An insider tip provides a comic sketch of the version of the oil industry practiced at NYMEX, the New York Mercantile Exchange. It takes a sense of humor to survive in the tense, noisy, win-some, lose-some environment of the planet’s biggest paper-barrel trading floor, housed in a low-rise annex to the towering World Financial Center beside the Hudson River in lower Manhattan. Always cash out of all your contracts before their final trading day ends. Forget just one, and you’ll have 14, 10-tonne trucks lined up at your house to unload 42,000 U.S. gallons (1,000 barrels, 158,730 liters) of crude. Worse yet, you have to dispatch a fleet of tankers to keep each commodity-futures contract’s promise to deliver that much oil to someone else. Or worst of all, if your luck runs out completely you go broke too – you wind up having to buy the physical cargo needed to fulfill the paper commitment on a day when the oil price is rising by the minute.

“Everybody that works in this business has a little bit of a gambling junkie in them – otherwise, you wouldn’t be here,” says Remy Wagman, president of RJM Energy and a 14-year NYMEX veteran. “But if you’re completely a gambling junkie, it’s not an industry to work in for you. You have to know when to stop.”

The in-joke is a professional’s word to the wise about the stakes in commodity trading. In practice, the paper deals seldom reach their ultimate potential conclusion as wet-barrel transactions, although the rules for futures contracts – as “derivatives” which represent genuine oil – include a procedure known as “exchanges of futures for physicals.” But good and bad bets have consequences in real money.

For industrial firms that go into futures trading – producers, refiners and merchants – the gains or losses are differences between price expectations embedded in paper-barrel futures contracts and eventual outcomes on wet-barrel markets. Known as commercial participants, dealers in the underlying tangible commodity use the exchange as a financial hedging arena for protecting or stabilizing the value of their main business by locking in deals.

For speculators – such as hedge and mutual funds, pension plans, banks and personal investors, collectively known as non-commercial participants – the gains or losses on futures are potentially the full value of the commodity. They have no wet barrels to compensate for the paper ones.

Pros win more than they lose by sensing turning points and cashing out when bets go bad or perform as well as anyone has a reasonable right to expect. “I can be in and out in as little as 60 seconds, sometimes in an hour,” Wagman says. “You can’t win every day. It’s not mathematically possible,” he adds. “You can have four good trades in the morning, and then one in the afternoon that wipes them out.”

What makes the oil market move? Wagman does not rely for answers on computer statistical programs known as “black boxes” among traders. He calls himself one of the last old-time warriors for still showing up in person at the NYMEX, four years after the exchange vastly expanded its oil pit by creating a digital substitute that stays open 23 hours and 45 minutes every weekday for global trading across all time zones.

At the last peak of the market, when oil briefly topped US$147 a barrel in mid-2008, NYMEX trading volume hit 640 million paper barrels daily – eight times the real-world consumption of wet barrels. And that did not count frenzied activity in oil, as a financial item like stock indexes or interest rates, which went unrecorded in arenas that are exempt from disclosure requirements because they are outside the U.S. or excused from reporting by 1990s deregulation.

“It’s still a game of supply and demand,” insists Wagman. He has never been to an oil well. He uses little of the stuff, commuting by train and subway between his Long Island home and New York’s financial district. But as a declared traditionalist he persists in seeing futures trading as based on wet-barrel production and consumption.

Joe Raia

An Alberta Brand Joins World Oil Touchstones

Alberta oil stepped up to the big league of international commodity trading this summer. As of July 25 the New York Mercantile Exchange (NYMEX) added Western Canadian Crude, or WCC for short, to its product lineup. The brand is a new counterpart to old global benchmarks such as West Texas Intermediate (WTI), North Sea Brent and Arab Light. WCC is a mixture of heavy crude, oil sands bitumen and upgraded synthetic crude or liquid byproducts of natural gas added as “diluent” or thinner for pipeline shipping. The blend is slightly thinner than maple syrup and resembles summer farm machinery lubricants. Under its original name of Western Canada Select, WCC has been marketed by a Calgary producer group since 2004. The promotion to international stature as standardized 1,000-barrel supply contracts stems from rising production, growing brand credibility and recognition of Canada as consistently the top source of oil imports by the United States, says NYMEX energy manager Joe Raia.

Wagman adds, however, that the base can sometimes be hard to trace. NYMEX’s role as the world’s oil-price factory, constantly revealing the gyrating value of the number one-energy source by matching up buyers and sellers in an open forum for reported transactions, has grown more complicated.

“Over the last couple of years, while supply and demand is still the first and foremost indicator [foreshadowing prices], there has been more linking between our commodity market, equity markets and currency markets,” says Wagman. Eight times out of 10, for instance, oil-price increases go hand-in-hand with drops in the value of the U.S. dollar and vice-versa, show records kept by researchers at Rice University in Houston.

“All these are now valid pieces of the puzzle,” says Wagman. “You can’t just look at the price of oil in isolation. You have to take into account other markets and mindsets, as other sets of eyes. You have to be connected – not who-you-know connected, but connected to outside forces and outside markets.”

As a realist who trades for industrial clients and on his own account, he agrees with reminders of the human element in economics by watchdogs like Paul Volcker, former chairman of the U.S. Federal Reserve System and President Barack Obama’s chief financial reform adviser. “One basic flaw running through much of the recent financial innovation is its premise that thinking embedded in mathematics and physics could be directly adapted to markets,” Volcker said in an acceptance speech for a 2010 award from the Stanford Institute for Economic Policy Research.

“A search for repetitive patterns of behavior and computations of normal distribution curves are a big part of the physical sciences. However, financial markets are not driven by changes in natural forces but by human phenomena, with all their implications for herd behavior, wide swings in emotion, and political intervention and uncertainties,” said Volcker.

“Every once in a while they’ll throw you a curve ball,” agrees Wagman. He chats with an Alberta Oil visitor to the NYMEX at just such an odd time – one of the two days in 10 when the oil price and the U.S. dollar’s value both fall after a surprise. A bleak American employment report, widely interpreted as showing that the economy is still weak and energy demand is liable to falter, generates negative
betting all around.

The new financial reform bill enacted by the U.S. Congress with guidance from Volcker and Obama, on top of spectacular investor and bank losses in derivatives trading, has potential to increase activity on NYMEX by restricting unregulated arenas. But Joe Raia, the exchange’s managing director of energy products and services, says the New York commodity-futures temple does not rely on government help to make converts. “We didn’t get where we are by customers being forced to use us,” Raia says. “We’ve had growth because customers want to clear with us.”

In financial lingo, “clear” and “clearing” are magic words. They describe an advantage that sets public exchanges like NYMEX apart by making them trustworthy. The terms refer to their back-shop service of ensuring that all trading participants have the cash or credit to satisfy the obligations created by their deal-making.

Provided they pass the means test, financial players from hedge funds to charitable foundations are as welcome as oil producers and refiners on the commodity exchange. “You need speculators in every market. You need people to trade with. Speculators provide liquidity,” says Wagman. “This market is on a fine line. It’s speculative. But at the end of the day the world needs oil. We’re not splitting atoms here. We’re just trading oil.”

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