Vericool Finance

Citigroup energy trader Andrew J. Hall is renowned for his art collection, his poor taste in garden sculptures and a penchant for practising callisthenics with a personal ballet tutor.  Lately, however, this enigmatic British-born trader who runs Citi’s US Phibro subsidiary – has been embroiled in a public row over the payment of a $100m bonus.  That, in turn, has led to questions about how traders like Hall make their cash by betting big on the movement of prices.

The conspiracy theories are flying. Could the bubble in commodity and oil prices have been caused by a conspiracy of traders, speculators and investment banks?  And, with prices rising strongly again, are we in for a repeat performance?

We’ve always been sceptical of the market manipulation idea – mainly because the sheer size of the world oil market means that it’s impossible to ‘corner’.  Yet some of Phibro’s activities give pause for thought.  As The New York Times reveals, the company often wagers that the price of oil will rise so quickly that it can make money by storing oil in chartered supertankers until the price goes up.

In theory, we might say this doesn’t matter:  a speculator buying up oil when prices are cheap and then selling it when there’s a shortage can actually even out prices.  But this isn’t an economics workshop.  Citi’s $100 Million Man bought oil and kept it off the market. When you consider the threat of regional bottle necks or – worse – the possibility that total supply could fail because speculators are tying up tankers, its doesn’t look good.

Regulators seem to agree.  The US Commodity Futures Trading Commission (CFTC) will shortly release a report showing speculators played a significant roles in driving wild swings in oil prices - a move bound to intensify scrutiny on investors.  Other watchdogs are falling into line.  In Britain, the FSA has always downplayed the role of speculators.  But – following warnings from Gordon Brown and Nicolas Sarkozy on the need to curb dangerously volatile oil prices – it has met with oil brokers, banks and hedge funds to review regulation.

More transparency might help, but a witchhunt for speculators won’t do much to alleviate price volatility, which is mainly down to the availability, of easy money.  Plenty of factors affect the oil price, concluded mason, not least supply and demand; and most studies show that speculation causes only small swings.  Yet it is worth discovering how this high-risk, high gains trading game is played – and the role it had in creating such a spectacular price bubble.

Had the boss of Russia’s state-owned energy giant, Gazprom, predicted that the price of crude would shoot to $250 a barrel at any other time, he would have been dismissed as mad, self-serving or both. But in the current febrile market, in which the price is quite capable of jumping $10 in a day, anything goes.

Oil prices have quadrupled since 2004; another doubling would be as traumatic a shock to the world’s economic system as anything that has been thrown at it since WWII – certainly worse than the oil shocks of 1973 and 1979. The likely outcome for the West would be a lethal combination of stagnating output and rising inflation; and not even the growth economies of China and India could withstand an oil price that high.

The latest price spike has baffled many, but it can’t all be put down to the widening gap between supply and demand. Nothing has happened in the real economy to justify such a sharp and steep rise. The current surge is far more likely to be a speculative bubble. The oil price is being kept high by a paper market driven by institutional investors, such as pension funds, which have channelled billions into oil futures, often as a hedge against the falling dollar.

However, it is not quite that simple. It’s a myth that the impact of speculation is more than marginal. Production is falling globally, partly as a consequence of rising resource nationalism. Access to resources for international oil companies such as BP remains very restricted.

Markets, in time, will adjust. Consumers in Europe and the US are already responding to high prices by moderating demand. But what the high oil price really tells us is that we need more investment in energy efficiency, technology, new production and new energy sources.

The hard fact is that none of the touted alternatives to oil – nuclear, ethanol, or renewables – will have any significant effect for at least a decade. The cavalry is not just over the hill – it has yet to leave the fort. Barring an unlikely huge increase in the value of the dollar, oil prices will therefore remain high.

Over the coming months, oil could feasibly fall by $20-$30 as some of the hot money leaves the market, but it is of general consensus that we’ve now got to live with crude at $100 plus. Oil at $250 could remain a pipe dream, but we should prepare for a painful adjustment nonetheless.

