COLUMN-Insider trading rules should apply to oil outages: Kemp

Fri Oct 26, 2012 6:57am EDT

By John Kemp

LONDON Oct 26 (Reuters) - Severe maintenance overruns at Nexen's Buzzard oilfield have highlighted the need for a better regime for disclosing price sensitive information about oil output and problems in the North Sea.

Buzzard's delays have slashed output of the benchmark-setting Forties crude stream in October - contributing to a significant short-term rise in the price of crude and refined products such as gasoline for customers across the EU.

The EU should set aside objections from the industry and use the current review of the market abuse rules to mandate disclosure, and ban trading on information about supply disruptions, until the information has been disclosed to the market as a whole.

Buzzard's maintenance was supposed to be completed by October 10, according to verbal guidance issued to stakeholders. But in its third quarter earnings release, issued on Thursday, the company admitted the project had taken longer than expected and the platform is only now being restarted, some 20 days or more late.

"We are in the process of restarting the platform and expect production to ramp up in the next week to 10 days," the company said.

Even now it has not explained the reasons for the overrun. The earnings release blandly notes that "the scheduled turnaround ... was completed with no significant issues discovered, though it did take longer than expected."

Buzzard's problems have been a major contributory factor to the chaos in the Forties loading programme. All 16 cargoes scheduled to load in October have been deferred, one November cargo has been cancelled and two more have been delayed.

Because Buzzard accounts for the lion's share of Forties output, and Forties usually sets the price for the entire Brent-Forties-Oseberg-Ekofisk (BFOE) benchmark, which is in turn used to settle futures contracts, Buzzard's problems have had an impact out of all proportion to the amount of production actually lost.

Maintenance overruns helped push Brent for November delivery up by $7 per barrel (6 percent) between October 3 and the contract's expiry on October 16, pushing the premium for November Brent to as much as $1.40 over the December contract before expiry , and widening the gap with U.S. crude.

Yet the process for disclosing routine maintenance, overruns and other production problems remains ad hoc and the lack of a proper disclosure regime heightens the risk of insider dealing and market abuse.

INSIDE INFORMATION

At present, like other commodity markets, the Brent market benefits from a special and more generous regime on insider trading under EU regulations.

For all other asset classes, the EU rules on insider dealing and market abuse state: "inside information shall mean information of a precise nature which has not been made public ... which if it were made public would be likely to have a significant effect on the prices of those financial instruments or on the price of related derivative financial instruments" (Article 1.1 Market Abuse Directive 2003/6/EC).

"In relation to derivatives on commodities" however, the rules apply only to information "which users of markets on which such derivatives are traded would expect to receive in accordance with accepted market practices" (Article 1.1 Directive 2003/6/EC).

The special treatment for commodities was spelled out in more detail in a follow-up directive in 2004.

For commodities, the definition of inside information is restricted to information which is "(a) routinely made available to users of those markets; or (b) required to be disclosed in accordance with legal or regulatory provisions, market rules, contracts or customs on the underlying commodity market or commodity derivatives market" (Article 4 Directive 2004/72/EC).

So under the special rules for commodities, information which is not routinely made available or required to be disclosed does not count as inside information - even if it would be likely to have a significant effect on prices for the physical commodity and derivatives based upon it.

Since information about production problems and delays is not routinely disclosed or required to be disclosed, it does not count as inside information.

Well-connected market participants can trade on such information without worrying about whether such trading is manipulative.

MAD REVIEW

The special exemption for commodity markets is defended by many in the oil industry. But it has already drawn critical attention from regulators.

Reviewing the Market Abuse Directive in 2011, the European Commission worried that "the lack of a clear and binding definition of inside information in relation to commodity markets may allow information asymmetries."

As a result, "investors in commodity derivatives may be less protected than investors in derivatives of financial markets because a person could benefit from inside information in a spot market by trading on a related derivative market."

"For this reason the definition of inside information in relation to commodity derivatives should be aligned to the general definition of inside information extending it to price sensitive information which is relevant to the related spot commodity contract as well as the derivative itself."

The Commission has proposed a new Market Abuse Regulation which would more or less align the definition of inside information in commodities with other asset classes (MAR 2011/0295 (COD)). The regulation would also require such information to be made public as soon as possible.

PUSHBACK

In January 2012, the Futures and Options Association (FOA), on behalf of the UK derivatives industry, explained that while it supported closer alignment of the definition of insider trading, it had reservations about the broad and uncertain scope of the proposed changes.

"More clarity" was needed on what would constitute inside information in commodity markets, said the FOA. "If more clarity is not provided, and no defences are available, there will be a chilling effect on the real economy, as legitimate commercial activities are hindered," the FOA warned.

"Legitimate activities include exercising trading discretions, hedging underlying assets, and managing changes in supply and demand, and to meet contractual delivery obligations" which should all be excluded from the insider trading rules.

The definition should only apply to "events outside of normal operational activities" ("Position paper on the European Commission's proposals on MAD and MAR" FOA January 2012).

The FOA provided a helpful illustration of the sort of exclusion from insider trading rules that it support.

In "Scenario 1 - oil producer pipeline shutdown" the FOA describes "An oil producer which also carries out trading in financial instruments and derivatives on commodities by way of hedging learns of a problem with one of its pipelines resulting in the shutdown of the supply."

"This would give rise to an exposure as a result of having to buy in additional supplies to meet obligations. The oil producer is under no primary legal or regulatory obligation to disclose the information under EU, national or market rules but is unsure whether the information may be deemed to have a significant effect on the price of relevant instruments if it were made public."

"In the absence of certainty and/or guidance, the oil producer may take the view that this information may be inside information under the new definition, in which case, it would be unable to trade on the basis of this information, and to hedge the exposure caused by the pipeline shutdown."

HEIGHTENED VOLATILITY?

The effort to increase transparency could have unintended consequences, actually worsening volatility and raising prices, Shell warned a conference in Brussels last month.

The oil company cited the example of a refinery outage creating a shortage of gasoline. "Currently that's kept internal within the company," said Mike Conway, president of the company's international trading and shipping arm, in remarks reported by Platts.

Forcing immediate disclosure could encourage some other traders to exploit the company's production problem, and increase price volatility, creating a price spike ("Draft EU market abuse rules could raise commodity prices: Shell" Platts Sep 26).

"Just knee-jerking and saying here's what happened could distort the market in a different way and doesn't allow companies like ourselves that have a variety of ways to solve the problem to do it in a way that minimizes the impact to the marketplace," Conway said.

While banks and hedge funds complain about selective access to information, Conway countered "we have that information because we paid for it" by investing in physical infrastructure .

But that is no reason why the insider trading rules should be different for commodity markets.

Market prices are already moving significantly ahead of the publication of information about delays at Buzzard. In recent weeks, big changes in the Brent/WTI spread and the premium for front-month Brent have generally preceded news leaking out that the resumption of production has been put back again.

Given concerns about the narrow physical base of the Brent benchmark regulators and exchanges must do everything possible to maximise transparency to maintain confidence in the system and avoid the potential for abuse.

Mandating disclosure of production problems and delays as soon as possible, and bringing them within the scope of the insider trading rules, is an essential step to maintain and enhance market integrity.