what he called the “odd insight” that provided a lightbulb moment: on flights to China, he had noticed continuing improvements in the standards and quality of service, rising toward world levels. “Rightly or wrong, I associated that with China’s involvement.” Something new was happening in the world economy.
Initially, many people found the whole concept of BRICs wacky. They shook their heads and asked what these diverse countries could possibly have in common. “They thought it was just some kind of marketing gimmick,” said O’Neill. But by 2004 the concept of BRICs was providing a different—and powerful and compelling—framework for looking at the world economy and international growth. Competing banks, which had previously made fun of the idea, were now launching their own BRIC funds. And in the ultimate stamp of approval, leaders of the four BRIC-anointed countries eventually started to meet for their own exclusive BRICs-only summits.
“BRICS,” said the Financial Times, became “a near ubiquitous term, shaping how a generation of investors, financiers and policymakers view the emerging markets.” Investors started to buy equities linked to the BRICs. They also bought financial instruments linked to oil. For the growth of these countries—especially the “C,” China—was driving the demand for commodities and thus prices. Thus for investors—whether running hedge funds or pension funds, or retail investors—the commodity play was not just about oil itself, but about the booming economies that were using more and more oil.10
TRADING PLACES
And now there were a lot more people in the oil market—the paper barrel part of the market—investing with no intention nor any need of ever taking delivery of the physical commodity. There were pension funds and hedge funds and sovereign wealth funds. There were the “massive passives”—the commodity index funds, heavily weighted to oil and with all the derivative trading around them. There were also exchange-traded funds; there were high net-worth individuals; and there were all sorts of other investors and traders, some of them in for the long term, and some of them very short term.
Oil was no longer just a physical commodity, required to fuel cars and airplanes. It really had become something new—and much more abstract. Now these paper barrels were also, in the form of futures and derivatives, a financial instrument, a financial asset. As such, prudent investors could diversify beyond stocks, bonds, and real estate, by shifting money into this new asset class.
Economic growth and financialization soon came together to start lifting the oil price higher. With that came more volatility, more fluctuations in the price, which was drawing in the traders. These were the nimble players who would, with hair-trigger timing, dart in and out to take advantage of the smallest anomalies and mispricings within these markets.
This financialization was reinforced by a technological push. Traditionally, oil had been traded in the pit at the NYMEX by floor traders, wearing variously colored jackets, yelling themselves hoarse, wildly waving their arms and making strange hand gestures, all of which was aimed at registering their buys and sells. This system was called “open outcry,” and it was enormously clamorous.
But around 2005 the importance of the floor traders began to decline rapidly with the introduction of the electronic trading platforms, which directly connected buyers and sellers through their computers. Now it was just push a button and the trade was done, instantaneously. Even the “button” was a metaphor, for frequently the trade was executed by a commodity fund’s algorithmic black box, operating in microseconds and never needing any sleep, let alone any human intervention once it had been programmed. The paper barrel had become the electronic barrel.11
OVER THE COUNTER
Futures contracts on commodity exchanges were only part of the new trading world. There were also over-the-counter markets, which did not have the regulatory and disclosure requirements of the futures market. Those who were critical of them dubbed them the “dark markets” because of this lack of regulatory oversight and transparency, and because they were suspicious of how they worked and of their impact. These were, after all, a form of financial derivative—a financial asset whose price is derived from one or more underlying asset. The cumulative risk and systemic impact of such derivatives could be very large because of their leverage, complexity, and lack of transparency.
The over-the-counter off-exchange markets were the place for tailored, bespoke transactions where participants could buy oil derivatives of one kind or another, specifically designed to meet a particular market need or investment strategy. Banks became the “swap dealers,” facilitating the swapping of one security, currency, or type of