When Does Maintaining Confidentiality become Market Abuse?

When Does Maintaining Confidentiality become Market Abuse?

December 22, 2015
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On 25th November 2015 there was an agreement between the European Parliament and the European Council on the regulation of benchmarks[1], including oil benchmarks. On 17th December 2015 the price reporting agency, Platts, held a meeting to discuss, among other things, the future make-up of the influential Dated Brent benchmark.

This brought home to me that either the oil industry will have to rethink radically its current approach to commercial confidentiality or the European rules on the regulation of benchmarks are unachievable for oil. Bear with me and I will explain.

I have blogged ad nauseam on the Dated Brent benchmark [See “WE ARE GONNA NEED A BIGGER TANK” and “The BATTLE OF THE BENCHMARKS”] and I do not intend to cover old ground in this blog.  Suffice to say that the Dated Brent benchmark, in its current form, has built in obsolescence, because the four blends of crude oil that make up the Brent (BFOE) basket – Brent, Forties, Oseberg and Ekofisk- are on a declining trend. To ensure liquidity and to prevent market abuse, further changes will have to be made to the composition of the basket.

When and how any such changes may be made raise interesting issues for oil producers in the context of the rules on the regulation of financial benchmarks.

Production Forecasts and Tipping Points

Information available to the participants in the wider oil market, including futures, forwards and derivatives traders, concerning forecast production from oil fields is very sparse and very fragmented. Such information that is available typically shows a, more or less, asymptotic smooth decline in the total over the next 5-10 years.

But that is not how decisions are taken on the future production from oil fields. There are tipping points.  Theoretically oil fields are decommissioned when the cost of production exceeds the revenue from the sale of oil. These decisions are taken in Joint Operating Committee (JOC) meetings by the partners in each field based on a forecast of revenue and costs.

The JOC meetings that have been taking place this quarter have been informed by a forward oil curve well below $50/bbl. It is likely that we will see a spate of oil field closure announcements during the first quarter of 2016 some of which will involve fields currently forming the blends in the BFOE basket.

When sufficient fields using particular infrastructure such as terminals and pipelines cross their tipping point and shut down, this precipitates an economic decision on the closure of the infrastructure itself because infrastructure also has a commercial tipping point.

Any decision to close down an asset is complicated by the impact on the NPV of the asset when the abandonment costs and the tax breaks that are given to companies to cushion the impact of abandonment costs are taken into account.

These are complex calculations that have to be approved by the partners in each joint venture before any action is taken. But in the case of the oil fields and the infrastructure associated with the Brent (BFOE) benchmark it appears that the decision makers may be subject to sanctions, including criminal sanctions, under the Market Abuse Directive if the asset owners do not make these decisions available to market participants promptly and widely.

Information with an Impact on Benchmarks

The EC’s statement on benchmarks referred to above defines a benchmark as “an index or indicator used to price financial instruments and financial contracts or to measure the performance of an investment fund.” The new regulation is in line with the International Organization of Securities Commissions (IOSCO) Principles on Financial Benchmarks published in July 2013.

The EC expresses the opinion that the changes being made “to its market abuse and criminal sanctions proposals alone will not improve the way benchmarks are produced and used. EU regulation is necessary to improve the functioning and governance of benchmarks and to ensure that benchmarks produced and used in the EU are robust, reliable representative and fit for purpose and that they are not subject to manipulation.”

Anyone wanting a quick overview of how the European regulation of markets has worked in the past and is now changing can find this in Consilience’s article “We are better Informed, but are we any the wiser?

But the significance of European Regulations for oil benchmarks lies in the definition of market abuse.  Market abuse can involve the spreading of false information or it may involve insider dealing.

What constitutes inside information is what now puts oil producers at risk of skating on thin ice. If there is a company or a group of joint venture companies who have taken the decision to close down oil fields or assets that have an impact on a price benchmark, then it is my interpretation of the new rules that the companies are obliged to make these facts known to the market in general.

For example, if you are a market participant say in the USA who is dealing in Brent futures or Brent swaps and options with respect to oil for delivery in, say, the 2016-2020 period aren’t you entitled to know that the value of that benchmark is likely to be depressed by increasing quantities of Buzzard in Forties Blend, the blend that usually sets the price in the Brent (BFOE) basket? Or that one or more of the BFOE pipelines or terminals will shut down if particular fields are shut down so that there is likely to be a material change in formula or content of the price benchmark, using International Swaps and Derivatives Association (ISDA) terminology?

I don’t know the answers to these questions, but I would like to know at what point does compliance with a confidentiality clause in a Joint Operating Agreement crosses the line and become market abuse by with holding price sensitive information? If the joint venture owners of the assets that make up the benchmark do not disclose all they know about the forward production profile of the asset does any action on their part to buy or sell the benchmark grade, or components thereof, become market abuse by virtue of insider dealing?

Call me old-fashioned, but to my mind if I invest in an asset, or invest my shareholders’ money in an asset, I should reasonably expect to enjoy quiet title to the production from that asset without third parties, who may be competitors, or regulators continually knocking on my door for the details of my decisions related to that asset. But it appears that that may no longer be the case. If my asset has an impact on a benchmark price it seems I am required to bare my soul to the outside world, whether it is in my commercial interests to do so or not.

Who is in the Hot Seat?

It is unclear to me from the new rules who is obliged to make “market participants” aware of information that may have an impact on a benchmark price? The field operator? The terminal or pipeline operator? Each of the Joint Venture partners in any “relevant” asset however defined? I am not a lawyer but I do not think the European Directives or Regulations have developed far enough to make that responsibility clear.

Using the example I have cited here- the Brent (BFOE) benchmark- there are a few possible names in the frame of responsibility.

  1. There are the oil companies themselves, probably but not certainly, the major oil companies who broadly run the terminals and who also trade in BFOE benchmark instruments, because they could reasonably be expected to understand the market implications of shutting down a producing asset, pipeline or terminal.
  2. There is the Norwegian Petroleum Directorate, which has oversight of Norwegian producing assets and infrastructure.
  3. There is the UK Department of Energy and Climate Change and/ or the UK Oil and Gas Authority.

The Norwegian and the two UK authorities cited above have historically taken in reports from oil companies concerning their investment and decommissioning plans but have typically stopped short of taking any view or disseminating any recognition of the impact of such decisions on the functioning of price benchmarks. That has not in the past been their jobs. Such government departments have a duty of confidentiality on the commercial aspects of the data reported to them.

The question is does the EC ruling concerning the regulation of benchmarks require such authorities to break this duty of confidentiality in the cause of the market transparency and the integrity of benchmarks?

It seems that the Law of Unintended Consequences has again raised its head in the oil market.

[1] http://ec.europa.eu/finance/securities/benchmarks/index_en.htm