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Last December, Credit Suisse Group AG (NYSE: CS) closed two very popular ways of betting on oil to the public.
Both were exchange-traded notes (ETNs) pegged to oil prices, and both had been multibillion-dollar plays that allowed regular people to profit from swings in crude.
But while there's no public price listed anymore, financial institutions keep trading these "zombie" notes…
And it's massively distorting oil prices, as we saw with Wednesday's 5% drop in oil prices.
These ETNs Used to Bring Profits to Regular Investors
These ETNs were 3X "bull" and "bear" notes, respectively. That's to say, the bullish one – VelocityShares 3X Long Crude Oil ETN (UWTI) – rises in value three times more than the New York benchmark for oil does, West Texas Intermediate (WTI).
Meanwhile, the bearish one – VelocityShares 3X Inverse Crude Oil ETN (DWTI) – moves up three times as fast as WTI falls (and vice versa).
Of course, both also lose value three times as fast as WTI moves against them. That makes both risky for regular investors, and they're certainly not the kinds of securities you put in a portfolio hoping to send junior to college.
These are very volatile.
Nonetheless, the folks in my Micro Energy Trader trading service scored 98.75% and 127.13% gains as we moved in and out of UWTI.
DWTI, the bearish ETN, was less capitalized, and I always regarded it as having too much risk for retail investors.
But here's what's really interesting about both UWTI and DWTI today.
While Credit Suisse dropped them from general trading and stopped providing daily trading values (thereby making them unusable for normal investors), the two notes remain in use.
For the individual investor, other, less liquid clones replaced them. However, these have even greater volatility and insufficient trading volume, making them prone to extreme swings and unjustifiably excessive levels of risk.
But among oil traders, UWTI and DWTI are spoken of in the present tense. They still exist on the secondary market – meaning investors can trade them with each other.
And in this current "zombie" form, both are beginning to distort the underlying price of oil…
Private Trading of These "Zombie" Notes Is Distorting the Market
These days, oil traders use the two ETNs as "indicators" or "barometers" of the oil market. Or at least, that's what Credit Suisse says.
Yet, traded privately – without any market value published for public view – UWTI, DWTI, and other derivatives are instead driving magnified profits for the very guys disfiguring the prices to begin with.
This is hardly the first time these folks have figured out how to take control over the connection between "paper" barrels (futures contracts) and "wet" barrels (actual oil consignments).
The difference this time around is the impact.
Remember, each of these notes carries a 300% markup on the actual value change in the underlying commodity.
Of course, if a heavy-hitting futures contract mover has made a move either for higher or lower prices, or even if the fellow is reacting to perceived market developments, cutting a series of futures contracts, options, and other derivatives preceded by buying the privately available UWTI or DWTI (or a spread derivative on them) will provide the opportunity for a profit…
A profit that's well beyond what's justified by the change in oil value itself.
Normally, the low trading volume of UWTI and DWTI would be a signal that the stock (or ETN) has problems. After all, low liquidity is usually an indication that volatility follows any uptake in trading.
Except in this case.
UWTI and DWTI are today almost exclusively traded among institutions and trades that control both paper and wet barrels. If the same party does not have positions in both, they will pair off with players owning the "other side" of the transaction.
I say "almost exclusively" here because the continued participation of Credit Suisse and other finance houses is also shielded from public view.
What this "new" practice shows is the latest step in a long but accelerating attempt to make profits from artificially manipulating the market…
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.