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Oil-fixing probe risks further muddying the waters

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It's that old oil cartel again. David Cameron, the British Prime Minister thumped the table yesterday, threatening to introduce criminal sanctions against oil market rigging. His bark was a bit late because the European Commission has already bitten, or at least swooped. Earlier this week, the Commission's anti-trust officials conducted dawn raids on three European oil majors, searching for evidence that crude oil traders had colluded in fixing benchmark prices quoted by Platts, the oil price reporting agency. Consumer and motoring lobbyists are demanding the scalps of big oil, but no one seems to have any good ideas about how to run a better oil market.

At issue is Brent, a benchmark price quoted daily by Platts journalists who observe bid and offer prices for volumes of Brent crude oil that appear in a half hour "window" at the end of the day. These are voluntarily submitted, mostly by a handful of big oil companies and commodity traders. There is no obligation to submit prices to Platts and the volume of Brent trade has been dwindling for years as the wells run dry. So problematic has been the oilfield decline that Platts has been forced to include other oils into the mix. "Brent" is now Brent, Forties, Oseberg and Ekofisk (BFOE) but the decline continues and there has even been suggestions that West African crude or Russian crude should be included to maintain market liquidity.

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The Platts price is an assessment – the journalists can exclude anomalous bids and can even bar companies from taking part, if they feel their bids are not credible. During the financial crash, one large player was excluded due to rumours about its solvency. If it sounds like a curious way to run a market, you are missing the point. It is not a market but merely an observation, a snatch photograph of a market happening. We don't know what occured before or after the picture was taken and we don't know what is happening beyond the tiny frame.

From this half-hour photograph is derived the price of almost every barrel of oil outside of North America. West African, central Asian and Far Eastern crudes are all valued at prices above or below Brent. It even affects North Americans because gasoline prices on the US East coast tend to be driven not by the mid-West oil market but by North Atlantic oil market and that means Brent. It also affects the huge balloon of oil derivatives because commodity futures must in the end touch down at the price of the underlying commodity; Brent futures contracts are settled with a price provided by Platts.

There is therefore every incentive for traders to influence the Platts Brent price by misreporting or not reporting. If it sounds a bit messy and prone to manipulation, it is worth remembering how it used to be. In the bad old days, the oil majors would simply post prices at which they would buy and sell crude, and tended to post the same prices. For their clubby intertwined relationships, they were dubbed the "Seven Sisters." Curiously, the Sisters kept crude oil prices low in order to benefit their refining and gasoline-selling activities. The Arab nations became fed up with their meagre share of the ultimate fuel price and, in order to redress the balance, they created OPEC. A cartel that was keeping the oil price low was replaced by another cartel intent on keeping the price high.

We have moved on to something a bit more sophisticated, but it is not clear where we go from here. If the G8 and the European Commission want a regulated market, they first need to capture it. Oil is not fungible like shares or bonds. It is a fragmented commodity of different grades, qualities and values that cannot be corralled into a single unified exchange. Were a regulatory body to attempt to impose such a structure, the market would vanish, just like street vendors at the arrival of a curious policeman.

Alternatives to the dwindling Brent benchmark are already proposed in Russia, Dubai, Singapore and Shanghai. It is a moot point to what extent these venues will offer better regulated oil trading. If the Commission and the U.S. Commodity Futures Trading Commission (CFTC) are clever, they will focus on enforcing more transparency, and keep regulation on the back foot.

Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.

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About the Author

Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K. With a career spanning investment banking, journalism and consulting for global companies, he was for many years a financial writer and columnist for The Times of London. More

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