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A Transparent Call for Control Over Oil Futures

By Adam Lass, Senior Editor, WaveStrength Options Weekly

Ride OPEC's outrage to 70% gains

"I am shocked - SHOCKED - to discover that there is gambling going on here."
- Captain Renault (Claude Raines, Casablanca, 1942)

That just might be my all-time favorite movie line. Bogart aficionados know it was exclaimed by Claude Rains' jolly Nazi collaborator, as he simultaneously collected his ill-got gambling gains and closed down Rick Blaine's casino.

The reason I love it is that it so well captures this sort of hypocrisy. The line is so perfect it's downright archetypal. Take most any week's news and you will read some dolt somewhere echo its sentiments.

The Fly in OPEC's Ointment

For example, just yesterday, the secretary-general of the Organization of Petroleum Exporting Countries, one Abdalla El-Badri, called upon the regulators of the world's futures markets to do something about all the rampant speculation on his client's precious crude oil.

Prior to attending this week's big confab in Davos, Switzerland, El-Badri opined via e-mail that "OPEC has repeatedly called for the need to reduce the role of excessive speculative activity in the market. Today, it is impossible to know who is actually buying and selling oil futures."

In case you somehow missed it, allow me to sketch out a brief history of the events that have El-Badri so hot and bothered.

Some Is Good…

Oil had been making overall advances in price for most all the seven years that the folks in the Oil Patch held the White House (and perhaps more importantly, the Old Executive Office Building, from where Vice President Cheney appears to have been determining most of our energy policy). But even that steady creep didn't hold a candle to the excesses of volatility we experienced in 2008.

The first half of the year saw crude oil surge some 46%, an incredible increase in view of the fact that there were no material events genuinely impacting supply or demand in that time. Sure there were the usual storms, strikes and minor military skirmishes that encumber most any trading season. But in the end, none of this actually impacted supply in any serious fashion.

Meanwhile, on the demand side, we now know that the U.S. economy was already well ensconced in recession. And yet, prices at the wellhead and gas pump continued to skyrocket.

But Too Much Stinks

If you want to find the mysterious driving force for this first-half-2008 spike, you need look no further than the trading floor of the New York Mercantile Exchange. By March of last year, speculators had racked up some 115,145 net-long crude future positions (as per those fine folks at the CFTC, who supposedly regulate this market).

Now, one would imagine those other fine folks at OPEC would enjoy seeing prices climb that high. $147 per barrel will buy you one heck of a new marble-and-gold palace, or perhaps even forestall a revolution amongst your eternally beleaguered poor another year or two.

And yet, this sudden largesse was making the folks at OPEC increasingly nervous. You see, they had been down this road a time or two before, and had learned a critical lesson along the way.

Waking Up Dead

Have you ever boiled a lobster? (Stick with me here: it's germane. Really!) If you dump the wrigglers into boiling water, they thrash about and panic, supposedly spoiling their delicate flavor. (Not that anyone can really tell under all that butter.)

No, the trick is to place the live lobster into a pot of cold water, and then slowly raise the temperature. Little fella doesn't even notice until he wakes up dead, as it were.

The same is true of crude oil consumers. Crank up prices an average of four bits a year for the better part of a decade, and no one says boo. Spike prices 50% in one season, however, and suddenly folks are looking to change their habits.

Change for the Better?

Last year, that's exactly what happened. Miles driven were cut back to levels unseen since the 1940s. Thermostats were dialed back, electric lights turned off, and massive SUVs sat languishing on auto sales lots.

By mid-July, the folks at the NYMEX were forced to switch trading direction, with floor contracts showing a net short position for the first time in decades. By November, the CFTC showed 52,984 contracts speculating on further price drops.

And drop it did. By December, we were seeing crude futures in the high $30s - an astounding fall of nearly 75%. As anyone in any capital-intensive biz will tell you, this is no way to run a railroad.

Or a Turn for the Worst?

This whole affair drives the oil types nuts for a myriad of reasons. First of all, it makes it darned hard to plan. Exploration and development take years and billions to work out. A field that seems reasonably worth exploiting at $60 a barrel may be a windfall at $120/barrel, a tax shelter at $50 and a bankrupting boondoggle at $30.

But you know what I think really bothers the sheiks, et al.? It's a fair guess that the trading floor was an exclusive insiders' preserve for decades. Now guys like El-Badri complain that wild-eyed speculators are raiding their private cellars: "Today, it is impossible to know who is actually buying and selling oil futures."

When El-Badri and his cronies ask for "more transparency," what they really want is more exclusivity and control. And seeing as how Washington is somewhat inclined toward "centralized command and control" these days (that was a joke, albeit a grim one), I do believe that they will most probably conspire with the sheiks and oil companies to shut the speculators out of the market.

I'll Take My Winnings Now, Rick

Seeing as how we can't stop this juggernaut, I suggest we ride it instead. A smoothly operating oil patch will most probably benefit all the usual suspects, so let's start by picking up shares of the biggest, meanest fellow about. That would be ExxonMobil (XOM: NYSE). Or, if you would care to leverage a bit, you might do as we suggested to WaveStrength Options Weekly readers and purchase mid-dated, at-the-money calls against the same, looking for some 60% to 70% over the next month or two

Call me cynical, or just a pragmatist like our dear Captain Renault. I'll take my winnings now, thank you.

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