The murky world of oil dealers, fixers and skimmers

It takes two to contango

Oil dealers rather than producers, processors and consumers keep the market wheel turning in the world – at prices orchestrated through an almost mystic system of loopholes and twilight zones. Cracks seem to appear in that system, as the exposure of one of the wheelers and dealers illustrates. Whether or not the system as such is to be thoroughly revised is something on which whether or not market upheavals as recently experienced will occur again. This could very well happen unless sales mechanisms will become constrained in open domains.

by Charles van der Leeuw, KZW senior contributor

The murky world of oil dealers, fixers and skimmersIt may sound like a chord resounding from some remote world to many a soul. But when Cahal Milmo, reporter for The Independent (the English one, that is) spotted about 2.5 million barrels of oil products on board of the two tankers Delta Ios and Burgas in international waters off the coast of Singapore, he struck the right string. As it appears, soaring crude oil prices in the first three quarters of 2008, followed by a dramatic decline reducing prices to less than a third of what they where in last year’s summer peak in the order of $150 per barrel, again followed by a recovery bringing benchmark prices for North Sea Brent, the Caspian main benchmark minus a discount due to quality difference, back in the range between $65 and $70 a barrel.

“At first glance, the decision by Trafigura Group and Vitol Holding BV to charter the newly built ships at an estimated cost of 47,000 Sterling a day to do nothing for up to four months in Southeast Asia while laden with cargos of diesel worth at least ?77 million per vessel makes little economic sense,” Milmo’s article reads. “[…] Far from it. The phenomenon of ‘floating storage’ which has been brought about by a huge oversupply of global tanker capacity and unusual market conditions, is just one example of the multitude of ways in which a small group of private, mostly Swiss-based companies have become adept at turning vast profits from the closed and often murky world of independent oil trading.”

If spot prices remain steadily below futures contract prices for a tangible period of time, there is a trend on the market dubbed contango. The opposite is called backwardation. Contango occurs when supply dynamics exceed those of demand – within traditional market mechanisms, that is. What appears to have happened in the course of the current economic and financial slump in the world could be dubbed contango orchestration. This is what seems to be done in present times by the likes of Glencore, Vitol and Trafigura, as well as by some if not most of their peers.

The main aim is to thwart attempts by OPEC and by major oil multinationals to cut production in order to keep sales prices profitable. It also prevents oil companies from profit-taking on future contracts by keeping up certain volumes of over-the-counter reserves of crude oil and oil products. Apart from that, the manoeuvre allows those who use it to snatch off up to 25 US dollar per barrel to fill their own pockets at the expense of oil producers and their host countries – including those of Central Asia and Siberia, the article suggests. For countries such as Kazakhstan and the Russian Federation, with 1.5 and 4.5 million barrels of crude in exports each day, a 20 to 30 per cent loss means a lot of money down the drain at times economic constraints require income maximisation more urgently than ever before.

Contango orchestration is not as new as it seems, though, and is thought to have been introduced first by a Dutch oil trader whose name is far from unknown in Kazakhstan. At first, John Deuss made use of maritime no-authority zones during the 1970s and 1980s with the aim to let oil and oil products deliveries change ownership at full sea and thereby circumvent embargos against South Africa and later against Iran. This eventually led to the introduction by governments of so-called end user certificates, which any oil producing company had to show to the authorities and if they were not in accordance with the facts could be fully libeled for. But before this happened, Deuss, in the wake of his elder peer Marc Rich who was then at the head of what today is known as Glencore, had already made a fabulous multi-billion fortune on the loophole. It is mainly Deuss who is (rightly or wrongly) believed to have changed, with the waning of political embargoes, the maritime limbo into a commercial tool used by traders for price manipulation through contango orchestration – with the method being by and large the same. And end-user certificates or not, the method remains perfectly legal as long as maritime jurisdiction remains in the embryonic state in which it is.

