August 4, 2013 4:17 pm
Oil markets: The danger of distortion
Governments are deliberating whether to impose more supervision, writes Ajay Makan
©Alamy
Warped system: oil prices are notoriously hard to track and some companies do not co-operate with the price reporters
As Opec ministers gathered in Vienna in May to discuss the oil market, one man stood out. On the terraces and in the lobbies of the grand hotels favoured by members of the oil producers’ cartel, Jorge Montepeque was holding court.
A Guatemalan-born US citizen with a fiery temper and sharp tongue, Mr Montepeque is the architect of the system that now underpins global trade in oil. In Vienna he was his ebullient self, stopping at tables to swap gossip between meetings. But for Mr Montepeque this was no normal Opec gathering.
Two weeks earlier the European Commission had swooped on offices across Europe in pursuit of any evidence of price fixing in oil markets. Along with the oil majors BP, Royal Dutch Shell and Statoil, and the Dutch trader Argos Energies, officials raided the Canary Wharf headquarters of Platts – the price reporting agency where Mr Montepeque has worked for decades.
The raids earned the oil market comparisons with Libor, the discredited interest rate rigged by some of the world’s biggest banks for years. They came as governments were already weighing direct supervision of the unregulated trade in physical oil. And they have added to fears among some participants that the market is only likely to become more opaque, if traders stop co-operating with price reporting agencies.
Platts, a relatively small cog in New York-listed McGraw-Hill Financial, proudly calls itself an organisation of journalists. Yet Platts has more importance to the giant energy companies, trading houses and investment banks that trade oil than any other media organisation.
Platts reporters monitor bids and offers for products from the blends that make up Dated Brent – the international crude benchmark – to jet fuel. Each day they publish prices or “assessments” that are used by traders to price oil deals worldwide.
A Platts assessment underpins the Brent futures market, used by airlines to protect against price moves and by hedge funds to speculate; the British government uses Platts assessments to calculate taxes on oil producers; and ultimately Platts’ prices play a part in the cost of petrol at the pump.
Traders say that gives Mr Montepeque great power.
“You need to have a dialogue with Jorge. If you don’t, he could keep you out [of the oil market] forever,” says an executive at a large Swiss-based commodity trading house.
Platts executives, who responded on his behalf, acknowledge Mr Montepeque’s outsize profile but play down his actual power: “No one would deny that Jorge is a big personality in the oil market but decisions do not rest with one person,” says Dan Tanz, head of editorial.
Prices in the oil market are notoriously difficult to track. Trade is fragmented into hundreds of different blends of crude oil and regional markets for refined products, such as petrol and diesel.
Individual reporters at companies such as Platts are responsible for assessing many thinly traded markets at the same time. Traders can choose which transactions to report and, with billions of dollars at stake, there is a strong incentive to fix prices.
“The game of having a leveraged position in the futures market and then trying to change the Platts price by a few cents is as old as the market itself,” says one trader.
Some companies do not co-operate with price reporters at all. If no transactions take place in a market on a given day reporters have to estimate prices based on quotes, introducing a subjectivity to the process that is unpopular with regulators after Libor.
Mr Montepeque is credited with bringing order to a market that had previously relied even more on judgment. He designed what is known as the “Platts window” in Singapore in the 1990s, before introducing it to the European and US markets.
As global director for market reporting in London, Mr Montepeque continues to oversee and fine tune the methodology and, with colleagues, reviews applications from traders wishing to submit prices.
In the window – a tightly controlled 30-minute period at the end of the day – authorised companies electronically submit bids and offers to Platts reporters. If those bids are met, a company has to trade. Platts is free to publish all data.
“Let’s be clear – the window is more rigorous, more transparent and more accurate than what went before,” says one veteran trader, who is otherwise critical of Mr Montepeque.
But Mr Montepeque’s system is now at the centre of a European Commission competition probe. Pannonia Ethanol, a Hungarian company, has complained that it was denied access to the window for ethanol trading, and at least two of the raids focused on ethanol market records, according to people familiar with the situation.
Platts declines to say why Pannonia was refused entry to the window but says the application process is clear-cut and clearly communicated to candidates. Companies already active in the window would have been consulted on whether Pannonia had a record of trading ethanol, but traders cannot veto new entrants.
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In addition to examining access, investigators are looking for evidence of price rigging. This might involve attempts to move a price up or down by just a few cents, for example, by submitting unrealistic bids or offers or concluding transactions away from the prevailing price. Platts says its price reporters disregard prices unrepresentative of the market, making it hard for contributors to manipulate its assessments.
Still, regulators’ scrutiny of the physical oil market has been growing ever since oil prices hit record levels in 2008. The Commisison investigation has also drawn the glare of the press.
Under instruction from the G20, Iosco, an umbrella body of market regulators, published a code of conduct for oil-price reporting agencies last year. Companies such as Platts are now undergoing their first external audits by accountants.
The European Commission is working on separate proposals, which are set to be far more radical. A draft leaked in June would make both traders that submit quotes and the reporters that publish them legally liable for any losses in derivative markets resulting from incorrect prices. The formal proposal is expected in September.
