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July 07, 2006

Round Tripping
by Rob Kirby

I've been around, how about you? I've been pushed around, screwed around, led around the block on more than one occasion - which coincidentally, some of you might better know as being 'led down the proverbial garden path'. Oh, I've run around, been on merry-go-rounds, was married once to someone who 'slept around', heck, I've even read the book around the world in ninety days! Around town; uptown, midtown and downtown - I've done the rounds. Round tables, round-a-bouts, round cheeks and round house - now you've got to get a kick out of that!

I'm not messing around here - just looking for good segue to what I really want to talk about; round tripping.

Now, I'd like you all to consider the following recent confessions from energy firms about "round trip" trades:

"Reliant admitted 10 percent of its trading revenues came from "round-trip" trades. The announcement forced the company's president and head of wholesale trading to both step down.

DMS Energy announced 80 percent of its trade in 2001 were "round-trip" trades.

That means 80 percent of all of their trades that year were bogus trades where no commodity changed hands, and yet the balance sheets reflect added revenue. If that isn't fraudulent, I do not know what is.

Remember, these trades are sham deals where nothing was exchanged.

Duke Energy disclosed that $1.1 billion worth of trades were "round-trip" since 1999. Roughly two-thirds of these were done on the InterContinental Exchange; that is, the online, non-regulated, non-audited, non-oversight for manipulation and fraud entity run by banks in this country. That means thousands of subscribers would see false pricing.

A lawyer for J.P. Morgan Chase admitted the bank engineered a series of "round-trip" trades with Enron.

Dynegy and Williams have also admitted to "round-trip" trades.

Although these trades mostly occurred with electricity, there is evidence that suggests that "round-trip" trades were made in natural gas and even broad band."

The descriptive above was read into evidence by none other than Senator Dianne Feinstein. I'm simply borrowing her words from the Congressional Record, Proceedings and Debates of the 108th Congress [2003], First Session, where Ms. Feinstein characterizes this type of trade,

"By exchanging the same amount of commodity at the same price, I believe these companies have not engaged in meaningful transactions but deceptive practices to fool investors and drive up energy prices for consumers. It is, therefore, imperative that the Department of Justice, the Federal Energy Regulatory Commission, the Securities and Exchange Commission, the Commodities Futures Trading Commission, and every other oversight agency within this Federal Government conduct an aggressive and vigorous investigation into all of the energy companies that participated in these markets."

Ms. Feinstein delivered this soliloquy in the aftermath / investigation of the Enron debacle. She is essentially "outlining" how BANKERS [like J.P. Morgan Chase] aid and abet their clients [in this case Enron] in "engineering" desired outcomes in markets in which they operate. In this particular case, of course, the commodity being discussed is electricity and what we are being treated to is snippets of just how its price was "engineered" higher - largely on the backs of consumers in California.

What is important to take away from the revelations above is that commodity prices can be, and in fact are - illegally manipulated. But remember, prices are not necessarily only manipulated UP!

Who would possibly want to manipulate prices down?

So, what if your 'client', instead of Enron, was "someone even more special" - like the U.S. Treasury or the Federal Reserve? What if these clients had been busy for the past few years printing money like bandits [I actually prefer the term Pirates] and were hitting the wall so to speak as the price of virtually everything was beginning to precipitously rise as a result. Of course, they ran the gambit inventing ways to disguise the real inflation [debasement of the currency] in the economy through the use of hedonics, seasonal adjustments and other sophisticated Tom Foolery - like creation of asset bubbles and exporting inflation through the bloated trade deficit? But, just for fun, let's assume now they had exhausted their proverbial bag of tricks but were still living the lie - and had a vested interest in keeping the price of a strategic commodity, like natural gas, DOWN to give credence to their claims that inflation was still somewhat under control - having already lost just that - control - where pricing of crude oil is concerned?

Now I have to admit, the chances of such a case - just like the one described above - ever occurring in the real world must be pretty slim, ehh? I mean, I'd hate to even guess at what the "odds" might be for such a situation to really happen. But as ridiculous as it seems, I'm going to suppose that this long odds situation really has happened and try to figure out what else might have logically happened if such a scenario were to occur, ok?

An Ongoing Hypothetical Case Study

For such a situation to occur - to control the price of natural gas - I would want a "real player" quarterbacking the whole affair. Someone with who had their hands in everything:

"J.P. Morgan Chase is one of the largest, if not the largest, participant in the overall derivatives markets. According to the U.S. Office of the Comptroller of the Currency, J.P. Morgan Chase had $34.7trillion [more than 48 trillion reported as of June, 2006] in derivatives on their books (measured in notional value) as of September 30, 2003. The bank acts as a dealer in many derivatives markets and uses 99.5% of its derivatives for trading purpose with only 0.5% used for other purchases such as hedging its banking activity;"

Quite possibly and most likely, you'd want someone with experience in the natural gas arena:

"Prior to its merger with J.P. Morgan & Co., Chase Manhattan Bank set up an energy trading business in the British Channel Islands named Mahonia, Ltd. The business, based in New Jersey, conducted billions of dollars of natural gas trading with other energy companies. Many of its transactions took place just before year-end. Often, the deliveries of natural gas and oil were sold right back to those who delivered them through complex derivative transactions. Approximately 60 percent of Mahonia's trades were with Enron Corp."

