“Leon Hess, whose oil company made more than $200 million by trading oil futures during the Persian Gulf crisis . . . said he longs for the days when oil company barons could get together and decide prices and supply levels largely among themselves, rather than depending on the violent price swings created by traders who react to rumors and headlines.
“‘I’m an old man, but I’d bet my life that if the Merc [New York Mercantile Exchange] was not in operation there would be ample oil and reasonable prices all over the world, without this volatility,’ Hess said at a hearing the Senate Committee on Governmental Affairs held on the role of futures markets in oil pricing.”
-- “Oil Baron Longs for Past, Not Futures,” Newsday, November 2, 1990
Now bare in mind, he was railing against the instability and volatility on the traditional exchanges. I can't imagine what he'd say about OTC markets.
Few times have I had to do this much research to discover simple truths about a subject. And, all modesty aside, if I (and by extension the 2 of you) find this challenging work, what chance does the average person whose passions do not lie in discovering such things have?
Each night recently, work or no, I've been watching a series entitled "Monarch", via Netflix. It is 2 parts, approximately 6 1 hour episodes per part, starting at about 450 AD with the Anglo settling of Britannia. I'm up to Henry VIII, he just married Catherine of Aragon. And I'll tell you what, I'd sooner be tasked with reciting from memory the precise line of succession, with all the Edwards, Richards and Henry's, then to pursue this further. But I will anyway, because it's important.
Titus, the question you stumbled upon (or rather I stumbled upon) is more profound then I could have possible imagined. You asked if crude oil could be purchased in currency other then the USD on these OTC exchanges. In researching this, it all came together for me.
First, let me back up. My source for much, not all, but much of this post was an exhaustive study done by Houston, Texas Bauer College of Business, or "UH." It is a fantastic source, itself source cited out the wazoo,and section III, which you can find HERE, is a 49 page dossier on the crude futures market, including extensive discussion on OTCs. The only problem is it's from 2003. However, the they did their best to address the issue in layman's terms, and it is bearable (for the most part to read). Knowing that it is dated means you need only know that every number presented has since exploded. I got through the first 27 pages before I had to stop, for a little thing called life, and get this post up before my day's "to-do's" went undone.
Now, understand first that OTC's existed prior to Clinton's 2000 Act. They were limited though because ti was a grey area of oversight. Participants didn't know if CEA, the SEC, etc rules covered these innovative transactions. As technology increased - primarily the web - these these OTC's grew in number. Enter the 2000 Act meant to clarify the oversight - and boy did it. Between the electronic technology to instantly connect parties and the Act which unleashed these parties like Tom Cruise racing to stake his land in far and Away, these things exploded.
These transactions between private parties that formally took place on organized exchanges, became so popular that what I call "semi-organized" exchanges emerged to service them. They're like a dating website. See, the traditional exchanges (say, the Chicago Mercantile Exchange) involve set fees, regulation, disclosure etc. They're intrusive (in comparison) and more expensive then conducting OTC's. But how to meet these other parties whom wish to avoid the traditional costs and sunlight? Well, enter ICE. No, not the immigration task force, but the but the International Exchange. From the UH study:
"...in 2000, several investment banks and oil companies formed the Intercontinental Exchange (“ICE”) to trade in OTC energy and metals derivatives. Located in Atlanta, Georgia, the ICE is an electronic exchange open only to large commercial traders. Rather than provide a counterparty to all trades, as do the NYMEX and IPE clearinghouses, ICE acts only as a posting facility for bids and offers, which the traders can then choose to accept or reject. Any large commercial company can trade on ICE’s facility without having to employ a broker or pay a fee to a member of the Exchange. All trades are bilateral deals between the buyers and sellers. There is no clearinghouse and, accordingly, no requirement to post margins. The ICE website advertises: “There are no memberships. No artificial restrictions. No dues or fees beyond those incurred in the trading itself.”
And there's another clearinghouse based in Dubai. And think about it, why do business on the traditional Mercs when you can do business much cheaper and more efficiently on these "semi-organized" exchanges?