All this is forcing price reporters to change. Platts will soon publish requirements for access to the window for the first time.
“Platts has become much more process-oriented and we recognise the need to evidence that to our stakeholders, including regulators,” says Mr Tanz.
Trading oil is not for the faint-hearted. Single companies may be responsible for selling the entire output of a single country. The resulting power and wealth breeds confidence.
Price reporters have a certain swagger, describing how their window allows complex markets to operate.
“Unlike virtually every other commodity market, it is simply not possible to create a standardised trading environment for physical oil,” says Dave Ernsberger, the global director of Platts’ oil business who was brought in to temper Mr Montepeque’s abrupt style.
A common gripe among traders is that there is no way to appeal when they disagree with a published Platts’ Price. The same goes for Platts’ ability to exclude a party from the window in a process known as “boxing”. Boxing cannot only impair a trader’s ability to transact in a given market – as some counterparties prefer to trade within the window to influence prices – it can also raise questions about a company’s solvency.
At the height of the financial crisis Platts restricted the access of both Goldman Sachs and Morgan Stanley to the window, with Mr Montepeque arguing that oil companies did not want to trade with banks. The move added to concerns about the banks’ creditworthiness when they were already under huge pressure.
“We want these [price reporters] to feel some kind of needle in their back, that somebody’s watching them, so they cannot do anything they want. These are private companies, they are unregulated, they are people who do not have to give an account to anybody of what they do,” says an executive at one energy company.
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According to price reporters, the availability of oil prices itself is now at stake. In a document circulated among regulators in Brussels, a rival of Platts argues that traders will stop sharing quotes if the European Commission draft proposals are enforced.
“Physical energy market participants would instead opt to trade privately ... that would mean a return to opacity in oil and other energy markets,” says London-based Argus.
In the absence of accurate physical prices, derivative markets would also be compromised, making it harder to hedge against price moves effectively.
An executive at a Swiss-based trading house says: “[Legal liability] would make people more cautious about submitting data and that would mean the prices you get are not the most accurate representation.”
Even rival regulators are cautious about Brussels’ approach. Alp Eroglu, who is leading Iosco’s reform process, said shortly after the Commisison raids on oil companies and Platts: “As regulators you need to punch but not kill. A big concern is that people will stop participating [in the window].”
The threat to the system can be overstated. The Commission may row back from its more radical ideas when it publishes its formal proposals in September. Any regulation would then have to be passed by the European parliament.
The Platts window has also proved remarkably resilient to the barrage of negative publicity. Co-operation with price reporters is the only way companies have of influencing published prices and that is something traders say they will not give up lightly.
Many oil producers also remain committed to the price-reporting model. Assessments directly influence government revenues in countries such as Saudi Arabia and Kuwait, which sell much of their output at prices derived from assessments by Platts or Argus.
In Vienna officials from Gulf states said they had no intention of changing the way they price exports. Some suggest regulators should keep out of the physical oil market altogether.
When Iosco published a report last year, Saudi Aramco shot back: “Lack of understanding permeates the document ... It appears [to] have been drafted by financial market regulators who have no genuine understanding of physical commodity markets.”
But for Mr Montepeque, these are trying times. Having resisted the attempts of energy companies, commodity traders and the governments of oil producers to limit his role in the oil market for more than a decade, it may be government action – and public opinion – that proves decisive.
Rate rigging: Libor comparisons go only so far
For politicians and pundits, comparisons between the alleged manipulation of oil prices and the rigging of interbank lending rates have proved irresistible.
“This problem has similarities with the benchmarks in the financial sector and with the investigations we are carrying out on Libor,” Joaquin Almunia, the EU competition commissioner, said after he ordered raids on oil majors and Platts in May.
Like Libor, which three of the world’s largest banks have admitted to rigging for several years, oil prices published by companies such as Platts are often based on quotes, rather than actual transactions.
And, as in the Libor scandal, regulators have targeted some of the most famous companies in the world. For Barclays and Royal Bank of Scotland, read BP and Shell.
Whereas banks’ Libor submissions did not represent commitments to lend or borrow, oil traders are required to transact if any bids or offers they submit to Platts meet willing buyers or sellers. That should discourage participants from submitting outrageous quotes in an effort to influence prices.
Another difference lies in the role of the price reporter. The British Bankers’ Association, which published Libor rates, took a trimmed average of submissions which was supposed to knock out off-market bids. Commodity price reporters portray this method as formulaic and say their reporters are instructed to actively consider whether every bid or offer represents the market.
Platts executives argue this distinction is crucial, and that it means oil prices are far less prone to manipulation than financial benchmarks.
“Absent judgment you are left with a mechanical system which takes you into the world of Libor,” says Dan Tanz, vice-president for editorial at Platts, in an explicit rejection of the comparison that has infuriated many in the industry.
Whatever their differences, however, the energy and finance industries do now face a common challenge: finding a transaction-based method for assessing benchmarks, which will satisfy regulators’ demands for transparency in the aftermath of the financial crisis.
Copyright The Financial Times Limited 2013.
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