Investigation Into Oil Industry Price Rigging Mirrors LIBOR Scandal

The European Union is investigating price-rigging in the global oil market, a widely-known yet unaddressed problem. That investigation hit a peak with last Tuesday’s raids of British Petroleum, Royal Dutch Shell, and Statoil offices. By the end of the week, Sen. Ron Wyden (D-OR) asked the U.S. Justice Department to undertake its own investigation into the effects on U.S. consumers.

Day-to-day oil transaction prices are based on benchmarks set by private firms, and the EU investigation focuses on the firm Platts, whose oil price benchmarks are “the most influential,” according to CNN Money. By manipulating individual transations late in a given day, traders can tweak the next day’s benchmark to increase their profits on other deals.

This looks to be very similar to last year’s massive, undercovered LIBOR scandal, in which megabanks colluded to gear a supposedly market-driven interest rate toward their own interests. CNN Money explains the shared pitfalls of basing daily price-setting on voluntarily-provided, unaudited data from the biggest players in the two industries:

“[T]hey are both widely used benchmarks that are compiled by private organizations and that are subject to minimal regulation and oversight by regulatory authorities,” the review, led by former financial regulator Martin Wheatley, said in August . “To that extent they are also likely to be vulnerable to similar issues with regards to the motivation and opportunity for manipulation and distortion.” […]

There are also concerns about the fact that reporting to Platts is done by traders voluntarily. In a report issued in October, the International Organization of Securities Commissions — an association of regulators — said the ability “to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data” submitted to Platts and its competitors.

LIBOR manipulation impacts $800 trillion in assets globally. Similarly, oil prices are a core driver of the price of nearly every consumer good, especially food. LIBOR manipulation helped force massive cuts to public services in American cities by blowing up the balance sheets of those cities, and the apparent manipulation of oil prices is likely to have a similarly long and destructive reach.

The shared features of the LIBOR scandal and the burgeoning price-rigging investigation in the oil industry suggest a policy lesson: Left to themselves, the biggest industries in the world tend to cheat in their own interests, at great cost to consumers.

The LIBOR scandal, regarded as the largest financial fraud scandal in history, led to over $2.5 billion in fines and forced changes in the U.K. Under a law passed earlier this year, the process by which LIBOR is set will receive tighter government oversight from a new agency. But that change is insufficient, according to the American head of the Commodities Futures Trading Commission, and fraud remains a possibility.

These structural incentive problems crop up in myriad other markets. Finance expert Barry Ritholtz has a roundup of dozens of other types of market manipulation by insiders, far beyond oil and LIBOR. Privately and voluntarily generated core prices tend to discourage competition at the expense of consumers, as economist Costas Lapavistsas argued earlier this year in the Financial Times. “The answer,” according to Lapavistas, “is public intervention in the rate-setting process, whether through the central bank or otherwise.”