banks are holders of trillions of dollars in FDIC insured deposits.

In other words, if any of the banks’ pipelines rupture, power plants explode, oil tankers spill, or coal mines collapse, taxpayers may once again be on the hook for yet another too-big-to-fail bailout.

If you think that there’s no way that the government or the Fed would allow this to happen again after 2008, think again.

Via the Guardian:

“In a small provision in the budget bill, Congress agreed to allow banks to house their trading of swaps and derivatives alongside customer deposits, which are insured by the federal government against losses.

The budget move repeals a portion of the Dodd-Frank financial reform act and, some say, lays the groundwork for future bailouts of banks who make irresponsibly risky trades.”

Recall from my past letters where I said that the Fed wants to engulf you in their dollars. If yet another bailout is required, then the Fed would once again be the lender of last resort, and Americans will pile on the debt it owes to the Fed.

It’s no wonder that in the report, it actually notes that the Fed was the facilitator of this sprawl by the banks:

“Without the complementary orders and letters issued by the Federal Reserve, many of those physical commodity activities would not otherwise have been permissible ‘financial’ activities under federal banking law. By issuing those complementary orders, the Federal Reserve directly facilitated the expansion of financial holding companies into new physical commodity activities.”

I’ll go over the specific details of the report in a later letter, but the conclusion is simple: Banks are not only manipulating prices through paper trades, but they are directly maintaining control via the actual underlying physical commodity.

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Fighting Back

The manipulation of commodity prices by the big U.S. banks is not news to one of the biggest buyers of commodities in the world: China.

China has already launched an international gold exchange this past September to become a bigger player in market pricing.

Its actions make complete sense because the price of gold, or any other commodity, should be directly influenced by where it is consumed the most; in gold’s case, that’s China.

With the recent manipulation of oil prices, China has also now approved the launch of the Shanghai oil futures exchange. This will mark the first internationalized futures contract in Chinese history.

China is the second largest oil consumer in the world, so it makes sense that oil will be traded in this nation.

However, in order for this exchange to take off, China will have to finally liberalize its oil sector – a feat which has been expected, but yet to be fulfilled, for quite some time.

But given China’s ambition to make its currency fully convertible, I would expect that China’s oil market will soon be liberalized in order to invite trust amongst foreigners. A new Petrodollar, so to speak.

For traders to trust China’s oil futures platform, China will have to back it with physical inventories. And that, of course, means China will have to buy a lot more oil.

What to Expect for Oil in 2015

As I predicted in my last letter, “The Covert Connection Between Saudi Arabia and Japan,” the manipulation of oil’s drop was meant partly  to spur a rise in retail sales just in time for the holiday spending season, and just in time to boost markets before the end of the year.

Retail sales in Britain have now reached a growth not seen in over 25 years.In the U.S., it will be the first time in ten years that the Saturday before Christmas takes the top spot for the highest single sales day of the year. Meanwhile, sales estimates continue to top analyst expectations and the market continues to climb.

That means oil’s drop has done what it was meant to do: hurt Russia, help Japan, boost consumer spending, and send the stock market to new highs.

What does this mean for oil?

Because so many things were leveraged based on oil prices, we’re now at a point that the price of oil can only go up. Otherwise, we would risk a major financial collapse as a result of the debt leverage associated with the commodity.

The scope of the destruction if oil were to continue falling for an extended period of time is yet to be determined. There is more than $4 trillion worth of energy commodity derivatives exposure from some of the largest U.S. banks.

When you consider that many of the energy producers have hedged themselves against oil’s fall, it would be a reasonable assumption that many of the Big Banks’ derivatives exposure consists of bets in the wrong direction.

Will the banks be allowed to fail? Or have the banks quietly protected themselves, knowing that oil will go back up?

A few weeks ago, I suggested that the price of oil is a function of manipulation, and not as much about supply and demand; the question now becomes when the manipulators will boost oil prices back up?

The shale boom over the last few years have led to oil companies in both America and Europe to take on record levels of debt. Much of this debt was financed above a Brent crude price of $70 per barrel (which I believe will be the average price for 2015).

Can Europe handle a financial contagion as a result of falling oil prices, when it already has so many other problems?

The drop in oil prices has already caused a financial disaster for Norway and Russia. If oil’s drop continues, it will do the same for America and Europe.

Debt defaults for oil companies in America have already begun and credit has frozen up. If oil doesn’t bounce back next year, be prepared for a financial disaster contagion. Will the powers that be allow that to happen?

I don’t think so. The question is, at what price does oil still hurt Russia, but prevent a wave of defaults in North America?

I believe it’s between US$70-80 a barrel.

What do you think?