Now enter your question Titus. Can you purchase oil contracts with funds other then the USD. I looked at this for hours this morning. And I have to conclude "yes." I could not find a direct standard on these ICE style exchanges, but I soon realized that was because their are none. AS the report makes clear, they just advertise the offer, you do the rest. They could be paying for them in pixie sticks for all anyone knows, let alone the Sterling. What we can know is that at some point the crude was bought with USD. It had to be. That's the deal we cut with OPEC, they only sell crude to those buying in US dollars. Enter the brewing perfect storm, and what I meant about this all coming together for me.
As Titus noted, oil sales throughout the world are denominated in US dollars. Since 1973 OPEC exports have been priced in US dollars. This marketplace gave rise to trillions of petrodollars that get cycled into international oil trade via US dollars. Since most countries rely on oil imports, they are forced to maintain large stockpiles of US dollars in order to continue imports. This creates a consistent demand for US dollars and positive pressure on the US dollar’s value, regardless of economic conditions in the US. This in turn allows the US government to issue currency below cost of currency production and bonds at lower interest rates than they otherwise would be able to. As a result the U.S. government can run higher budget deficits at a more sustainable level than can most other countries.
So think about that scenario. Here we come off the Gold Standard in 1971. Then turn right around in 1973 and cut a deal with OPEC to sell their product exclusively in ISD. So in fact we exchanged what backed our currency from one tangible asset to another. We went from a gold standard to an oil standard (ironic given the company name of America's first oil monopoly). The USD is in effect, a "petro-currency."
This is why we have been the world's standard currency, the reserve currency. Oil makes every country's, 1st, 2nd or 3rd world, economy go round. And you can't get oil without US Dollars. And just as an aside, I don't know about you, but do you think swapping gold as the asset which backs our dollar, for oil, was a "good" move? We went from gold to a deal cut with an orginization whose code of moral conduct would raise eyebrows in the Court of Caligula. And I'm supposed to feel secure with that swap?
Enter what happened 12 days ago.
On April 18, 2011, the Chicago Mercantile Exchange launched six Euro-denominated oil contracts. Pricing, margining and treasury for exchange-cleared oil price management can be fully executed in Euros. These contracts should make certain trading functions more streamlined for oil exporters to and from oil consumers in the Euro-zone, with no need to buy US dollars to effect oil trades.
Why? Why would they do this? To be more competitive with OTC markets like ICE? That's part of it, in my opinion. But it doesn't fully explain this move because even those ICE markets, those OTC driven markets, still originate with a crude purchase in USD. You can't get the oil from OPEC without a Ben Franklin, period. There can only be one explanation - they're testing the waters. See, this petro-currency of ours has allowed us to remain the dominant world currency reserve in the post gold standard era. But we have so abused the privilege, by running up deficits unprecedented in human history, that foreign markets are testing whether it's a better deal for them to move to something else. If the denomination of oil sales changes to another currency, such as the Euro or the Yen for example, countries would sell dollars and cause the banks to shift their reserves, because they would no longer need US dollars to buy oil. Forty years of petro-dollars would start to get flushed from central bank reserves. This shift in petro-currency reserve status would lower the US dollar, exponentially, near collapse.
In other words, this oil backed scenario of USD allowed us one hell of a long leash. We could screw up, even screw up bad, and the world would help to maintain the value of the dollar because they needed it to maintain their economy - to buy oil. But we have so depreciated our dollar with wreckless spending, so exacerbated the length of that leash, that we are driving up the cost of oil FOR THEM. As our Fed prints more money, the cost of oil goes up because there are now more petro-dollars get it? We're casuing world-wide energy inflation. The cost of lubricating the economies around the world goes up. And those economies are getting pissed. And think about it from OPEC's perspective. Do they want to continue to be paid exclusively in a currency that is committing suicide via spending and printing? And what are they to do if China and India et al band together and say, "we want to business in Euros"? If you're OPEC what do you do? At current the US is still the largest consumer of energy, but as China rises it is feasible they or India may eclipse us as the world's leading energy eater. Once that happens OPEC may seriously consider any suggestion of their's to alternate out of the USD. How could they not if we are replaced as OPEC's top client?
Forget everything else - if we have $14 trillion out in debt, and are furiously printing money to spend (like the current administration), and amist that OPEC switches to a different petro-dollar, causing this forty year flush from foreign central reserves (causing the market to be flooded with USD in addition to the printed money, and debt owed), brother - that's game over. We are the Wiemar Republic at that point. It's pick up your pay check in a wheel barrel time.
