The Brent Crude Benchmark Is Fit and Well

Adrian Binks is chairman of Argus Media, London.

The article in EPW “Reassessing the Brent Benchmark for Crude Oil” by Akshay Mathur (21 December 2013) asserted that the price assessment process for Brent crude is too complex and, at the same time, vulnerable to manipulation. This is not the case today, following concerted efforts over the past few years to improve the way that the Brent benchmark is assessed. This evolution of the Brent benchmark over the last 30 years has been carried out through the interaction of several groups with different interests – the companies involved in purchasing and selling North Sea crude, which write the key contracts; price reporting agencies (PRAs), which independently assess and report prices; and regulated energy exchanges, which may use these physical market prices to settle financial contracts.

Complexity

The complexity of North Sea crude pricing is well understood by participants in the oil market, including companies based in the European Union, the United States, Switzerland, India, Russia and China, as well as by the PRAs and by economists who have studied oil pricing. Some economists may not have fully understood the complexity of North Sea and global crude markets when their research began before the price spike of 2007-08, but have done much work since then. It is misleading to quote research from 2007, as the EPW article does, when this has been superseded by subsequent work and by market developments. It is equally misleading to quote from preliminary reports to the G-20 leading nations from 2011, when these have been overtaken by final reports published in subsequent years.

Pricing in oil markets has been under more scrutiny in recent years than almost any other market in history. The culmination of many years of academic research into oil markets was published last year by the International Association for Energy Economics (IAEE) in The Energy Journal (Volume 34, Number 3, 2013). It says: “A central message of the work conducted here is that speculation is not a principal determinant of oil prices, and that prices are driven primarily by market fundamentals.” This 242-page special issue of The Energy Journal presents nine papers on oil price determinants, none of which backs up claims made by non-specialist commentators of widespread manipulation in oil markets. In short, the oil price depends on supply and demand.

The International Energy Agency (IEA), the Organisation of the Petroleum Exporting Countries (OPEC), the International Energy Forum (IEF) and the global securities regulatory umbrella group the International Organisation of Securities Commissions (Iosco) commissioned a lengthy report for the G-20 from independent consultants (April-June 2011). This unpublished report, by consultants Liz Bossley and John Gault, recognised that complexity in price identification, if not properly understood, can lead to the wrong conclusions: “Oil prices and oil price reporting can appear to be very complex and lacking in transparency. There are reasons for this complexity, which, when understood, can go a long way towards clarifying the meaning of oil prices published by the PRAs and explaining the differences amongst their price assessments.”

The Iosco, in collaboration with these international organisations, followed up the consultants’ report with a further investigation. This led to the publication of the Iosco “Principles for Oil Price Reporting Agencies, Final Report”, in October 2012, which G-20 endorsed and which the PRAs are now implementing during an 18-month evaluation period. According to Iosco, “PRAs had made significant efforts to implement the principles” by September 2013. Thorough implementation by PRAs of these internationally agreed principles continues this year, following the completion of successful assurance reviews last year by independent auditors. These reviews are freely available on PRAs’ websites. Iosco, in collaboration with the other international agencies, will publish its evaluation of the 18-month implementation period later this year.

PRAs are independent and have no vested interest in the outright price level of oil. They have a track record of discounting market information that they know to be unrepresentative of market values. This is not a subjective process, because it depends on cross checking data against information from other sources. The oil market needs reliable and timely price information to function well. Until the 1970s, before PRAs, oil prices were opaque and were determined by the major oil companies known as the “Seven Sisters”. PRAs have brought transparency that allows market pricing, determined by supply and demand, to identify benchmarks that are trusted by consumers and producers alike, replacing those set unilaterally by governments or energy producers in their own interests.

No Manipulation

Nothing similar to revelations in Libor and foreign exchange markets happened in the Brent crude oil market in 2013. The European Commission investigation into potential collusion involving biofuel and oil price information supplied to one PRA is in its early stages and has yet to reach any conclusions of wrongdoing. This investigation does not involve Argus Media.

In the main US court case cited in the EPW article, allegations about so-called manipulation of Dated Brent are made with no apparent evidence beyond inference. The allegations fail to account for factors such as refinery supply obligations, field maintenance, arbitrage and the actions of other market participants – which, as in any market, counter the wishes of any one party. They ignore the fact that values for cargoes depend on delivery times. Time premiums are common in all markets, to the extent that terminology has been developed in economics to describe the phenomenon. When prompt prices are lower than forward values – as in an example cited as “manipulative” by the US court papers – this is known as contango. The opposite is called backwardation. The relationship of prompt and forward values is crucial in Brent crude price formation, and is well understood by market participants and oil economists.

In physical oil markets, as well as timing, issues such as viscosity, product yield, sulphur content and the cost of freight have an impact on price. Oil needs to move in ships, storage tanks and pipelines. To deal with this diversity, PRAs have developed methodologies that define clearly which cargo sizes, loading points, destinations, qualities and delivery periods will be considered in their price assessments. They rely on voluntary disclosure by buyers and sellers, ensuring that no market participant is able to have an undue influence on prices through official government favouritism of any kind. No one can compel disclosure, as energy market participants are spread around the world under different jurisdictions. The independence of PRAs, with reporters spread around the world, is the best way to ensure that information is obtained to reliably identify price benchmarks.