The oil price has now tripled since the start of 2004, ending two decades of cheap energy. The oil market briefly paused for breath after a lone trader broke through the $100 barrier, but speculators are intent on pushing the price higher.

As ever, many of the factors behind this price spike have less to do with actual supply and demand and more to do with rumour and anxiety: one expert calculated that around $30 of the $100 price is “risk premium” reflecting worries over supply rather than real problems. But with oil industry capacity so tight, that twitchiness will not go away, and prices will continue to swing about like laundry in a gale.

Just because not enough oil is readily available in today’s market doesn’t mean not enough of it is under the ground. The gooey tar-sands of Canada contain almost as much oil as Saudi Arabia. The real problem is that during the cheap-energy era, oil firms cut investment in new capacity to a minimum: eventually, universities will churn out more geologists, and shipyards more offshore platforms, though it will take a long time to make up for two decades of under-investment.

Meanwhile, governments in many oil-rich countries are trying to grab more of the profits – thereby deterring or excluding private investment. The world’s oil supply would increase markedly if Exxon Mobil and Shell had freer access to Russia, Venezuela and Iran.

So will the oil price come down significantly any time soon? Investment bank forecasts for average barrel prices in 2008 range from $80 to $95, and many analysts believe the only real threat to high price levels is global recession. Meanwhile, green investors were certainly toasting the $100 a barrel achievement as clean biofuel, solar and wind power begin to look viable as fossil fuels become more expensive.

Of more immediate significance, however was E.ON’s announcement of the first new coal-fired power station in Britain for 30 years. Coal is cheaper. It’s also the dirtiest fuel on the market. Whatever politicians say about climate change, the likelihood is that we’ll stoke the furnaces with more coal. If that increases the risk that our planet cooks, it’s another price we’ll pay for $100 oil.

When it comes to energy in Russia, timing is everything. In 1912, the Rothschilds swapped their Russian oil assets for big shareholdings in Royal Dutch and Shell. Five years later, the wisdom of the move was confirmed when the Nobel family was forced to flee the revolution, selling their one-third share of the country’s oil output for a derisory sum.

BP now finds itself in a similar place. When it struck a joint venture with Russian companies to exploit a giant Siberian gas field in 2003 through the creation of TNK-BP, President Vladimir Putin was guest of honour at the signing ceremony. Now it seems all but certain to lose control of this asset over what most agree are trumped-up charges of underproduction.

The sabre-rattling in the Kremlin is so loud BP would probably regard anything that stopped short of a complete sequestration as a triumph. But while the loss of the $20bn Kovykta field would be a blow, there may be worse to come.

The question is whether this is a precursor to a wider assault on BP’s interests in Russia, currently the company’s biggest source of oil.

Shell has already had a substantial part of its Russian assets confiscated – sorry “renegotiated”, so it seems naïve to assume that Putin and his successors will leave the rest of BP’s interests untouched.

Regaining control of assets, which many Russians believe were sold off on the cheap to Westerners, has as much to do with restoring Russian pride and honour as its geo-politics. But once the principle of confiscation is established, there is no knowing where it will end.

Why should the Kremlin stop at the energy sector? Telephony, where European companies have up to $15bn of exposure, could be viewed as “strategic” too. Yet many Western investors remain sanguine – foreign direct investment in Russia is rising. In time, this may come to be viewed as incredibly complacent.

Nothing should surprise us about Putin’s increasingly Kafkaesque Russia. His goal on energy policy is to use the world’s growing dependence on Russian energy exports as a tool to exercise influence. In the light of this, an urgent review of Britain’s energy policy is needed.

Time is running out: Russia already supplies a quarter of European gas imports and has plans to grab 10% of the UK market. It is time to pursue a vigorous policy of energy independence, which can only be achieved via a wholehearted move into nuclear power. If Gordon Brown is looking for a realpolitik, pro-business policy to kick off his premiership… that should be it.