Now, this threat to move from the USD as the reserve petro-currency gets tossed around by people whom want to rattle the US cage, routinely. Russia chatted it up in 03', Iran has, Venezuela has. All of it went nowhere. But when the Chicago Mercantile Exchange talks about it (hell, actually does it on a limited basis) we better sure as hell pay attention, and do something. Especially when every other piece of the perfect storm I just described, is already in place.
But what is that something?
The world's need for oil is not going anywhere. And in lieu of a return to the gold standard, which has almost zero chance of occurring, ever, we must defend our status as the world's petro-currency.
1.) We have to get control of our national debt. Whether it's challenging our dominance as the world's petro-currency, or any other aspect of the US based world economy, China, Russia and India are playing for keeps. And OPEC will side with whomever emerges. We can not emerge with $14 Trillion in debt on our back, period.
“‘I’m an old man, but I’d bet my life that if the Merc [New York Mercantile Exchange] was not in operation there would be ample oil and reasonable prices all over the world, without this volatility,’ Hess said at a hearing the Senate Committee on Governmental Affairs held on the role of futures markets in oil pricing.”
-- “Oil Baron Longs for Past, Not Futures,” Newsday, November 2, 1990
Now bare in mind, he was railing against the instability and volatility on the traditional exchanges. I can't imagine what he'd say about OTC markets.
Few times have I had to do this much research to discover simple truths about a subject. And, all modesty aside, if I (and by extension the 2 of you) find this challenging work, what chance does the average person whose passions do not lie in discovering such things have?
Each night recently, work or no, I've been watching a series entitled "Monarch", via Netflix. It is 2 parts, approximately 6 1 hour episodes per part, starting at about 450 AD with the Anglo settling of Britannia. I'm up to Henry VIII, he just married Catherine of Aragon. And I'll tell you what, I'd sooner be tasked with reciting from memory the precise line of succession, with all the Edwards, Richards and Henry's, then to pursue this further. But I will anyway, because it's important.
Titus, the question you stumbled upon (or rather I stumbled upon) is more profound then I could have possible imagined. You asked if crude oil could be purchased in currency other then the USD on these OTC exchanges. In researching this, it all came together for me.
First, let me back up. My source for much, not all, but much of this post was an exhaustive study done by Houston, Texas Bauer College of Business, or "UH." It is a fantastic source, itself source cited out the wazoo,and section III, which you can find HERE, is a 49 page dossier on the crude futures market, including extensive discussion on OTCs. The only problem is it's from 2003. However, the they did their best to address the issue in layman's terms, and it is bearable (for the most part to read). Knowing that it is dated means you need only know that every number presented has since exploded. I got through the first 27 pages before I had to stop, for a little thing called life, and get this post up before my day's "to-do's" went undone.
Now, understand first that OTC's existed prior to Clinton's 2000 Act. They were limited though because ti was a grey area of oversight. Participants didn't know if CEA, the SEC, etc rules covered these innovative transactions. As technology increased - primarily the web - these these OTC's grew in number. Enter the 2000 Act meant to clarify the oversight - and boy did it. Between the electronic technology to instantly connect parties and the Act which unleashed these parties like Tom Cruise racing to stake his land in far and Away, these things exploded.
These transactions between private parties that formally took place on organized exchanges, became so popular that what I call "semi-organized" exchanges emerged to service them. They're like a dating website. See, the traditional exchanges (say, the Chicago Mercantile Exchange) involve set fees, regulation, disclosure etc. They're intrusive (in comparison) and more expensive then conducting OTC's. But how to meet these other parties whom wish to avoid the traditional costs and sunlight? Well, enter ICE. No, not the immigration task force, but the but the International Exchange. From the UH study:
"...in 2000, several investment banks and oil companies formed the Intercontinental Exchange (“ICE”) to trade in OTC energy and metals derivatives. Located in Atlanta, Georgia, the ICE is an electronic exchange open only to large commercial traders. Rather than provide a counterparty to all trades, as do the NYMEX and IPE clearinghouses, ICE acts only as a posting facility for bids and offers, which the traders can then choose to accept or reject. Any large commercial company can trade on ICE’s facility without having to employ a broker or pay a fee to a member of the Exchange. All trades are bilateral deals between the buyers and sellers. There is no clearinghouse and, accordingly, no requirement to post margins. The ICE website advertises: “There are no memberships. No artificial restrictions. No dues or fees beyond those incurred in the trading itself.”
