In re Crude Oil Commodity Futures Litig.

913 F.Supp.2d 41

In re CRUDE OIL COMMODITY FUTURES LITIGATION. This Document Relates to: All Actions.

Master File No. 11 Civ. 3600(WHP).

United States District Court, S.D. New York.

Dec. 21, 2012.

Bernard Persky, Hollis L. Salzman, William V. Reiss, Robins, Kaplan, Miller & Ciresi, LLP, Kellie Lerner, Labaton Sucharow & Rudoff LLP, Steven R. Goldberg, Steven R. Goldberg, Attorney-at-Law, Samuel Fawkner Abernethy, Stephen David Houck, Menaker & Herrmann LLP, John Douglas Richards, Pomerantz Haudek Block Grossman & Gross LLP, Linda P. Nussbaum, Jay W. Eisenhofer, John D. Radice, Grant & Eisenhofer P.A., Nicholas R. Diamand, Lieff Cabraser Heimann & Bernstein, LLP, Rebecca Sol Tinio, U.S. Attorney's Office, David K. Bowles, Di Santo Bowles Bruno & Lutzer LLP, Daniel Hume, David E. Kovel, Roger W. Kirby, Kirby McInerney LLP, Deborah M. Sturman, Milberg LLP, Christopher J. Gray, Law Office of Christopher J. Gray, P.C., Leslie Scot Wybiral, Louis Fox Burke, Louis F. Burke PC, Christopher Lovell, Christopher Michael McGrath, Lovell Stewart Halebian Jacobson LLP, Frank Rocco Schirripa, Michael A. Rose, Hach Rose Schumacher Schirripa & Cheverie LLP, New York, NY, Brendan Patrick Glackin, Eric B. Fastiff, Joseph Richard Saveri, Lieff Cabraser Heimann & Bernstein, LLP, San Francisco, NY, Eric L. Cramer, Merrill G. Davidoff, Michael Dell'Angelo, Berger & Montague, P.C., Deborah R. Gross, Law Offices Bernard M. Gross, P.C., Philadelphia, PA, Andrew S. Hicks, Schiffer Odom Hicks & Johnson, PLLC, Stephen D. Susman, Susman Godfrey LLP, Houston, TX, Daniel H. Charest, David D. Shank, Terrell Wallace Oxford, Warren T. Burns, Susman Godfrey LLP, Dallas, TX, Vincent Briganti, Lowey Dannenberg Cohen & Hart, P.C., White Plains, NY, W. Joseph Bruckner, Lockridge, Grindal, Nauen & Holstein, P.L.L.P., Minneapolis, MN, David Matthew McGlone, Preti Flaherty, Boston, MA, Elizabeth Anne Campbell, Gregory P. Hansel, Randall B. Weill, Preti Flaherty Beliveau Pachios & Haley, LLP, Portland, ME, Benjamin D. Brown, Christopher J. Cormier, Daniel A. Small, Kit A. Pierson, Michael D. Hausfeld, Ralph Johnson Bunche, III, Cohen, Milstein, Hausfeld & Toll, PLLC, William P. Butterfield, Seth Rich Gassman, Hausfeld LLP, Washington, DC, Samuel Howard Rudman, Robbins Geller Rudman & Dowd LLP, Melville, NY, for Plaintiffs.

Brigitte T. Kocheny, Elizabeth M. Bradshaw, Timothy J. Carey, Winston & Strawn LLP, Chicago, IL, Fred F. Fielding, Levi McAllister, Mark R. Haskell, Morgan, Lewis & Bockius LLP, Washington, DC, for Defendants.

MEMORANDUM & ORDER

WILLIAM H. PAULEY III, District Judge:

This putative class action asserts violations of section 2 of the Sherman Act, 15 U.S.C. § 2, and the Commodities Exchange Act (“CEA”), 7 U.S.C. § 13 et seq., stemming from the alleged manipulation of West Texas Intermediate grade (“WTI”) crude oil prices in 2008. Defendants move to dismiss the Consolidated Amended Class Action Complaint, dated May 29, 2012 (the “Complaint”) under Federal Rule of Civil Procedure 12(b)(6). For the following reasons, Defendants' motion to dismiss the Complaint is denied.

BACKGROUND

The Complaint recounts substantially the same events at issue in an enforcement action by the United States Commodity Futures Trading Commission (the “CFTC Action”). See U.S. Commodity Futures Trading Comm'n v. Parnon Energy Inc., 875 F.Supp.2d 233, 236–40 (S.D.N.Y.2012) (denying Parnon's motion to dismiss). Plaintiffs' factual allegations are accepted as true for the purpose of this motion.

I. The WTI Physical Market and the WTI Futures Market

The Complaint identifies two closely-related markets: the “physical” or “cash” market for WTI crude oil, in which actual barrels of crude oil are bought and sold for commercial use and the WTI “futures” or “derivatives” market, in which investors trade contracts for future delivery of WTI crude oil.

