The result of the attempted corner and price rise was classic substitution on the part of the oil well service companies. After Halliburton blamed the guar price spike for the drop in their Q1 margins they, Schlumberger and Baker Hughes all began developing substitutes for the humble bean. From HAL's Sept. 4 Q3 profit warning:
The other two-thirds of the margin depression was due to the jump in prices for a key hydraulic fracturing ingredient, guar. McCollum reiterated that high guar prices would weigh on North American margins throughout the rest of this year.The other effect was a rush in India to plant guar rather than foodstuffs with the result that guar has given back 2/3 of the 900% price rise and farmers are in the position of not being able to cover the costs of inputs. There's no doubt that the situation will add to the epidemic of suicides among farmers which passed the quarter-million mark last year.
"I suspect that there won't be significant relief from guar pricing in the fourth quarter," he said, while noting the recent good news of rain in India, the world's dominant supplier of guar beans.
"All indications suggest that we should see a significant moderation in guar pricing as we go into 2013," he added.
McCollum said a positive aspect was that Halliburton's substitute for guar, PermStim, met 5 percent of its guar demand in the second quarter, and the uptake had been even more dramatic in the current quarter. Rival Baker Hughes Inc has reported similar success with its own guar substitute.
The recent guar trading scandal gives a peek into the murky world of Indian commodity futures
markets and reveals how commodity exchanges are acting like casinos for speculators, moving
away from their avowed objectives of price discovery and price risk management in an efficient and orderly manner.
Guar (Cyamopsis tetragonoloba) is a drought resistant crop grown mainly in Rajasthan and parts of Haryana and Punjab. The sowing season for guar seed begins in July and the crop is ready for harvesting in October. Most guar farmers sell their produce to traders at the farm gate and nearby markets. A part of produce is also kept by farmers for seed, animal feed and fodder purposes. India is the largest producer of guar seed in the world and accounts for 80 percent of the world’s total guar seed production. Guar gum, extracted from guar seed, is used as a thickening agent and additive in food products such as soups and ice-creams. Of late, the global demand for guar gum is growing rapidly because of its use in “hydraulic fracking” process to extract oil and gas from shale. Almost 80 percent of country’s total production is exported to US, China and Europe.
Considered as a narrow commodity due to its limited potential for cultivation in peculiar agroclimatic conditions, the total area under guar seed production was 2.9 million hectares in 2011. The prices of guar seed and guar gum vary from year to year depending on the monsoon conditions. Since 2004, guar seed and guar gum contracts are being traded in the Indian commodity futures markets.
The Abnormal Price Rise
Guar seed and guar gum prices rose at an extraordinary rate during the six months period between October 2011 and March 2012. On October 1, 2011, guar seed was selling at Rs.4263 (US$177) per quintal (100 kilograms).
By March 2012, the guar seed prices had touched a high of Rs.32000 per quintal. The prices of guar gum surged almost 900 percent in the futures markets, from Rs.11230 per quintal on November 11, 2011 to Rs.98350 per quintal in March 2012. The trading in guar gum was hitting the upper circuit almost every other day in the futures markets during February- March 2012.
There is no denying the fact that strong export demand for guar products pushed up prices in the first four weeks but a 900 percent price increase cannot be attributed solely to this factor. The key factor behind the massive increase in guar prices was the excessive speculation – totally disproportionate to hedging activities of these two commodities in the futures markets.
The Forward Markets Commission (FMC) – the statutory body which regulates commodity derivatives trading in India – found huge disparity between the ratio of open interest and the volume of trading in guar seed and guar gum contracts. The day trading volumes were far in excess of open interest, clearly indicating the pre-dominance of speculative trading in both commodities.
Such was the magnitude of speculative buying (coupled with market manipulation through circular trading, cross deals and other abusive practices) that the trade multiples in guar futures contracts reached close to 700. In other words, twice the size of annual production of the crop was traded in the futures markets on a single day.
The Modus Operandi
Betting on a strong export demand and limited domestic production, speculators and non-commercial players were able to corner a sizeable share of the guar futures trading by buying large futures contracts through related entities – with common postal and Internet Protocol addresses. This trading through related entities was deliberately carried out to manipulate the prices in a coordinated manner in future.
Large traders in the futures markets in
collusion with spot market traders
managed to hoard a sizeable portion of
physical stocks and thereby created an
artificial shortage in the spot markets.
According to Nidhi Nath Srinivas, Commodities Editor of The Economic Times, five large traders used 45 related entities to corner 3 percent of the total monthly volume of guar trading in the futures markets. The FMC as well as commodity exchanges took no action at that time to stop these irregularities.
The market observers have noted that the bulk of speculative buying in guar futures contracts was financed by non-bank finance companies, linked to financial conglomerates providing brokerage and unsecured lending to large traders. Recognizing the fact that a surge in guar futures prices cannot be sustained unless the spot (physical) market prices are influenced, speculators and non-commercial players sought delivery from sellers in the futures markets. With the result, sellers rushed to the spot markets to cover their positions which, in turn, triggered a sharp rise in spot market prices.
In addition, large traders in the futures markets in collusion with spot market traders managed to hoard a sizeable portion of physical stocks and thereby created an artificial shortage in the spot markets. In a report to Ministry of Consumer Affairs, Food and Public Distribution, the FMC has claimed that nearly 90 percent of hoarding of guar stocks in private godowns/warehouses was financed by private banks. Although these loans were primarily given to traders, private banks treated them as
agricultural loans in order to meet the priority sector lending norms. A large number of rogue brokers were also found to be involved in frequent client code modification (transferring a transaction from on client to another) for tax and regulatory avoidance purposes. In March 2012 alone, transactions worth Rs.145700 million were reportedly involved in such practices.
It needs to be emphasized here that the purchase of guar gum by the US oil and gas drilling industry actually declined from February 2012 onwards. But surprisingly this major development had no effect on the guar prices in both futures and spot markets. Thus, the widely held notion that market prices are determined by fundamentals (the interaction of demand and supply) proved untenable in the case of guar futures trading.
A Bonanza for Speculators
Within a span of few weeks, speculators, non-commercial traders and day traders – who had no genuine interest or exposure in the underlying commodity – earned huge profits from trading in guar seed and guar gum futures contracts. According to media reports, the investigations carried out by FMC found 4490 entities were involved in guar gum price manipulation and they together made profits of Rs.12910 million....MORE (8 page PDF)