It’s fair to say that the last 12 months have seen a dazzling display of both ineptitude and dishonesty from our banking community. In no particular order, we have seen the culmination of the PPI scandal (Payment Protection Insurance), the mis-selling of interest rate swaps to small businesses and further whopping losses incurred by trading “legends” working for UBS ($2bn) and JP Morgan ($5bn). To top it all, we now have the Libor scandal, where emails actually exist saying things like “hi guys, we got a big position in 3m libor for the next 3 days. Can we pls keep the libor fixing at 5.39 for the next few days. It would really help”. Quite astonishing…
With no seeming end to these financial scandals, is it any surprise that the pricing mechanisms used in the oil industry are now coming under scrutiny? The press, politicians, trading associations and even parts of the trade itself have all lined up to claim that the oil price can be / is being rigged in the same way as Libor and that something should be done about it.
To compare the banking and oil industries, let’s first go back to 2008 when the financial crisis hit and the oil price collapsed. From 2004 onwards, prices had risen to an unprecedented high of $150 per barrel. But then, in the space of 4 short months (July 2008 – October 2008), the value of oil went down to $35, thus wiping out all of the rises that had been experienced over the previous 4 years. Virtually overnight, profits of the Oil Co’s were decimated, billions and billions of $ were owed in derivative contracts and ruinously empty oil tankers were “anchored-up” for months on end, whilst the charter fees racked-up.
Of course, the well-documented Government bail-outs for the likes of Shell, Exxon and BP have been explored before… erm – wait a minute, there were no bail-outs for the oil industry! In fact, the industry just quietly went about its business as usual. There were no major bankruptcies, nor major payment defaults. Swap and Derivative arrangements were all fulfilled and most importantly of all, the oil kept flowing – all this against a backdrop of butchered credit lines and complete financial meltdown. The oil majors and minors simply cut their cloth accordingly and in an incredible move, even cut the bonuses of their top brass to reflect the lower returns being generated.
So whilst Oil Co’s are large and profitable beasts, they are not banks and do not behave like banks either. Yes, they sometimes do not help themselves with complex methodology, but just because something is complex does not mean it is flawed. Plus, the oil community trades from the well-head, the refinery gate, the product jetty or the petrol pump, unlike the banks, who trade from a screen.
But the main difference between the setting of Libor and the reporting of fuel prices lies in the words themselves; one rate is set (Libor), whilst the other is reported on (fuel). Libor to be clear, is the average interest rate as estimated by leading banks in London (that they would be charged if they borrowed from other banks on the following day). So Libor is not only an estimate for the future (thus making it largely subjective), but it is also set by a panel of London banks (the so-called “Contributor Banks”), normally not numbering more than 8-10. European petrol prices on the other hand are based on actual wholesale trades of petrol (whether to barge or ship) that have taken place in Antwerp, Rotterdam and Amsterdam (ARA). On any given day that the Libor Contributor Banks are “forecasting” their rates, between 15 and 25 actual sales in excess of 3m litres are taking place in ARA, with buyers and sellers often totaling more than 40 in number. So when Platts and Argus (the 2 independent price reporters in Europe – another difference versus Libor), say that their prices are robust, this is because they are basing them on hundreds of actual sales, for every grade of fuel and in every corner of the world.
In fact, oil pricing still demonstrates the pure rules of supply and demand, far better than most market sectors. If high oil prices make few people happy, then blaming the oil industry seems to conveniently ignore the well documented demand increases that the world has experienced in the last 20 years (explored in last month’s report). Conspiracy theorists will always believe the worst and let’s face it, the world’s bankers have given them ample material for the next 100 years, but oil prices are not set in darkened rooms by shady Russians, mysterious Saudi Sheiks and villainous traders. Instead, they are set by supply and demand. Supply is represented by the industry that brings the product to market, whilst demand is you and me, plus the other 7 billion users of fuel in the world.