I talked to a reporter this evening about the breaking story on how some traders at BP (British Petroleum) attempted to corner a segment of the US propane market. One fellow already pleaded, and it looks like he will bring down some of his colleagues. And given the situation with fuel prices, this will not look good for BP -- even though the events happened in '03 and '04.
But the curious thing -- a twist on the dog that didn't bark -- is that by BP's own admission, they lost money on the strategy!
So take the following scenario. Someone borrows 100 gallons of gas from me, promising to pay me back in a week. Heh, heh, I think....and begin to buy up all the available supply of gas. Come next week, I think, that poor lapdog is going to have to come begging to me to buy the 100 gallons that he needs to pay me back. What fun that will be.
But what if my counterpart is at least as shrewd as the nearest tree, and he anticipates what I might be up to. So he lines up an alternative supplier for the 100 gallons, and when I try to extract my profit from him, he turns to the supplier next door and buys the 100 gallons he needs. I get my 100 gallons, plus I have an extra 100 gallons that I probably had to pay higher prices for.
This sounds like the BP case. They lost money with their strategy because of the high prices they paid for the supply they "cornered" and they also had to hang on to a lot of the supply they bought (they wanted to sell it to the short traders for February delivery, but had to hold onto it into March).
(This is also similar to the classic story of predatory pricing, where one firm holds the price of a product very low, waiting for the competitors to go out of business. The problem is that holding price down costs the predator a lot, and the competitors often have a simple response of letting the predator have all the market at below-cost prices.)
I don't doubt that some of the BP traders might have had in their minds the dreams of a classic corner. They likely even discussed their strategy, which they thought of as a corner. At UCLA, I remember Harold Demsetz saying how businessmen often collude to charge the competitive price. Collusion and corners are hard to implement. Should we punish people for trying? I can certainly understand why the commodities exchange, the CFTC, might want to penalize the traders and the firm -- BP in this case. But should we send them to jail? Seems a little harsh to me. I don't dispute that the effort to corner a market is socially wasteful, but do we really know that these guys were not just doing their price discovery job, but using colorful language to make what might be a dreary day trading job a little more interesting?
The last twist here is that when I started explaining this to the reporter who had called, he clearly lost interest. He was asking me about how often such things must happen, and how damaging they would be (now really, how much do you think consumer prices were affected by propane prices on one set of February 04 contracts for propane in one part of the country?). Just another case of the media looking for a story that will sell, instead of one that will inform?