The oil market has worrying echoes of the Libor scandal

THE oil trader had a crystal-clear order to his lieutenant: “Make sure you start talking the (market) down.” He did that, and a lot more, submitting “false and misleading” bids and offers to manipulate a key US oil benchmark, making millions in profits. The Glencore traders rigged US fuel-oil prices for nearly five years before they were caught, according to a plea agreement between the company and the US Department of Justice.

It wasn’t the only malfeasance engulfing that particular benchmark. In the past four years, the Commodity Futures Trading Commission has fined all of the top three oil trading houses for either successfully manipulating the fuel-oil market or, at the very least, trying to influence pricing via elaborate schemes. The US regulator slapped fines on Vitol Group in 2020; in 2022, it did the same to Glencore; and only last week, it fined Trafigura Group too.

Three major scandals in relatively quick succession, along similar lines and involving the industry’s biggest players, suggest the misconduct can’t be brushed aside as one-offs; instead, they indicate a systemic problem that regulators should address. Something is rotten in the market.

The cases haven’t attracted much attention because they focus on a relatively obscure corner of the market: Fuel oil, the stuff used to fire power stations and ships. Moreover, around the same time, the three trading houses were admitting to much more egregious conduct, including bribery, corruption, and money laundering, so the manipulation cases were overshadowed. But they’re still important.

To understand what happened, one needs to delve into the plumbing of the oil market. The prices of dozens of oil benchmarks in the physical market are set – or assessed, in the industry’s jargon – by so-called price reporting companies. The most important of these is Platts, a unit of S&P Global, a New York-listed US$140 billion firm better known for its credit-rating business.

Platts and its rivals assess the market by observing bids, offers and actual deals, plus an element of so-called market colour. Blending these elements is designed to produce a price that reflects market reality, plus or minus a margin of error. Platts focuses on a designated window during the trading day, typically lasting 30 to 45 minutes: So for that brief period, the bids and offers posted by traders can have an outsized impact on price setting.

If all the above sounds a bit like the Libor scandal, where money-market traders colluded to manipulate interest rates, it’s because the price discovery process is very similar – particularly its reliance on the assumption that prices posted by traders would always be truthful.

Not everyone involved in the fuel-oil market is guilty of misrepresentation. But via court pleas and regulatory rulings, we know that staff at the world’s biggest independent oil trading houses – Vitol, Trafigura and Glencore – repeatedly lied or embarked on strategies to mislead the reporting firms, resulting in artificial prices.

In some cases, the misconduct went unnoticed for years, with multiple examples of manipulation; in other cases, regulators have uncovered just single instances of wrongdoing, lasting only weeks. Put together, the instances undermine confidence in the price-setting mechanism, much as the Libor scandals revealed how unreliable the system of setting money-market rates was.

Shockingly, those doctored fuel-oil prices still stand uncorrected, as if nothing out of the ordinary had happened and they were the product of real supply and demand forces, rather than manipulative greed. I asked Platts about it, but the company didn’t respond to a list of questions. Instead, it e-mailed a short statement that said “Platts has not been accused of any wrongdoing”. It added that its “methodologies are designed to ensure that we publish assessments that reflect market value”, saying that it is “confident in its processes”.

In the past, regulators have launched broad industry initiatives to clean up their markets. Libor, the suite of interest rates once dubbed the world’s most important number, has been scrapped and replaced by benchmarks designed to reflect actual transactions rather than relying on what traders say the cost of borrowing is. A similar overhaul of how oil products such as fuel oil are priced is overdue; a full investigation may well uncover more widespread manipulation.

The Commodity Futures Trading Commission (CFTC) should follow the example of the Justice Department, which has prioritised erasing corruption and bribery in oil trading. In doing so, it needs to address oversight of how the oil benchmarks are compiled, and why the industry isn’t learning the lesson from previous manipulation. Importantly, unless regulators impose tougher penalties, oil traders will continue to dismiss fines as the cost of doing business. Trafigura paid a fine of about US$55 million, for example, compared with net profit last year of US$7.4 billion.

The good news is that the CFTC seems to be making a start. The penalties on Vitol, Trafigura and Glencore, the three goliaths of the oil trading industry, are a sign of that. More worryingly is the situation in Europe and Asia. The lack of enforcement action on the other side of the Atlantic and Pacific on similar benchmarks that depend on market honesty means one of two things: non-US traders are completely honest and transparent, or they’re just not getting caught. Hmmm.