SemGroup's Fall and the Impact on Oil

by: Prudent Speculations July 31, 2008 | about stocks: DBO / OIL / SGLP / USO    

Prudent Speculations

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Anyone who follows the MLP sector is undoubtedly aware of the recent implosion of SemGroup Energy Partners (SGLP).  There have been several articles put out by the press that list this event as example #1 on why one should not be involved in the sector, I questioned that thought process in my previous article which can be found here.  

Today I thought I would briefly touch on the relationship between SemGroup’s demise and the decline in the price of oil.  For  those in need of a refresher, SemGroup Energy Partners' implosion was caused by the bankruptcy of SemGroup Energy Partners' general partner, SemGroup LP which recently lost over $3 billion dollars after positions in oil derivative contracts went against the firm.  Prior to the bankruptcy filing, SemGroup LP provided over 90% of SemGroup Energy Parner's revenue. 

Additionally the market was expecting substantial asset dropdowns at SemGroup Energy Partners from the parent company over the next several years.  Given the firm’s high level of customer concentration and the market's relatively large expectations for balance sheet growth, it was only natural to see the stock plummet after the news broke. 

It was disclosed on Tuesday that SemGroup LP's massive losses were not caused by the firm’s hedge book, which is fairly interesting as it shows management's aggressive nature and strong desire to deliver outsized profits via the commodity market for the company’s stakeholders.  It is typical of most companies in SemGroup’s industry to keep a hedge book filled with derivatives to mitigate their exposure to commodity prices.  

However, SemGroup LP's massive losses were due to substantial speculative bets in the oil market that far exceeded the firm’s hedging needs.  SemGroup LP's creditors had not authorized such speculative trading in oil futures, which is why SemGroup LP kept its activities secret until it was too late to rectify the situation. SemGroup LP disclosed it was facing a liquidity crunch during a conference call with creditors mere days before the crash in SemGroup Energy Partners' unit price began to fall.  As you can see from the chart below, the unwinding of SemGroup LP's massive oil bets are correlated almost exactly with the fall in the price of oil.  Is this a coincidence?  I doubt it.  First it is too coincidental and secondly we have seen this phenomenon before.

Back in 2006, the collapse of the hedge fund Amaranth Advisors caused a similar reaction.  Amaranth as you may remember collapsed due to massive speculative bets in natural gas futures that went against the firm.  Amaranth Advisors notified creditors of its liquidity crunch in early September of 2006 and on September 20, 2006, Amaranth Advisors gave up control of its portfolio to creditors who began the liquidation process.  As you can see from the chart below, this event had a significant impact on the natural gas market.  The chart during the month September is nearly identical to that of the one above.

I strongly believe that SemGroup LP's bankruptcy is one of the main contributing factors behind the recent decline in the price of oil.  In the short term, speculators clearly determine the price of oil.  However, I still believe that the longer-term fundamental factors reign supreme.  The current high price of oil is in my opinion clearly justified by fundamental factors and while short term factors such as the SemGroup blowup are important, they should not detract for the story behind the oil run up, which I detailed here. 

Wednesday's bullish gasoline storage data further supports my idea that the recent decline in oil was due to the unwinding of SemGroup LP's leveraged oil bets instead of fundamental factors.  The fact that gasoline and oil inventories continue to drop along with the price of oil can only be explained by disruptions in the energy market.  The price of oil should continue to rise or at the very least remain steady until we reach a point in time where gasoline inventories stop dropping.

Disclosure: None.

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This article has 9 comments:

  •  
    Jul 31 07:27 AM
    Was there a measurable impact on supply due to the fact that the big tankers couldn't get up the Mississippi River due to the barge accident? Is the 20 million gallon difference (between the estimate and the actual) explained, in part, by the processors shutting down for a couple of days?
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  •  
    Jul 31 09:43 AM
    In the news from the talking heads for weeks speculation was not the cause for the run up..,, Now the demise of a hedge fund that got caught once agian on the flop. Now we see that speculation was the reason. It is always about the money. Beting at the casino is the same addiction as betting in the markets. Some people just can't take a small good profit and walk away.. They want more. The lure of easy money. What is the price we all pay for this gross obscene manipulation of a good system. We now have naked shorting and firms spending money once again that they are not authorized to spend. The need for greed. We are paying one heck of a price for a small number of peoples gambling addiction.
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  •  
    Jul 31 11:00 AM
    Actually despite inventory reductions in gasoline, there is no fundamental support for oil at $150. Maybe the inventory numbers are due to barge traffic issues. Energy usuage as the price of oil has increased is declining in the US as well as the fast growing economies of China and India. I am not sure how far it has to fall, but if you cannot get pump prices closer to $3 in the US, I am not sure you will see a change in behavior. People have begun replacing the heavy car fleet for a lighter more gas efficient one. Something needs to change that buying behavior - and $3.80 gas isn't going to do it more than $4.00 gas started it. The bulls are wayyyy out in front and will seize on any issue to try and keep the price up. As the bears come in under them watch the cards begin to fall. Another SemGroup will appear.

    There are more SemGroups out there that were allowed to hedge positions without any verification they had the financial wherewithal to cover them. Speculation is fine, but if I am not forced at the time of placing my "bet" to declare my financial support for that bet, why do we wonder why all these hedge funds seem to keep going under. I am loathe to invite government regulation because that invites its own kind of hell, but if the market is unwilling to police the "money down" requirements, we are going to get regulation we don't want to begin to invite.
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  •  
    Jul 31 11:55 AM
    The SemGroup bankruptcy got me thinking of other company's that could go the way of ENRON.