And there's another clearinghouse based in Dubai. And think about it, why do business on the traditional Mercs when you can do business much cheaper and more efficiently on these "semi-organized" exchanges?
Now enter your question Titus. Can you purchase oil contracts with funds other then the USD. I looked at this for hours this morning. And I have to conclude "yes." I could not find a direct standard on these ICE style exchanges, but I soon realized that was because their are none. AS the report makes clear, they just advertise the offer, you do the rest. They could be paying for them in pixie sticks for all anyone knows, let alone the Sterling. What we can know is that at some point the crude was bought with USD. It had to be. That's the deal we cut with OPEC, they only sell crude to those buying in US dollars. Enter the brewing perfect storm, and what I meant about this all coming together for me.
As Titus noted, oil sales throughout the world are denominated in US dollars. Since 1973 OPEC exports have been priced in US dollars. This marketplace gave rise to trillions of petrodollars that get cycled into international oil trade via US dollars. Since most countries rely on oil imports, they are forced to maintain large stockpiles of US dollars in order to continue imports. This creates a consistent demand for US dollars and positive pressure on the US dollar’s value, regardless of economic conditions in the US. This in turn allows the US government to issue currency below cost of currency production and bonds at lower interest rates than they otherwise would be able to. As a result the U.S. government can run higher budget deficits at a more sustainable level than can most other countries.
So think about that scenario. Here we come off the Gold Standard in 1971. Then turn right around in 1973 and cut a deal with OPEC to sell their product exclusively in ISD. So in fact we exchanged what backed our currency from one tangible asset to another. We went from a gold standard to an oil standard (ironic given the company name of America's first oil monopoly). The USD is in effect, a "petro-currency."
This is why we have been the world's standard currency, the reserve currency. Oil makes every country's, 1st, 2nd or 3rd world, economy go round. And you can't get oil without US Dollars. And just as an aside, I don't know about you, but do you think swapping gold as the asset which backs our dollar, for oil, was a "good" move? We went from gold to a deal cut with an orginization whose code of moral conduct would raise eyebrows in the Court of Caligula. And I'm supposed to feel secure with that swap?
Enter what happened 12 days ago.
On April 18, 2011, the Chicago Mercantile Exchange launched six Euro-denominated oil contracts. Pricing, margining and treasury for exchange-cleared oil price management can be fully executed in Euros. These contracts should make certain trading functions more streamlined for oil exporters to and from oil consumers in the Euro-zone, with no need to buy US dollars to effect oil trades.
Why? Why would they do this? To be more competitive with OTC markets like ICE? That's part of it, in my opinion. But it doesn't fully explain this move because even those ICE markets, those OTC driven markets, still originate with a crude purchase in USD. You can't get the oil from OPEC without a Ben Franklin, period. There can only be one explanation - they're testing the waters. See, this petro-currency of ours has allowed us to remain the dominant world currency reserve in the post gold standard era. But we have so abused the privilege, by running up deficits unprecedented in human history, that foreign markets are testing whether it's a better deal for them to move to something else. If the denomination of oil sales changes to another currency, such as the Euro or the Yen for example, countries would sell dollars and cause the banks to shift their reserves, because they would no longer need US dollars to buy oil. Forty years of petro-dollars would start to get flushed from central bank reserves. This shift in petro-currency reserve status would lower the US dollar, exponentially, near collapse.
In other words, this oil backed scenario of USD allowed us one hell of a long leash. We could screw up, even screw up bad, and the world would help to maintain the value of the dollar because they needed it to maintain their economy - to buy oil. But we have so depreciated our dollar with wreckless spending, so exacerbated the length of that leash, that we are driving up the cost of oil FOR THEM. As our Fed prints more money, the cost of oil goes up because there are now more petro-dollars get it? We're casuing world-wide energy inflation. The cost of lubricating the economies around the world goes up. And those economies are getting pissed. And think about it from OPEC's perspective. Do they want to continue to be paid exclusively in a currency that is committing suicide via spending and printing? And what are they to do if China and India et al band together and say, "we want to business in Euros"? If you're OPEC what do you do? At current the US is still the largest consumer of energy, but as China rises it is feasible they or India may eclipse us as the world's leading energy eater. Once that happens OPEC may seriously consider any suggestion of their's to alternate out of the USD. How could they not if we are replaced as OPEC's top client?