Unlike the physical WTI market, the WTI futures market rarely involves the actual delivery of crude oil. Instead, participants trade “long” and “short” positions in WTI futures contracts. WTI futures are traded on several exchanges, including the New York Mercantile Exchange (“NYMEX”) (Compl. ¶ 1.) A NYMEX WTI futures contract is an agreement for the purchase or sale of WTI on a fixed date in the future in Gushing, Oklahoma. The earliest delivery month for a futures contract is the “near” month. The seller of a futures contract, i.e., the person committed to deliver the commodity in the future, is in the “short” position. (Compl. ¶ 27.) Conversely, the buyer committed to accept delivery is in the “long” position. (Compl. ¶ 27.) In theory, WTI can be actually delivered under a futures contract, but investors almost always settle futures contracts financially prior to the close of trading for a given contract, which is known as the “expiry date.” The expiry date for NYMEX WTI futures contracts is the third business day prior to the twenty-fifth calendar day of the month preceding the delivery month. (Compl. ¶ 37.)

To liquidate their holdings and realize profits on their positions, investors enter into an offsetting futures contract for the same quantity of the commodity:

Thus, a short who does not intend to deliver the commodity must purchase an equal number of long contracts; a long must sell an equal number of short contracts. Money is made or lost in the price different[ial] between the original contract and the offsetting transaction. If the price of the future has declined, usually because of market information indicating a drop in the price of the commodity, the short will realize a profit; if the futures price has risen, the long will realize a profit.

Leist v. Simplot, 638 F.2d 283, 286 (2d Cir.1980). Except for price and quantity, every aspect of a NYMEX WTI futures contract is standardized, and all NYMEX WTI futures contracts trade in thousand-barrel lots. (Compl. ¶¶ 26, 34.)

A spread contract is another way investors in the WTI futures market can profit from fluctuating crude oil prices. One type of spread is a “calendar spread” consisting of alternating positions in two consecutive futures contracts. (Compl. ¶ 40.) A “long” calendar spread obligates the holder to accept delivery of WTI in a future month and sell the same quantity of WTI in the subsequent month. (Compl. ¶ 40.) Conversely, a “short” calendar spread obligates the holder to deliver WTI in a future month and accept delivery of the same quantity in the subsequent month. (Compl. ¶ 40.) Traders realize a profit on a calendar spread when they predict correctly whether the price of WTI in the second month will go up (a long spread) or down (a short spread) compared to the price in the first month. The greater the fluctuation in price between the two months, the more profit the investor realizes.

In contrast to the WTI futures market, participants in the WTI cash market purchase physical contracts under which WTI is actually delivered the following month in Cushing. Physical contracts are traded until the end of the third business day following the expiry date of the near month NYMEX WTI futures contracts. (Compl. ¶ 44.) This three-day period following the expiry date is known as the “cash window.” (Compl. ¶ 44.) Most commercial users of crude oil complete their purchases or sales of crude oil needed for the following month before the cash window opens. (Compl. ¶ 45.)

II. Contango v. Backwardation

To understand the complex price manipulation and monopolization scheme alleged in the Complaint, it is necessary to plumb two futures pricing scenarios: “contango” and “backwardation.” For most commodities, the price of a futures contract includes such carrying costs as storage, insurance, financing, and other expenses the producer incurs as the commodity awaits delivery. Thus, typically, the further in the future the delivery date, the greater the purchase price of the futures contract. That relationship is known as “contango.” See Virginia B. Morris and Kenneth M. Morris, Standard & Poor's Dictionary of Financial Terms 41 (2007); see also Barbara J. Etzel, Webster's New World Finance and Investment Dictionary 74 (2003) (“contango[:] A pricing situation in which the prices of futures contracts are higher the further out the maturities are. This is the normal pricing pattern because carrying charges such as storage, interest expense, and insurance have to be paid in order to hold onto a commodity.”).

Near-term supply of crude oil is generally inelastic because supply in the near term does not increase even if prices rise significantly. Long-term supply, on the other hand, is elastic because it can usually increase to meet market prices. Thus, if there is a shortage or tightness in immediate supply, traders are willing to pay a higher premium for near-term supply relative to long-term supply. Such a market condition is the opposite of contango and is called “backwardation.” See Jerry M. Rosenberg, Dictionary of Banking and Finance 41 (1982) (“backwardation: a basic pricing system in commodities futures trading. A price structure in which the nearer deliveries of a commodity cost more than contracts that are due to mature many months in the future. A backwardation price pattern occurs mainly because the demand for supplies in the near future is greater than demand for supplies at some distant time.”).

III. The Parties

Plaintiffs Gregory Galan, John Losordo, Jr., FTC Capital GmbH, Todd Kramer, and Adams Affiliates, Inc. are individuals and corporate entities that traded NYMEX WTI futures contracts and calendar spreads in 2008. (Compl. ¶¶ 12–16.) Defendants Parnon Energy Inc., Arcadia Petroleum LTD, and Arcadia Energy (Suisse) SA, (collectively, “Parnon”), are wholly-owned subsidiaries of Farahead Holdings Ltd. and operate as a single enterprise to trade in physical and futures contracts for crude oil, including WTI. (Compl. ¶¶ 17–19.) Defendants Nicholas J. Wildgoose and James T. Dyer were responsible for Parnon's WTI trading strategy during the...