Contango Lesson: How Koch Industries Raises Gas Prices

Last Updated Apr 14, 2011 8:54 PM EDT

Not only hedge funds, banks and other speculators manipulate the price of oil. So do big energy companies, such as Koch Industries. The chemicals and petroleum company does it by purchasing large stocks of oil and storing it in offshore supertankers and giant containers. Then it sits on those supplies until oil prices rise.

That strategy is called "contango," which is when the future price of a commodity is expected to top the current price. This isn't unusual in these markets. It just means that demand at some point down the road is forecast to exceed supply. Unlike pure speculators dealing in futures contracts, however, companies like Koch actually buy and hold oil. And because that reduces supply, as demand increases gas prices rise. Fortune's Jon Birger estimated in 2008 that a 200,000-barrel-a-day decrease in oil supplies could boost gas prices by upwards of 40 cents a gallon.

Liberal blog ThinkProgress turned up a 2009 interview by a senior Koch executive, one David Chang, in which he detailed how the company had hoarded oil as crude prices were falling in 2008. He said at the time:
The drop in crude oil prices from more than US$145 per barrel in July 2008 to less than US$35 per barrel in December 2008 has presented opportunities for companies such as ours. In the physical business, purchases of crude oil from producers and storing offshore in tankers allow us to benefit from the contango market where crude prices are higher for future delivery than for prompt delivery.
Koch fights financial reform
The use of contango as a trading strategy, which can hurt investor returns, is no secret. Investment firms have even designed mutual funds and exchange-traded funds that aim to soften the impact of contango.

But Koch's stockpiling of oil appears to be less widely known. The company complements this approach with an aggressive lobbying campaign in Washington to block financial reform, especially efforts to tighten regulations on commodity and derivatives trading. Reports investigative news outfit the Center for Public Integrity:
[T]he Dodd-Frank law gave the Commodity Futures Trading Commission and the Securities and Exchange Commission the authority to craft new rules to subject traders in the energy industry to increased regulation and transparency, capital and margin requirements, and supervision by a derivatives clearing house. Koch lobbyists worked to favorably shape the bill, and have not stopped working since it was passed.
Rigging the oil market is obviously a direct hit on U.S. consumers and businesses. But I'd also like to know what other commodity markets, which have steadily been "financialized" over the years, are vulnerable to hoarders like Koch.

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  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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