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Bears Crushed On Manipulation Comments

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Comments by some lawmakers that they had found no illegal manipulation of the energy markets sent crude prices soaring. Once the price began to move sharply higher a monster short squeeze began. Bears had been heavily shorting crude on expectations that the CFTC or lawmakers would either find some manipulation or enact some rules changes that would negatively impact prices.

The comments by lawmakers today still indicate they are going to change some rules to curb the current legal manipulation tactics but they will not be earth shaking. Goldman Sachs, JP Morgan and Morgan Stanley had been under informal investigation into manipulation tactics. One lawmaker said they found nothing wrong with their tactics but they were utilizing rules that had loopholes you could drive an oil tanker through. They intend to close those loopholes.

One rule exempts these banks from rules on certain types of trades and some position limits because in the past those types of trades were undertaken entirely by hedgers and were not speculative. Today there are some very large investors utilizing those rules to "game the market" according to one lawmaker. The second problem is the lack of governance of the ICE exchange and the Dubai Mercantile Exchange both of which are considered overseas exchanges and exempt from CFTC regulation. The rules are different on those exchanges and very large positions can be entered. Those two exchanges account for 35% of the volume in the crude futures.

The CFTC and lawmakers plan on forcing regulation of energy trades made on foreign exchanges and eliminating the SWAPS loophole used by big banks in the U.S. to avoid position limits. Both changes will impact the markets but not immediately since it will take time to get the rules and laws passed.

The lack of any criminal activity or sudden changes in margin rules was the all-clear signal for bulls to reenter the market. The $5.50 gain was the largest one-day gain in dollar terms EVER in the crude contract.

The spike in crude was helped by the inventory report on Wednesday. Crude levels fell for the 3rd consecutive week. The -4.8 million barrel drop for the week ending May-30th makes a total decline over the last three weeks of  -19 million barrels. Crude levels are 11.8% below last year. This would be extremely bullish for prices in almost any scenario.  However, gasoline inventories rose by +2.9 million barrels and distillates rose by 2.3 million barrels. Refinery utilization spiked from 87.9% to 89.7% and the highest level since the beginning of the year.

Refiners are starting to produce more gasoline and diesel but demand for these fuels is dropping like a rock. The MasterCard demand survey showed demand fell -4.7% over the prior week. Gasoline inventories are now 3.3% over 2007 levels. 

Reports that high oil prices are curbing worldwide demand for crude had served as the catalyst for selling. In the past few weeks, India, Sri Lanka, Indonesia, Malaysia, Taiwan, and Thailand have all raised petroleum prices on their consumers as subsidies have become harder to maintain.

I am not confident the spike in crude is going to hold since the majority of the move was short covering. Friday's action will be key to see if the bulls take profits or the shorts pile back on again.

Jim Brown

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