Deuss is suspected of having gathered his capital needed to start up his operations through two banks he used to run, and still owns, namely the Bermuda Commercial Bank and the First Curacao International Bank, based respectively on the islands of the same names. Since 2006, authorities have been investigating both banks and their largest single owner, namely John Deuss, and his associates for alleged fraud, forgery and tax evasion. During raids, police claims to have found in the order of 2,500 accounts linked to cross-border trade in electronic household articles and other merchandise which are suspected of having used the banks for a VAT carousel, through which in countries of origin VAT is being reclaimed that never has been paid to begin with. Fraudsters can save millions per transaction in this way and are usually most happy to share it with the bank servicing them.

The investigation has come almost a quarter century after the alleged wrongdoings must have taken place – meaning that very serious charges only could allow justice to have its course after all that time. In fall 2006, Deuss was arrested on Bermuda and extradited to The Netherlands, where he was put behind bars and interrogated for three months, before being released on bail. He keeps vehemently denying any wrongdoing, and instead accuses the Dutch prosecution of “twisting facts” in order to “smear and slander the reputation of me and my family”. The date for a pending trial has yet to be set – thereby suggesting that the Dutch authorities are indeed faced with trouble in gathering sufficient hard evidence.

Whatever the case, by mid-1985 Deuss had gathered enough capital to start thinking big. In summer, he established a new oil trade company, Atlantic Petroleum Corp., which in July purchased an infrastructure on the American east coast consisting of 546 petrol stations, a refinery with a capacity of 125,000 barrels a day, 27 crude oil terminals and the necessary pipeline transportation systems from Atlantic Richfield, also known as Arco, which was later to be bought out by BP. He is said to have paid 420 million US dollar for the deal over the counter. Little later, Atlantic bought and leased an impressive tanker fleet, and the contango method was put into practice bringing billion after billion for John Deuss.

Little light has been shed on Deuss’ role in the controversial privatisation of Russia’s oil industry with the break-up of the USSR. No longer in need for VAT loopholes on trade in electronic gadgets, Deuss’ two banks stayed in business – mainly to manage the gains from oil trade. By that time, Deuss had managed to become president of the national oil company of Oman. Using this title, he lobbied for the construction of the oil pipeline from Atyrau in northwestern Kazakhstan to the Russian Black Sea port of Novorossysk, which today is Kazakhstan’s main outlet for the country’s oil exportation. In the course of the process, Deuss was to lose his post, but the Omani company is still a minor shareholder in the Caspian Pipeline Consortium that owns the pipeline.

Why exactly Deuss thought the CPC scheme would fit in to his private business remains guesswork. One hint has been given back in late October 2006 by a periodical called Russian Intelligence pointing at Deuss’ close relationship with Stephen Curtis, an international lawyer acting outside the Russian Federation on behalf of Mikhail Khodorkovsky and the latter’s associate Leonid Nevzlin. Curtis perished in a mysterious helicopter crash in the south of England in spring 2005, more than two years after the decapitation of the leadership of Yukos and shortly before the company’s bankruptcy. “Is there a link between these elements and could Deuss be the victim of Russian revenge, with the Dutch [authorities] acting as stand-ins for Moscow?”, the article reads. “There is no evidence to back that possibility even though Deuss’ friends believe it could well be the case.”

As for the man in question, he keeps a low profile these days (something he always did) and refrains from answering too many questions. He no longer holds a monopoly over the contango orchestration method, which has been taken over by Deuss’ more institutionalised peers such as Glencore and Vitol. This, for all it matters, means that the problem on the market has not been removed, and oil trade keeps being interfered through kickbacks of a multitude of natures, including the contango trick. Oil companies, both state-run and private-run, have been slow to react – even though Kazakhstan’s national oil and gas company Kazmunaygaz recently announced that it had started to hedge part of its oil export volumes in paper trade directly and without the intervention of upstream purchasers.

One more recent phenomenon is that the likes of Glencore have started to invest money in production of oil, gas and non-ferrous metals directly – either through greenfield investments or, as in the case of KazZinc, purchased by Glencore, through acquisition. This could well mean that the reclusive oil trading companies are coming out with the huge accumulations of cash gained on their dealings, but it could mean as well that the easy days of skimming money from trade are over, and trade has started to be rationalised. It is about time, for all it matters – first of all in the interest of producers’ host countries, but also in the interest of consumers.It is about time, for all it matters – first of all in the interest of producers’ host countries, but also in the interest of consumers.