How Goldman Sachs was at the center of the oil trading fiasco that bankrupted pipeline giant Semgroup.

When oil prices spiked last summer to $147 a barrel, the biggest corporate casualty was oil pipeline giant Semgroup Holdings, a $14 billion (sales) private firm in Tulsa, Okla. It had racked up $2.4
billion in trading losses betting that oil prices would go down,
including $290 million in accounts personally managed by then chief
executive Thomas Kivisto. Its short positions amounted to the
equivalent of 20% of the nation's crude oil inventories. With the
credit crunch eliminating any hope of meeting a $500 million margin
call, Semgroup filed for bankruptcy on July 22.

But now some of the people involved in cleaning up the financial mess are suggesting that Semgroup's collapse was more than just bad judgment and worse
timing. There is evidence of a malevolent hand at work: oil price
manipulation by traders orchestrating a short squeeze to push up the
price of West Texas Intermediate crude to the point that it would
generate fatal losses in Semgroup's accounts.

"What transpired at Semgroup was no less than a $500 billion fraud on the people of the world," says John Catsimatidis, the billionaire grocer turned oil refiner who is attempting to reorganize Semgroup in
bankruptcy court. The $500 billion is how much the world would have
overpaid for crude had a successful scam pushed up oil prices by $50 a
barrel for 100 days.

What's the evidence of this? Much is circumstantial. Proving oil-trading manipulation is difficult. But numerous people familiar with the events insist that Citibank, Merrill
Lynch and especially Goldman Sachs had knowledge about Semgroup's
trading positions from their vetting of an ill-fated $1.5 billion
private placement deal last spring. "Nothing's been proven, but if
somebody has your book and knows every trade, it would not be difficult
to bet against that book and put the company into a tremendous
liquidity squeeze," says John Tucker, who is representing Kivisto.

What's known for sure is that Goldman Sachs, through J. Aron & Co., its commodities trading arm, was in prime position to use such data--and
profited handsomely from Semgroup's fall. J. Aron was Semgroup's
biggest counterparty, trading both physical oil flowing through
pipelines and paper oil, in the form of options and futures.

When crude oil peaked in July, Semgroup ran out of cash to meet margin requirements on options contracts it had with Aron, contracts on which
it had paper losses of $350 million. Desperate to survive, Semgroup
asked Aron to pony up $430 million it owed on physical oil. Aron said
no, declared Semgroup in default on its contracts and demanded
immediate payment of losses.

Some answers may emerge in late March when former FBI director Louis Freeh releases a report on the trading surrounding Semgroup's demise. He was hired by Semgroup and
given subpoena power by the bankruptcy court judge in Delaware.
Meanwhile the Securities & Exchange Commission is investigating,
and lawyers involved in the bankruptcy say that Manhattan District
Attorney Robert Morgenthau's office is looking into the actions of New
York firms in the collapse. His office declines to comment.

Goldman says only that any allegations of oil price manipulation are "without foundation." Merrill and Citi ( C -

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Goldman and Aron (where Goldman Chief Executive Lloyd Blankfein got his start) have had a deep connection with Semgroup. In 2004 two former Goldman bankers bought a 30% stake in Semgroup for $75 million through
their New York private equity firm, Riverstone. Both men, Pierre
Lapeyre and David Leuschen, had helped form Goldman's commodity trading
business, and Leuschen had been a director at Aron.

In late 2007 Semgroup entered into an oil-trading agreement with Aron. The companies began trading both oil futures and physical crude. Aron sent much of
the oil it bought from Semgroup to a Coffeyville, Kans. refinery in
which Goldman owns a 30% stake.

Semgroup's troubles mounted in the first quarter of 2008, when it had to post $2 billion in margin to cover losses. Goldman offered to underwrite a $1.5 billion private
placement. Kivisto's attorney Tucker and others believe that it was in
the Wall Street research for this offering that Semgroup's trading bets
became fatally exposed. In April the banks (Merrill Lynch and Citibank
were co-underwriters) required that Semgroup submit its trading
positions to a stress test, a process one source describes as a
"proctology exam." Goldman ended up abandoning the placement as
investors balked at braving the liquidity crunch.

Meanwhile the futures markets had gotten wacky. On June 5, with no news catalysts, oil futures spiked $5 a barrel, the biggest one-day jump since the
outbreak of the first Gulf war. The next day, on no news, the price
jumped another $10 to $138. Traders say that in the days leading up to
the $147 peak on July 12 there was the smell of blood in the water. "We
just kept bidding the market higher," one trader says.

According to a trading summary submitted with court documents, Semgroup had entered into some terribly costly trades with Aron. In February 2008
Semgroup sold Aron call options on 500,000 barrels of oil for July
delivery with a strike price of $96 per barrel. That meant that at the
peak Semgroup's loss on each of those barrels was $51, or $25.5 million
on that trade. Goldman says it "can't comment on the trading positions
of counterparties."

Shortly before it filed for bankruptcy, Semgroup sold its trading book to Barclays ( BCS -

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Capital. Barclays' bold bet was that the price of crude would fall,
erasing the losses. It is believed that 30 days later Barclays was
sitting on a $1 billion gain as oil indeed fell, to $114 a barrel.
Barclays wouldn't comment other than to confirm it still owns the book.
That prices plunged after Semgroup failed is more evidence of
manipulation, says Catsimatidis: "With the portfolio in Barclays' hands
they could not squeeze the shorts anymore. The jig was up, and oil
collapsed."

Since the bankruptcy, Aron has agreed to pay Semgroup only $90 million to settle up accounts. That's not enough for the dozens of oil producers who still haven't been paid for $430 million in
oil that Semgroup delivered to Aron. "We sued J. Aron because Semgroup
didn't do it," says Phillip Tholen, chief financial officer of oil
company Samson Resources. "I can't fathom why they wouldn't file
against J. Aron for those monies."

One possible answer: the Goldman connection. Going after Aron's cash would complicate matters with Riverstone, which still wields sway over the board. The creditors
have reason to keep Riverstone and Goldman happy; the duo has teamed up
to buy myriad energy assets in recent years, most notably a $22 billion
leveraged buyout of pipeline king Kinder Morgan. They are likely to
team up again to buy choice Semgroup assets out of bankruptcy.