While the recent revelations of multi-year LIBOR manipulation (but, but how was that possible: it involved thousands of people, operating for years, manipulating numbers - all the traditional reasons presented against conspiracy theory crackpots alleging that manipulation may be going on here, or there, or at the BLS, or somewhere), which we had said had been happening for the past 3 years, confirmed that the entire rate-based derivative market was a giant scam, at least one market spared from cartel whistleblower, i.e., insider, humiliation, was the commodities market. No longer. As the FT first reported [13], a Swiss trading office of Total Oil Trading sent a response letter to IOSCO (the International Organization of Securities Commissions [14]), alleging that the same kinds of market "pricing" shennanigans that have been now exposed to have taken place over bottles of Bollinger, may have been pervasive in the crude market as well.
From the letter which may have set off the same avalanche in the energy markets as the Barclays "settlement" did for rates:
TOTAL is a subscriber to the major PRA services for the energy markets (oil, gas, coal, power, CO2, and biofuels). The work done by the PRAs can generally be considered conscientious and professional. However, the published prices do not always represent those of the market with the same degree of accuracy. This heterogeneity exists both within individual PRAs and between PRAs. As well, the quality of the reporting is not always consistent over time. Finally, while certain PRAs have pricing processes that are reproducible using the underlying data, others do not (the principal difference being the use of “judgement” that may bias prices away rather than toward the market).
Barclays (only one bank for now, soon many others) already showed us in all too criminal (yet neither admitting nor denying guilt) terms what "judgment" means in the context of conflict of "interest rate" price setting. It means precisely the same in the energy market.
And while it was the BBA in the role of ringleader for the Libor scandal, it appears when it comes to commodity price fixing, the entity behind the scenes is Platts:
Very approximately, for all transactions linked to PRA prices, Platts represent 90% to 95% of transactions on crude 85% to 90% of transactions on products, and 85% to 90% of OTC derivative transactions. The remaining share is covered by Argus and other PRAs which are present in niche markets.
Traders, buyers, and marketers depend upon the PRA prices as a source of market references for on-going transactions. Oil market players contribute to the price assessment process by reporting their deals (ensuring the assessed prices take them into account). This interdependence between the PRAs and the oil market players defines the price discovery process.
Platts (the dominant price reporting agency) imposes a methodology that does not furnish a market price (based on the day’s prices) but rather a price to the market.
Sometimes the criteria imposed by PRAs do not assure an accurate representation of the market and consequently deform the real price levels paid at every level of the price chain, including by the consumer. The difference in methodologies between Platts and Argus is the greater integration of the shape of the forward price curve by Platts than by Argus (or ICIS or APPI, etc). Accordingly, when the market is in strong backwardation, Platts spot prices are lower than the rest and in contango they are higher.
Inaccurate pricing is not simply an issue regarding the pricing of OTC contracts. Margins for refiners and retailers as well as prices for end-users are directly impacted by erroneous prices.
The conclusion:
Where these margins are particularly narrow (such as in Europe) the volatility and uncertainty in PRA pricing methodologies can be very detrimental to the financial health of the companies concerned.
We doubt we need to get into the nuances of what happens when a cartel marks prices to a central distribution warehouse instead of market (we have done that already for the CDS market and for LIBOR), and what happens when surreality can no longer be sustained and all these market trading vehciles have to reprice to fair market values. Can one spell margin call driven liquidations?
And there you have it: while the commodity cartel had managed to keep quiet in the golden years, when everyone was making money, now that it is time to cull the competition, one by one the cartel members are stepping up and breaching the fundamental rule of the prisoner's dillemma: don't defect.
And just like in the Libor scandal one defection was enough to destroy the entire Libor-based market, so Total likely set the precedent for everyone else to follow suit and expose their competitors for unfair and potentially illlegal practices. Because if they don't do it first, the risk is someone else will do it to them. Finally, remember that in the new normal, a banker is a lawyer's biggest... enemy [15].
This is the FT's assessment [13]as well, which unsurprisingly exposes the same key cities as have dominated the LIBOR scandal:
The unusually candid public comments by the trading arm of Total have broken the omertà of the energy physical trading industry, a close-knit community in London, Geneva, Singapore and Houston where disputes are usually settled in private.
And for those curious just who the commodity "cartel" consists of, here are some names [16]that would prefer Total never existed (all of which provided response letters to IOSCO praising the pricing mechanism... of course):
- ISDA
- CME
- ICE
- Saudi Aramco
- BP
- ARGUS
- API
- GFMA
- IBGE
- CEAG
- IATA
- ICIS
- LEBA
- Platts
Or, in other words, the entire energy market status quo.
Full Total letter (pdf [16])