Straining to solve a problem that might be illusory, European regulators soon might create real problems by increasing the volatility of an important crude oil price marker.
The European Commission in September proposed regulations covering indices and benchmarks in financial instruments and contracts. The move responded to scandals of 2012 involving manipulation of interest-rate benchmarks, including the London Interbank Offered Rate (LIBOR) and Euro Interbank Offered Rate (EIOR), important in global financial evaluation. Worried that shenanigans might reach beyond financial markets, the EC expanded its proposal to encompass commodities, including oil.
Under relevant parts of the EC proposal, market participants who provide information to price reporters such as Platts would fall subject to direct regulation by the European Union and face unlimited financial liability for their disclosures. For transactions used in calculations of price indices, participation by information suppliers would be limited in size and value. Price reporters would be required to report suspicious behavior by their information sources to EU authorities.
These measures address a market that isn't perfect and never has been. It's a market with a unique structure combining forward cash and dated physical transactions to enable buyers and sellers to settle prices without knowing exactly when tanker loadings will occur. The system accommodates physical limitations of North Sea terminals.
The Brent market adapts not only to logistical realities but also to production declines from legacy fields on Europe's continental shelves. What's still called Brent crude is now a blend of production from Brent, Forties, Oseberg, and Ekofisk fields, abbreviated BFOE. The Brent market is practical but opaque; prices of many Brent deals aren't disclosed. Despite these peculiarities, Brent remains the eminent benchmark for oil valuations worldwide.
In a market with limited transparency, price discovery is a legitimate concern for regulators. The widely quoted and greatly influential Brent price is a product of judgment and interpretation. Lacking comprehensive sales-price information, the reporting agencies combine information from traders and other sources with their own analytical methods to derive values they think best represent market conditions. Obviously, the potential exists for market participants to manipulate prices—actually reported assessments—by lying to the price reporters. Users of the published price information must rely on the reporting agency's ability, through skill and internal controls, to identify and reject bad information.
After the banking collapse of 2008 and LIBOR-EIOR scandals of 2012, official suspicion runs high. In May, the EC and European Free Trade Association Surveillance Authority unveiled investigations into suspicions that representatives of Shell, BP, and Statoil had distorted trading information they provided Platts. Results of those probes have yet to be reported.
Because the benchmark affects values of much of what they sell, producers and refiners should want the market for Brent crude to work as efficiently, transparently, and honestly as possible. The EC initiative would not achieve those aims. The proposed requirements would restrict the flow of information. The reported price of the Brent family of crudes, newly subject to information more intermittent and less valid than what's available now, gain volatility and lose its connections with circumstances in the market. Many market participations say parts of the proposal would be impracticable. Adoption of the proposal in current form thus would not represent progress.
This month, the European Parliament's Economic and Monetary Affairs Committee is deliberating amendments to the proposal that were due in mid-December. The EC hopes work on its benchmark reforms will be complete before European elections scheduled in May.
In its rush, the EC is treating commodity and financial markets as functional equivalents, which they're not. It's overlooking physical realities that shaped the Brent market. And it's assuming that a potential for mischief automatically means mischief occurs. The approach is heavy on enforcement, light on practicality, and heedless of the tendency of frantic bureaucracies to do more harm than good. The imperfect Brent market indeed might need improvement. That's not what the EC now proposes.
