The Honey Pot

By: Rob Kirby | Fri, Oct 6, 2006
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In a couple of earlier articles, we've examined the relationship between first - plunging natural gas prices and the "astounding ramp-up" of notional in J. P. Morgan's derivative book in Q1:06. Then we took a look at the re-jigging of Goldman Sachs Commodity Index [GSCI] and its deleterious effects on the price of gasoline - just in time to bolster crumbling Republican popularity ratings prior to the crucial mid - term elections.

This essay serves to complete the energy tri-fecta with a little contrarian's look-see into some of the possible reasons as to what or who might be influencing the manic swings we've been experiencing in crude oil prices.

Background: All Roads Lead To Baghdad

As early as June of 2003, we know that certain American banking institutions were eying and sizing up potential new business in Iraq,

"Three of the top US banks, including J.P. Morgan, Citigroup and Bank of America, have set their eyes on the lucrative banking business in Iraq, according to a recent report in The Wall Street Journal. These banks and several others have conferred with Treasury Department officials in recent weeks. They are said to be interested in helping the Iraqis build a modern retail banking system as well as with trade finance, payments systems and foreign currency exchange....." [RK bold emphasis]

Amazing isn't it, how some helpful folks set up an English language web site so they could keep all of us in the Western World apprised of the 'late breaking news items' deemed important for us to get snippets of? Also, ever stop to wonder what the poor Iraqis would have done without the "help" of the likes of good ole J.P. Morgan Chase? Just think - a nice shiny, new retail banking system - yummy!!! And what's this about TRADE FINANCE, PAYMENTS SYSTEMS AND FOREIGN EXCHANGE? What could a war torn, debilitated bombed out infrastructure that is and was Iraq possibly have that would be of interest to good ole J.P.M? I mean, exactly what does Iraq have that the rest of the world wants or needs besides oil?

Well, there is a small issue of settling up some existing Saddam era sovereign debt, owed to an assortment of foreigners that we learned about in January 06,

"Despite initial complaints, Iraq's larger commercial creditors agreed in Singapore last month to trade their Saddam-era debt for new bonds with a NPV of 20% that of the former debts. In general Jubilee Iraq considers this to be a reasonable deal and praises the Iraqi government and all those involved. As a whole the commercial loans were less odious than the politically-motivated government loans, although there are still specific cases in which certain commercial loans could fairly be judged illegitimate due to their connection to corruption or arms dealing. Hyundai, one of the largest commercial creditors said: "Of course it isn't satisfactory, but we have decided to honor the deal.".....

I guess 20 cents on the buck in new bonds was preferable to 20 cents on the buck in a new loan, as this December 05 article would seem to indicate,

"The FT reports that restructuring of Iraq's outstanding debt is entering a pivotal stage this week. However, not everybody is pleased with a process that has been moving ahead at a rapid speed.

But some of the large commercial creditors say they are being treated unfairly and are getting a worse deal than government lenders.

Iraq launched the offer to the larger private creditors last month, giving them a choice of exchanging the debt owed to them for either bonds or loans. The offer, orchestrated by US banks JP Morgan and Citigroup, follows the completion of cash buyback deals with smaller commercial private creditors. Ali A. Allawi, minister of finance, said Iraq was "demonstrating its commitment to treating all creditors in a fair, transparent and even-handed way"....

So, while J.P. Morgan was treating [themselves, perhaps?] everyone fairly and transparently, a few of you might be surprised to learn that as a result of this same Dec. 05 article above,

".....said Richard Segal, chief strategist at Argo Capital, the hedge fund, "When it's all over, the private sector will receive half the 20 per cent net present value proclaimed by the Paris Club." Some private creditors argue that the assumptions that went into the Paris Club deal were flawed. They were based on IMF debt sustainability calculations that assumed a price of $26 for a barrel of oil. Oil prices are hovering just below $60." [RK bold emphasis]

Imagine that; another [group of, perhaps?] hedge fund[s] getting a good ole fashioned fleecing at the hands of "helpful" J.P. Morgan - with an assist to the I.M.F., who so kindly built an assumption of 26 bucks per barrel of oil into their restructuring!

What a bunch of stand up guys!

But It Gets Worse....So Much Worse

Now, if one stops to consider the timing of Iraq's FREE and DEMOCRATIC National Elections - forced upon them in December of 2005 - amid fierce insurgency and sectarian violence being reported daily in the mainstream western press - and the rationale that WE were all force fed how successful Democratic Elections would "CRUSH" the insurgent's will to fight. You all remember that, right?

Well, you might want to re-consider after reading the following as to why DEMOCRATIC ELECTIONS were deemed "so necessary" at that time. On December 23, 2005 it was reported,

"Today the IMF announced that, a week after the elections, the Interim Iraq Government has signed a Standby Agreement. This makes Iraq eligible for further IMF loans and commits it to following a list of IMF economic policies and meeting certain targets. It was a requirement of the Nov 2004 Paris Club debt agreement.