Forget everything else - if we have $14 trillion out in debt, and are furiously printing money to spend (like the current administration), and amist that OPEC switches to a different petro-dollar, causing this forty year flush from foreign central reserves (causing the market to be flooded with USD in addition to the printed money, and debt owed), brother - that's game over. We are the Wiemar Republic at that point. It's pick up your pay check in a wheel barrel time.
Now, this threat to move from the USD as the reserve petro-currency gets tossed around by people whom want to rattle the US cage, routinely. Russia chatted it up in 03', Iran has, Venezuela has. All of it went nowhere. But when the Chicago Mercantile Exchange talks about it (hell, actually does it on a limited basis) we better sure as hell pay attention, and do something. Especially when every other piece of the perfect storm I just described, is already in place.
But what is that something?
The world's need for oil is not going anywhere. And in lieu of a return to the gold standard, which has almost zero chance of occurring, ever, we must defend our status as the world's petro-currency.
1.) We have to get control of our national debt. Whether it's challenging our dominance as the world's petro-currency, or any other aspect of the US based world economy, China, Russia and India are playing for keeps. And OPEC will side with whomever emerges. We can not emerge with $14 Trillion in debt on our back, period.
2.) The OTC genie is already out of the bottle. It's in everything, in every market, in total it is a $600 Trillion derivatives market - you can't roll back the Clinton Act of 2000 without sending the entire economy of the world into cardiac arrest. What you can do is amend the oil futures commodity exemption. And by amend, I mean limit the position one can have for non delivered OTC contracts. In other words, if you're not buying oil that's going to be delivered (presumabley for use), there would be a limit to how many OTC contracts you can buy sell or trade. You base these on percentages of trade volume so as not to make the number artificial, and almost immediately archaic. Put simply, there will be less activity in OTC oil futures (less participation via the percentage limits or they'll return to the traditional organized exchanges), less flurry, less volatility. I put that chart (at the top) in this post to make this very point. Click on it if you need to, in order to see the spike demarcation line. It's clearly just after the 2000 Clinton Act (and yes, I intend to insert the name "Clinton" each and every damn time I refer to this Act, for the rest of my life - it's his, he owns it. Blaming Bush as an after thought is grasping). Such percentage based limits, as long as the percentage is based on market activity, will help (in my opinion) to smooth out the spikes, or at least those caused by speculators.
3.) It sounds trite and perhaps overly simple after all of this, but a comprehensive domestic energy plan with proven technology like nuclear, coal, and natural gas - and yes, more drilling - will serve to stabilize our position as the petro-currency of choice. Because our title as the reserve petro-currency is partly based on the ever expanding dynamism of our economy. People trust (or did) the worth of the US dollar based on the growth of that economy. In addition, the more available energy is the faster we will grow, the more we will buy from OPEC, keeping ahead of China and other rivals as OPEC's #1 customer. And believe me, as bad as that sounds, China being their #1 customer sounds much, much worse. As we all know, the high roller in the room gets the most attention, and we don't want Beijing being the big hand at the table ... getting all the comps once reserved exclusively for us.
3.) It sounds trite and perhaps overly simple after all of this, but a comprehensive domestic energy plan with proven technology like nuclear, coal, and natural gas - and yes, more drilling - will serve to stabilize our position as the petro-currency of choice. Because our title as the reserve petro-currency is partly based on the ever expanding dynamism of our economy. People trust (or did) the worth of the US dollar based on the growth of that economy. In addition, the more available energy is the faster we will grow, the more we will buy from OPEC, keeping ahead of China and other rivals as OPEC's #1 customer. And believe me, as bad as that sounds, China being their #1 customer sounds much, much worse. As we all know, the high roller in the room gets the most attention, and we don't want Beijing being the big hand at the table ... getting all the comps once reserved exclusively for us.
Well... That's my 2 petro-cents.
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