Oil Price Manipulation Awakens Libor, Enron Ghosts

Money Morning Article of the Week

by Ben Gersten, MoneyMorning.com

Last July, we warned you that oil prices could potentially be manipulated in similar fashion to the London Interbank Offered Rate (Libor), and now a recent raid of major oil companies highlights this growing danger to the $3.4 trillion-a-year crude market.

The European Commission last week stormed the offices of Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B), BP PLC ( NYSE ADR: BP), and Statoil ASA (NYSE ADR: STO) as part of the ongoing investigation to find out whether companies are manipulating oil prices and, if so, how long it has been going on and the possible ramifications.

The EC said in a statement,

“The commission has concerns that the companies may have colluded in reporting distorted prices to a price reporting agency (PRA) to manipulate the published prices for a number of oil and biofuel products.“

Besides major oil companies, big banks are active in the energy market and would likely benefit from any manipulation, David Frenk, director of research at the financial reform group Better Markets and a former commodities analyst, told CNN.

The ordeal has brought back memories not only of last year’s Libor scandal but also of the actions taken 12 years ago by Enron to control energy prices.

Robert McCullough, an energy consultant, told Bloomberg News that –

“We’re making exactly the same mistakes we did with Enron, just with a different commodity. The same manipulation we saw in electricity and gas pricing is what we’re seeing in oil.“

But unlike Enron, where shareholders, employees and Californians suffered most, the oil price manipulation could have much wider-reaching effects.

The commission added that even small distortions in oil prices may have a huge impact on the prices of crude oil, refined oil products and biofuels purchases and sales, potentially harming final consumers facing higher prices.

Here’s what investors need to know about the current situation in oil prices.

How Are Oil Prices Manipulated?

As with Libor rates, oil prices serve as benchmarks for trillions of dollars of securities and contracts and could easily be manipulated.

And like Libor, the fate of oil prices is left to be decided by a very small number of people facing little regulation and whose decisions impact millions.

Platts, a unit of McGraw-Hill Financial Inc. (NYSE: MHFI), is the most influential PRA. It, as well as other PRAs such as Argus and ICIS, receives voluntary price submissions from energy traders and then decide which prices to use when making price assessments.

Total SA (NYSE ADR: TOT), Europe’s third-biggest oil company, estimates that up to 80% of all crude and oil product transactions are related to reference prices such as those published by Platts, with as much as 20% linked to exchange-traded futures on the New York Mercantile Exchange and ICE Futures Europe.

Along with relaxed reporting requirements, the use of convoluted futures contracts, hedges, derivatives and other complex instruments to set oil prices has led many to suspect wrongdoing.

What’s worse is that oil prices might have been manipulated for more than a decade, according to the European Commission.

In addition, the assessments by Platts and other PRAs are used to value the raw materials used in the $2.2 trillion global base-chemical industry as well as coal, power, metals, emissions, liquefied natural gas and shipping rates.

While no company has yet been accused of or charged with any crimes, we know from the financial crisis that doesn’t mean all is well.

And last week Sen. Ron Wyden, D-OR, asked the Justice Department to join in the efforts of the European Commission.

Stay tuned for more on this ongoing scandal and the effects it could have on oil prices and energy-related investments.

For more on the latest energy developments, check out Money Morning’s recent report, The Next Big Change in the Energy Markets.

Related Articles:

• Money Morning:
  Will Oil Prices be the Next Manipulation Scandal?
• Bloomberg News:
  Enron No Lesson to Traders as EU Probes Oil-Price Manipulation
• CNNMoney:
  Oil-price manipulation: the next Libor?