Jubilee Iraq has been consistently arguing for the last few years that:

  1. Significant long term agreements such as this should be negotiated by a permanent elected Iraqi government.
  2. Many of the specific policy recommendations of the IMF could be disruptive, increasing poverty and unrest in Iraq.
  3. Cancellation of Saddam's odious debt should not be linked to economic conditions which infringe on Iraq's sovereignty........" [RK bold emphasis]

Of Course, All This Is Being Done For the Iraqi People...

Does it only appear to "moi" that the timetable for National Elections in Iraq - whether they were ready for them or not - was set by bankers? It sure smells like the helpful bankers wanted a government in place which would have the appearances of "BEING PERMANENT" before they could 'paper over' their long term agreements that could / would be disruptive or increase poverty and unrest in Iraq? I wonder if any of you, like me, are wondering just "who" Jubilee Iraq is anyway [linked above]?

Now, we've identified how "THE NEW IRAQ" managed to qualify for the new I.M.F. loans - it's all backstopped by oil, of course. And with a newly elected democratic government, the next thing Iraq needed, naturally, was a shiny new CENTRAL BANK to make sure everything went just right! You see, as an adjunct [actually a precursor to it] to this new Central Bank, there was established another entity known as the Trade Bank of Iraq,

"Trade Finance: The Trade Bank of Iraq (TBI) was established in July 2003 to facilitate trade of goods and services to and from Iraq by providing irrevocable letters of credit. The TBI officially became fully operational in December 2003 and has a services contract with a multi-international banking consortium led by JP Morgan Chase. Since opening in December, the Trade Bank of Iraq has issued or has pending 183 letters of credit, totaling $708.9 million in imports from thirty-one countries. Letters of credit have been issued on behalf of Iraqi Ministries as well as several state-owned enterprises." [RK bold emphasis]

As Bruce Proctor, senior vice president and global trade-services head at J.P. Morgan, discusses the Trade Bank of Iraq's roleand explains,

"Many foreign companies are interested in transacting business in Iraq, but aren't quite certain how to go about it. They regard the country as a potentially attractive market with tremendous infrastructure needs, but are concerned about the challenges that stand in the way. Exporters either have limited information on how to conduct business in Iraq or believe that the opportunities are limited to a select few companies with access to large contracts. Recent developments, however, have changed the landscape. In May 2003, after the U.N. Security Council and the United States lifted most economic sanctions, Iraq became officially open for business. With the new Trade Bank of Iraq (TBI) now operational, there are numerous opportunities for companies to participate in commercial trade flows or perform as subcontractors. In its first two months of operation, the TBI and its international banking partners issued approximately 100 import letters of credit (LCs) supporting over $200 million in humanitarian and reconstruction-related imports."...........

"Given that the country's banking sector is not yet fully recovered, TBI is playing a vital role in facilitating imports into the country. Established by the CPA last July, the Baghdad-based bank provides a critical payment mechanism for Iraq's procurement needs. A banking consortium led by J.P. Morgan Chase has assisted in the development and operation of the trade bank by providing banking knowledge, systems capabilities and operational support to the Iraqi-staffed institution."

Doing business in Iraq, with no rule of law - sounds like risky stuff, ehhh?

How J.P. Morgan Manages Risk.......

To get your head around how ole J.P. Morgan manages energy risk, we need look no further than their own web site, where they're more than happy to tell us,

Risk magazine, January 2006

J.P. Morgan was named Risk magazine's Energy derivatives house of the year in their January issue. According to Risk, "J.P. Morgan has emerged as a key player in energy derivatives over the past year." Since 2004, under the guidance of Beau Taylor, global co-head of Energy, the firm has built a leading energy trading practice. Focus has extended from natural gas and crude exotic derivatives to include electricity, coal and emissions trading. [RK bold emphasis]

They wear it like a badge of honor, don't they? To "borrow" a cliché [pun intended] - these guys really are good, aren't they?

Without being a lawyer, I'm going to go out on a limb and guess that J.P. Morgan being selected [like there was really a choice, ehhh?] to head up the Trade Bank of Iraq and "facilitate trade with the outside world" - good ole J.P. Morgan - like Pooh Bear himself - just might have happened to fall directly into the "honey pot" giving them free reign to sell a bit of crude oil forward to hedge a bit of their risk, perhaps?

If You've Got A Problem, Consult An Investment Professional....

