Downfall from Speculative Energy Trading

Last week, energy trader SemGroup LP (the 12th-largest private U.S. company) filed for bankruptcy after sustaining $3.2 billion in losses on energy futures and derivatives trades.

Semgroup suffered as oil prices ramped up, undercutting their positions on short crude futures, used as a hedge against its physical 500,000 barrel-per-day trading business. Some analysts suspect that fraudulent trades may have played a part in the collapse too.

The dramatic downfall shocked the firm’s backers and the entire industry, which were blissfully unaware of the huge trading losses. In June, Bank of America was also quoted as saying SemGroup was one of their best clients.

Due to the overwhelming deficit, SemGroup creditors will recover only half of the more than $7 billion they are owed. Shareholders including private equity giants Ritchie Capital Management, Riverstone Holdings and the Carlyle Group are expected to be wiped out.

In another case, the Commodity Futures Trading Commission (CFTC) filed civil charges against Optiver, a Dutch trading fund, plus two subsidiaries and three employees, for speculation of crude oil and gasoline futures prices on the NYMEX.

Optiver allegedly manipulated short-term prices on 19 different occasions in March 2007 (adopting a method known as “banging the close,”) and were successful at least five times, netting an illicit profit of $1 million.

Under such circumstances, it is timely that Senate is considering a bill that will compel the CFTC to limit the amount of trades by certain market players – namely the shady speculators who must account for a portion of the skyrocketing price of oil.

Unfortunately, the passing of this bill was stopped in its track by Republicans who believe the increase in oil prices are due to fundamental supply and demand factors. And they do have a strong case.

Fact is, driving out speculators and hedgers doesn’t solve the oil problem in its entirety. It may even create a less efficient market with shrinking liquidity. However, some form of regulation and penalties are still necessary to prevent rogue traders from wrecking havoc on oil prices and the general economy.

The downfall of the two firms in recent weeks serves as a wake-up call to energy traders that profits made today can be returned to the market tomorrow. More updates soon, stay tuned.

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