Oil trading all about profit with no easy fix for the system

The alleged wrongdoing concerning price fixing in the oil industry primarily concerns traders making money off other traders.

Traders in the crude oil and natural gas options pit on the floor of the New York Mercantile Exchange. Spencer Platt / Getty Images / AFP

Raids of oil companies' offices by European investigators in a surprise investigation into price manipulation going back as far as 2002. Immediate, outraged claims by consumer organisations. Last week's events trigger immediate memories of great financial frauds such as Enron or last year's Libor scandal. The hasty assumption, aided by some sloppy journalism, is that oil companies have been colluding to raise prices.
Reuters' Robert Campbell is one of the few to unravel the actual situation, which is both more complicated, and more interesting.
The investigators entered the offices of Shell, BP and Statoil, as well as the price reporting agency Platts. None of these companies has yet been accused of wrongdoing - the suspicion is rather that traders may have gamed the Platts system.
Oil producers and users, such as refineries, use the "paper" market to hedge against the risk of price movements. Without this, oil trade would be almost impossible, too financially risky even for the largest companies. But by taking a loss on physical holdings - real oil in ships or tanks - traders could make profits on much larger paper positions.
The leading crude and refined oil benchmarks - notably the US's West Texas Intermediate and UK's Brent - are sold on regulated exchanges in New York and London. These exchanges, with tightly specified products, highly liquid markets and thousands of mutually anonymous participants, are not vulnerable to the kind of manipulation suspected in last week's case.
But many energy products are unique - different oil grades, delivery points and timings - and may not trade every day, making objective prices impossible to determine. Reporters from price reporting agencies - Platts and its main competitor, Argus - talk to traders and apply their judgement and experience to assess the market. Other than Dubai and Oman, which avoid these problems by using exchange-based pricing, nearly all Middle East crude exporters price their sales against such assessments. The agencies cannot compel traders to talk or to tell the truth; skilled traders can also influence assessments by, for instance, trading in the "window" late in the day, or offering cargoes that are physically impossible to deliver. Yet tighter regulation might make markets even less liquid and so more volatile.
So the alleged wrongdoing primarily concerns traders making money off other traders. Oil companies' trading arms are independent profit centres - indeed, some of the major players, such as Vitol and Glencore, are trading companies first and foremost.
And traders could benefit from influencing prices either higher or lower - this would not have been a systematic attempt to keep prices artificially high. Indeed, The Economist alleged last May that a large Russian trader was manipulating Russian prices - down, not up.
On the other hand, illegal activity would increase the volatility and risk of the oil market and hence increase transaction costs, which would ultimately be passed on to consumers. So this is not a "victimless crime" - and the European Commission is entirely justified in going after any companies or traders shown to have manipulated prices.
Middle Eastern oil exporters would be worried, not about attempts to push prices up, but to keep them low, given, for instance, China's increasing market dominance.
Other than Oman and Dubai, virtually all the region's 17 million barrels per day of exports are referenced against price reporting agencies - not to mention the sizeable trade in refined oil products. Just a dollar per barrel less would cost the Middle East US$6 billion per year.
The European Commission's complex investigation may drag on for years. Meanwhile, the Middle Eastern oil exporters are largely passive bystanders. There is no easy fix to the current system, but they should think hard on how to use their influence to ensure more transparent, stable, competitive markets.
 
Robin Mills is the head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis and Capturing Carbon