    I started thinking of darling company's that were high fliers, highly leveraged, had flamboyant CEO's, and continued to dilute their shareholders.

    Chesapeake Energy fits that mold, and has recently engaged in some questionable transactions. Consider the recent series of events. On June 9th Chesapeake announces a surprise equity offering of $1.5 billion. A few days later CHK announces the sale of all their Arkoma Basin assets to BP for $1.75 Billion. A few days later CHK announces massive losses related to margin calls on its hedging programs. How much of this raising of cash was related to these margin calls? Did CHK receive good value on these sales of stock and the Arkoma assets? The stock was sold for $57.25 after selling for $74 a few days earlier. Aubrey McClendon has boasted that CHK has a fair value of $100. If so, then why did he sell out the shareholder for 57.25 cents on the dollar? Was CHK that desperate for cash? Remember, CHK only had cash of $4 million on 3/31/2008. Thats right $4 million. If you are whoring out your stock at 57.25 cents on the dollar, you have some liquidity issues. CHK's stock receives a tailwind because of share purchases by Mr. McClendon. One might consider the possibility that these purchases are being funded by the benefits Mr. McClendon receives via the company's Founder Well Participation Program (FWPP). This is the company program that dilutes shareholder earnings by allowing Mr. McCLendon to take positions in CHK wells. The earnings he receives on these well would otherwise flow to CHK shareholders. How much are these earnings? We don't know because CHK refuses to disclose such information despite the SEC's repeated request for CHK to do so. It's curious that two natural gas companies have CEO's making large purchases of their company stock. It's curious because these two company's have these unique "FOUNDER WELL PARTICIPATION PROGRAMS." These two company's are Chesapeake and Sandridge Energy.
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  •  
    Jul 31 01:11 PM
    I will believe that energy fundamentals are driving the commodity price after we see a few more companies have some interesting financial transactions. Thanks "leacabrerra"... for identifying some potential next SemGroups. This entire article is guilty of speaking of an essential truth in a very misleading manner. The rules of supply and demand were not largely responsible for the run up in oil prices. yesterday's gain is almost all gone by 1PM EST. We are headed down, maybe faster than anyone could imagine. That just makes all of these bull positions that much more tenuous. More failures are coming.
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  •  
    Jul 31 01:45 PM
    When bubble pops, some companies go bust. When Internet bubble popped, many (most) internet startups went bust, when housing bubble popped, it was time for financials. Now it's time for commodities traders who didn't manage risk and bet one way only.
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  •  
    Jul 31 06:21 PM
    this is the 1st article to tell it as it was.the almighty wall st. is the sole reason that the price of oil has been going thru the roof the past year.wall st. is so powerful, that they are the ones that make the world go round.they made the whole world suffer with these high energy prices for their own greed.people have died accross the world due to not being able to buy oil to heat their homes.wall st. accomplished what they sey out to do.this powerful man from tulsa oklahoma thought he could "out bet" the big boys.this man who did wonderful things for the city of tulsa (donating 10's of millions to make the city a better place to live), has lost everything.a few months ago this man was a billionaire, now he has nothing.he kept beating that oil was going to go lower & then started playing with options.as long as oil kept going higher, he was losing more & more money until he finally popped.now two hedge funds took over his company valued @ 2.4 billion dollars and some other invested group took his other assests worth a little more than another billion.the whole world suffered due to the greed of these devils.the man should of realized that wall st. never losses, that they have more billions than he "did".it's no coincidence that he had to file for bankruptcy on july 17th and oil started taking on july 14th (the "big boys" new he was filing).sine July 14th, oil has tanked 24 %.THE "BIG BOYS" WOULD OF RAN OIL TO $200 A BARREL UNTIL THESE POOR MAN WAS BUSTED. Too bad this man didn't take his losses & leave the table.THE WALL ST. BOYS ALWAYS WIN.You don't hear CNBC OR BLOOMBERG bring up this story. they come up with 20 other reasons why oil is now coming down.it's sick listening to their B.S. reasons, when they know exaclty what has caused oils decline.even the wall st. journal put this story in yesterday's edition on the very last page of one of their sections in the right hand corner @ the very bottom of the page (so it can be hidden ?).This industry is gutless & cold hearted & one day will have to answer for their actions !!!!!!!!
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  •  
    Aug 01 08:21 AM
    Actually, the article tried to say that the price of oil is not really that related to speculation, so I don't know if you really agree with it or not!

    Don't make this man out to be some kind of martyr. He played with fire and got burned. He couldn't cover his bet. If you cannot cover, don't play.
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  •  
    Aug 05 11:39 AM
    "Natural gas futures rose 9.9 cents to $8.825 per 1,000 cubic feet. On Monday, natural gas plunged 66.3 cents, or 7 percent, to $8.726 per 1,000 cubic feet, its lowest level in nearly six months. Prices have closed lower in eight of the last 11 sessions and have dropped 36 percent from the contract's all-time trading high of $13.752, reached July 2.

    The pullback is double the size of crude's recent slide. That has fed speculation on Wall Street that a large hedge fund or something like it may be near collapse and has dumped a vast amount of natural gas contracts to free up cash. Last month, SemGroup LP, based in Tulsa, Okla., folded after losing $2.4 billion in bad bets on oil futures. SemGroup's collapse came amid a massive sell off in the oil market."

    Oil below 120 and falling. The speculation is finally getting shook out of the market.

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