It is hard to imagine a more ignominious end to a once glittering career than that of Lord Browne of Madingley. After three years of mishaps and disasters, his hard-earned position as Britain’s most admired business leader already lay in tatters. Yet it is his private life that has finally brought him down, exposed in that most heartless of ways as a kiss and tell story by a former lover.

It wasn’t Jeff Chevalier’s allegations of improper business conduct that did for Browne – they were investigated and found to be trivial. It was the fact he lied when under oath when seeking an injunction to prevent the Mail on Sunday printing the details.

The BP chief hadn’t met his former lover when jogging in Battersea Park as he claimed, but through an internet dating service.

The public interest aspect of this sad and silly story looks slim to the point of desperation: it was a fig leaf to cover the prurient motives for telling it. When Browne told his shaving mirror it was not in the interests of BP shareholders that his gay private lifestyle became public property, he was not imagining the problem.

Attitudes, it is true, have changed since he started out. But having risen to prominence, it was too late for him to disavow impressions he had allowed to arise. Yet Browne cannot be let off the hook entirely. The secrecy at the heart of his life added to the closed and defensive nature of the court he created as BP’s “Sun King” – a nickname hinting at the overweening, even dictatorial nature of his leadership.

Ultimately, it was that culture which inflicted the greatest harm on the company because it led, indirectly, to management lapses – culminating in the explosion that killed 15 at the Texas City refinery.

Compared to the ramifications of that, this latest scandal is small beer and ought to have no impact on the operation of the company. Browne’s successor, Tony Hayward, was already lined up to take over from him in July and shareholders may greet his earlier arrival as a welcome opportunity to draw a line under the past.

As for Browne himself, one suspects it is not the end of the world, professionally. The world of arts is one possibility; private equity is another. Indeed, for all the misery he is enduring, his torment will not be entirely unmixed with relief.

There will come a morning when he awakes with a sudden sense that the Damoclean sword that has hung over him for so long has vanished.

Bullies often get what they want and the Russian state is no exception. After months of sustained pressure, Shell is poised to cede majority control of Sakhalin-2 – the world’s largest liquefied gas field – to the Russian state-controlled energy giant Gazprom.

The exact terms are unfinalised, but it’s clear that neither Shell, nor its Japanese partners Mitsui and Mitsubishi, have much choice in the matter. All three will swap sizeable stake-holdings for a combination of cash and other oil assets, and can probably count themselves lucky that at least Russia has not torn up the agreement, as some feared.

The message from Kremlin Inc is clear: the days of private majority stakes in the so-called “commanding heights” of the Russian economy are over. The Putin government is determined to see control of Russian resources in Russian hands, particularly those picked up by Western companies on extremely favourable terms during the anarchic Nineties.

In some ways you can’t blame the Russians: the country derives no benefit from those deals until the foreigners have recovered the cost of their investment. Since costs at Sakhalin-2 have doubled to $20bn, they were in for a long wait.

Besides, the practice of “mugging” oil majors is hardly unique to Russia. Britain has long been guilty of similar economic GBH using the only slightly less brutal weapon of windfall taxes.

Russia is no paragon of democracy, but it is unlikely voters would have opposed any move to extract a higher price out of Shell than it has so far paid for its assets.

But that doesn’t excuse this gas grab, which marks a poor day for the rule of law and the sanctity of contract. It bodes ill for other foreign groups, not least the BP-TNK joint venture. Given Europe’s growing dependency on Russian gas, the Kremlin’s disinclination to play by the rules is disturbing.

Gazprom is now a state within a state: some 40% of Russia’s GDP is controlled by the Kremlin’s tea-drinkers circle. Putin is operating a capitalist version of Stalin’s “Socialism in One Country” policy and it is all the more dangerous because no Russian company has the managerial and technical noose to meet the world’s energy needs.

Russia will remain an uncertain arena for investment until 2008 when Putin, if he can resist Tsarist urges, steps down. But the problem won’t necessarily go away. One possible berth for an unemployed president is the chairman’s office at Gazprom.