Introduction to Chapter 1

Introduction to Chapter 1

“My ventures are not in one bottom trusted, Nor to one place; nor is my whole estate Upon the fortune of this present year: Therefore my merchandise makes me not sad.”

Antonio, The Merchant of Venice, Shakespeare


At periodic intervals throughout my career as an oil trader I have observed with interest each financial trading scandal as it unfolded. From Nick Leeson to Kweku Adibola, from the demise of Lehman Brothers and all that followed to the still unfolding Libor debacle, one theme keeps recurring – when it comes to oversight of the trading function, management is asleep at the wheel.

We have had our own fair share of trading scandals in the oil sector too. Major oil companies still shudder at the mention of Transnor, the small trading company that challenged them in the mid-1980s on the issue of price-deflationary tax spinning and did very well for itself in out-of-court settlements. The Ceylon Petroleum Company’s unsuccessful attempt to avoid paying out on 2007/8 loss-making oil hedges to Standard Chartered Bank created more recent ripples throughout the industry.

Senior management of companies may try to claim that it did not know or did not understand what was happening down on the trading desk, but we are finding out that ignorance is a feeble defence at best.

This book is aimed at new crude oil traders or anyone who feels the need for a general understanding of how this crucial business activity works. It is designed to provide a sound framework of understanding of how oil trading functions and how oil price formation takes place in practice.

If you are embarking on a crude oil trading career you will find the vast majority of what you need to know, or where to find it, within these pages. If you are a senior oil industry executive or non-executive, a lawyer, financier, auditor, tax specialist, accountant or project manager and want to understand how oil trading actually works to make sense of the prices at which traders sell or finance oil production, then this is also the book for you.

Trading is a complex discipline; but trust me, it’s not as hard as you may fear – as this book hopes to demonstrate. My advice to oil executives would be to do a little bit of work now to get up the trading learning curve. If you are training to be an oil trader you may find it helpful to have a practical guide like this to fill in any blanks that your more experienced colleagues may take for granted and therefore forget to mention to you. Those in other professional disciplines that interact with the traders will find the jargon and basic principles they need to understand the traders and to spot any problems early. If you are responsible for over-seeing an operation that involves trading or if you direct a company where trading takes place as an ancillary activity of the business, reading this book will let you make more informed choices and also help you sleep better.

There is an alternative: you can so constrain the trading function in your company, in the case of an upstream company, that it only undertakes activities and contracts that the board, typically made up of drillers, engineers, refiners, lawyers, and accountants, i.e. those for whom trading is not a first language, understands. That way there can be no derivative surprises that embarrass the company on the front page of the Financial Times or the Wall Street Journal. But that is akin to using stone axes in the age of power tools and it won’t be long before your annual report becomes a disappointment to shareholders because money will be left on the table.

It is curious how oil companies will celebrate the success of a 50 cent per barrel annual saving in operating costs while leaving sales revenue to the mercy of an oil price that can, and routinely does, fluctuate by a dollar or more per barrel per day. Make the effort to understand what is happening to the revenue line and you can begin to manage it responsibly and appropriately for the circumstances in which your company operates.
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