Ask yourself this if you would; could there be a jurisdiction anywhere on the planet where the state of affairs is more murky or lacking transparency than Iraq? We get a better understanding of this concept from none other than, Saving Iraq From Its Oil, published by the good folks over at the vaunted Council on Foreign Relations [CFR],

"As the United States, the United Nations, and the Iraqi Governing Council struggle to determine what form Iraq's next government should take, there is one question that, more than any other, may prove critical to the country's future: how to handle its vast oil wealth. Oil riches are far from the blessing they are often assumed to be. In fact, countries often end up poor precisely because they are oil rich. Oil and mineral wealth can be bad for growth and bad for democracy, since they tend to impede the development of institutions and values critical to open, market-based economies and political freedom: civil liberties, the rule of law, protection of property rights, and political participation."

With an outstanding notional derivatives book measuring some 53 TRILLION at Q1:06 [representing a 5 TRILLION increase for the latest quarter alone] - we certainly know that the folks over at J.P. Morgan have a penchant for using OTC derivatives to hedge risk, don't we? Well, here's a snippet of what the Derivatives Study Center had to say about the wide spread proliferation and use of OTC derivatives;

"Fraud and manipulation are an ever present danger in these markets and should not be recklessly assumed away."


"One common strategy to manipulate market prices is through the use of derivatives markets, especially non-transparent over-the-counter derivatives markets, because a large position can be amassed and unwound without being observed by the overall market."

We also know that the possibility of fraudulent practices where OTC crude oil derivatives are concerned is something that politicos have duly noted and publicly discussed, don't we?

"The unavailability of key information on over-the-counter trading activity makes detection and prevention of price manipulation difficult, if not impossible."

Over and Above Extraordinary Popular Delusions and The Madness Of Crowds....

Oh, and just to refresh everyone's memory, let's not forget Enron's Special Purpose Entity of a fraudulent honey pot, Mahonia,

"These insurance companies were recently involved in a lawsuit that was initiated by J.P. Morgan. As the operator of Mahonia, J.P. Morgan faced major losses when Enron declared bankruptcy. The firm sought $1.1 billion from Enron's insurers to cover losses it suffered through the pre-paid energy trades. Enron's insurance companies, however, argued that they shouldn't have to pay. Their argument centered on the assertion that the 'trades' that they had insured had turned out to be "disguised loans." Their commitment to provide "absolute and unconditional" coverage, they stressed, did not apply toward covering "fraud." They held that J.P. Morgan had conspired with Enron to hide the company's debt by giving it loans masked as pre-paid energy trades with Mahonia."..................

"An impetus for J.P. Morgan to keep Enron afloat could have been that Enron was highly indebted to J.P. Morgan. Through joint ventures, Mahonia pre-paid trades, and securities, J.P. Morgan had a financial exposure to Enron of over $2.1 billion. Further, through its Mahonia deals alone J.P. Morgan earned $100 million in interest and fees from Enron. This amount is separate from the earnings the firm made as a lender, M&A advisor, structured finance provider, and limited partner for Enron." [RK bold emphasis]

Now, ask yourself if this type of behavior is / was habitual or was it a "one off" transgression? But before you answer that question, consider this;

Fraudulent U.S. Bank Derivatives Behind Parmalat's Insolvency
by Michael Edward

It is currently estimated that at least $17 BILLION (*updated estimate) of Parmalat funds have simply disappeared and cannot be accounted for. The way this came about is a complex web of high risk derivatives based on worthless bonds which, in turn, were founded through offshore shell companies. IF this derivatives scandal is ever fully exposed, the collapse of U.S. and European banks, and the U.S. and European economies, will be eminent. After derivative based scandals like Enron and WorldCom, this just may be the pin that bursts the financial balloon.

Starting in 1997, Parmalat entered into numerous North and South American company acquisitions. The purchase of these companies created large bank debts for Parmalat primarily through Bank of America, Citicorp, and JP Morgan Chase. By 2001, these Parmalat buy-outs were already drowning in red ink. Initially, the banks hedged these losses with high risk interest swap derivatives......

I wonder if J.P. Morgan's stock holders [or the counterparties, a.k.a. other sides, of their 53 Trillion worth of derivatives trades, perhaps?] have any idea that their financial fortunes might be somehow tied to long term contracts or outcomes in war torn Iraq? What do you all think?

Then again, there's probably no reason for concern. But we've all been told that what happens in Iraq is in the National Interest, right? So, on a parting note, let's just remember that Dawn Kopecki recently reported in BusinessWeek Online in a piece titled, Intelligence Czar Can Waive SEC Rules,

"President George W. Bush has bestowed on his intelligence czar, John Negroponte, broad authority, in the name of national security, to excuse publicly traded companies from their usual accounting and securities-disclosure obligations. Notice of the development came in a brief entry in the Federal Register, dated May 5, 2006, that was opaque to the untrained eye."

At the end of the day perhaps we should say, everyone can hibernate, go back to sleep and forget about all of this for the winter - there's nothing to worry about in this "if you don't know, it can't hurt you" Goldilocks World, is there?

Banking is fun,
My honey is gold,
And I've got some
How bout you?
Oh, bother!



Rob Kirby

Author: Rob Kirby

Rob Kirby
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