Why Charges Against Goldman Sachs Affect Oil Prices
Friday’s news that the Securities and Exchange Commission (SEC) had charged Goldman Sachs with fraud sent oil prices skidding. On Monday, continued concerns over the Goldman case combined with the reduced demand for jet fuel in the wake of Iceland’s volcanic eruption to push oil prices further down. The effect of a volcanic eruption on oil prices can, in a roundabout way, be explained through supply and demand of physical oil—if planes in Europe aren’t flying, there’s less demand for jet fuel. But Goldman Sachs is not Exxon, and the investment bank’s woes do not change how much oil is produced or consumed. So why does it matter to oil traders that Goldman Sachs has been charged with fraud?
The worry is that Goldman will sell off some of its massive investments in oil. If Goldman sells a huge amount of crude oil futures, they don’t add crude oil to the physical market, but they do flood the market with futures contracts, and all that effort to sell crude oil futures changes the balance of supply and demand in the futures market and moves prices lower.
Why would the SEC suit get Goldman Sachs to sell oil? According to oil analyst Stephen Schork, Goldman—and other investment banks—might want to squirrel away some cash just in case the SEC slaps a fine on them:
If banks like JPMorgan, Citi and Goldman Sachs have to build a defense fund for fines levied by the SEC, will they liquidate this trade, i.e., sell crude oil?
The Financial Times‘ Energy Source blog doesn’t think these banks have much need for a “defense fund” against the SEC; after all, Goldman’s 2009 profit was $13.4 billion, which is enough to withstand any fine the SEC could lay down. However, FT’s Energy Source still thinks there might be a good reason for Goldman and its compatriots to sell commodities, such as oil, and hoard cash. The SEC suit, while perhaps not too dangerous in itself, could be the harbinger of a wave of litigation against investment banks for their role in selling financial products associated with subprime mortgages:
There are numerous lawsuits pending against various banks from other investors who lost money on subprime-backed debt, and the SEC’s charge could both add weight to these claims and spur on new ones. And that is before even considering what the potential fall-out from massive reputational damage could mean, which seems to be a key reason why Goldman’s share price closed 12 per cent lower after the charges were revealed on Friday.
Behemoths like Goldman Sachs can handle one lawsuit filed by the SEC, even if it leads to a large payout. The real cost would come if those lawsuits, settlements, and fines pile up against Goldman, all of which would do further damage to the bank’s reputation—and therefore damage its stock value. If that comes to pass, for Goldman or for another investment bank deeply involved in the oil market, then a commodity sell-off might well be in order, and lower crude and heating oil prices could be imminent.