Then, perhaps you'd want this huge derivative player - to take a dominant position on some recognized exchanges in the subject market so as to position themselves to "put the clamps" on the price movement in the commodity.

JPMorgan awarded Energy Derivatives House of the Year

Risk magazine, January 2006

JPMorgan was named Risk magazine's Energy derivatives house of the year in their January issue. According to Risk, "JPMorgan has emerged as a key player in energy derivatives over the past year."

Now, after the price of natural gas is 'wrestled to ground', so to speak - I might have some explaining to do since the price of crude oil is making new all time highs. As the questions mount - with natural gas prices falling [or were they engineered, perhaps?] in three short months to one third of their all time highs - and crude oil is trading at an all time high of 75 bucks a barrel - you'd, no doubt, want to cover your tracks. You might even want to make claims that, due to a warm winter, natural gas inventories were bursting at the seams!

"Despite record storage levels in the summer, the futures market is sending record strong signals to inject more as quickly as possible. There could be many reasons for the strength of this futures market-based signal - fears about gas use in electric generation this summer, fears of hurricanes, fears of international pressures on oil prices. Still, the strength of the November through March seasonal price spread in the face of huge existing storage inventories clearly emphasizes the fact that gas markets value storage right now at unprecedented levels."

Of course, you would not want to mention the fact that warm winters are, in fact, a double edged sword! It was so warm folks that in southern climates they actually used record amounts of electricity [largely derived from nat. gas] to power air conditioners - but we won't mention that, ok?

ERCOT: Electric supply OK today

Conservation of usage still urged

09:40 PM CDT on Tuesday, April 18, 2006

By KIMBERLY DURNAN / The Dallas Morning News

Adequate electricity should be available as afternoon temperatures soar in North Texas, meaning rolling blackouts are unlikely, officials with the agency that oversees the state's power grid said Tuesday.

Dottie Roark, spokeswoman for the Electric Reliability Council of Texas, or ERCOT, said the state should have enough electricity supply to meet demand despite projected record-breaking heat. But she urged consumers to curtail electric use when possible.

"We don't expect a problem today ... but we never say never," she said. "We are encouraging people to bump up their thermostats a little and reduce their use of electricity."

Viewed in this light, would this not tend to cast government supplied natural gas inventory data in the same light as, say, inflation or employment data?

"Have you ever wondered why the CPI, GDP and employment numbers run counter to your personal and business experiences? The problem lies in biased and often-manipulated government reporting. We offer an exposé of the problems within the reporting system, and an assessment of underlying economic reality, through two basic services:"

The reality is this: There is no independent third party audit of what published natural gas inventory data is - is there?

But we do factually know that rolling blackouts on the electrical grid have occurred in places like Austin, Texas:

April 17, 2006 News Media Release

Austin Required to Implement Rolling Blackouts

The Electric Reliability Council of Texas (ERCOT) - which manages the statewide electric grid - ordered rotating blackouts Monday afternoon, April 17, 2006 across Texas. Cities across the state were each assigned a portion of 1,000 megawatts (MW) that needed to be turned off or "shed" to keep the statewide electric grid in balance.

The short supply situation was created by a combination of factors: Record temperatures that caused record electric demand for April and 14,000 MW of power plants off line undergoing annual maintenance and repair work. March and April are two of the months when this work is typically scheduled because electric demand is usually lowest during fall and spring months due to mild temperatures. In addition, five generating units in the state tripped off line shortly after 4:00 pm, creating a shortfall in generation that required immediate load shedding statewide to prevent a total blackout of the statewide electric grid. If the statewide electric grid shuts down, it would take 3-5 days to get the system back up.

But of course there are always rational explanations why we need not concern ourselves, right? Is this not reminiscent of the type of reasoning put forward as to why Americans should not be concerned about illegal immigration?

We need to remember that someone might have to take some heat, otherwise, regulators themselves might be accused of complicity or turning a blind eye to deliberate and premeditated market manipulation.

In the case of the Enron debacle, blame was laid at the heels of Arthur Andersen.

As Mr. Anthony Fell - Chairman of Canada's RBC Dominion Securities [the brokerage unit of Royal Bank of Canada] was recently quoted as saying,

"Gold bullion is the one investment and long term store of value which cannot be adversely impacted by corrupt corporate management or incompetent politicians -- each of which is in ample supply on a global basis," he said

Apparently, there are some that would have us all believe that BANKS DO NO WRONG - everyone else is guilty?

It would appear that banks [practicing philanthropy, no doubt?] simply pay their fines and move on to bigger and better things.

The Perils of Price Manipulation

For folks who would suggest that we all benefit from lower natural gas prices [even if they are manipulated] - consider this:

• artificially low prices discourage conservation
• artificially low prices discourage much needed research on and implementation of alternative fuel sources
• artificially low prices discourage exploration
• artificially low prices "speed up consumption" of a non renewable resource and lead to misguided uneconomic choices being made on behalf of governments and consumers alike
• artificially low prices are not sustainable
• artificially low prices mean our kids [future tax payers] ultimately pay for our largess

Good thing we're only talking hypothetically here, ehhh? It would be a real bummer if half this stuff was true, wouldn't it?

Rob Kirby
Kirby Analytics

Copyright © 2004 - 2006 Rob Kirby

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