Puzzle at the Gas Pump

The Wall Street Journal

Waiting at the pump while the car fills up is one of the dullest moments in life. The only reading material at your disposal extols the virtues of the fuel on your vehicle's pistons and, let's face it, few people care.

So here is a question to occupy those idle minutes: Are you paying a fair price for gasoline? Thanks to a recent nondecision by financial regulators, no one can possibly know.

On Friday, the International Organization of Securities Commissions, a global grouping of financial regulators, ended a two-year study of the $2-trillion-a-year market for "physical oil" with a whimper: a call for greater transparency but no binding rules.

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Iosco's inability to shed light on an obscure corner of the financial world raises a broader issue affecting sectors ranging from banking to information technology. National regulators are struggling to police markets that span the globe and are opaque by nature.

Physical oil—the actual buying and trading of the commodity—is a case in point. As an important determinant of prices for oil derivatives and, more indirectly, pump prices, the commodity is a key part of the financial food chain.

Questions on this market were first raised by leaders of the industrialized world following stomach-churning volatility in oil prices during the financial crisis. After critics blamed "speculators," the Group of 20 industrial and developing nations asked Iosco to look at the unregulated players that set prices in this market.

Unlike say, shares of stock, the value of physical oil isn't determined by the public interaction of supply and demand but is based on voluntary reporting by companies and traders.

Several for-profit entities collect the data, add other inputs, and publish prices. The biggest ones are Platts, a unit of McGraw-Hill Cos. (MHP), and Argus Media Ltd. They also publish newsletters and articles on commodities. Dow Jones Newswires, which like The Wall Street Journal is owned by News Corp. (NWSA), is also in this business. The three companies declined to comment.

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The problem with the current system, as Iosco acknowledges in its report, is that "the ability to selectively report data on a voluntary basis creates an opportunity for manipulating the commodity market data."

Manipulation is made easier by the fact that the current regime allows companies to submit estimates and bids rather than actual transactions, thus ensuring that prices are almost impossible to verify.

Indeed, in recent years U.S. regulators have settled a number of cases with companies accused of manipulating commodity prices, with traders allegedly submitting fake data in a secretive market to influence a benchmark price.

Sound familiar? Oil's price-reporting mechanism resembles the flawed process that led to the scandal over the London interbank offered rate, or Libor. That system is now being overhauled, with banks certain to lose the power to set Libor among themselves.

Not so for the oil market. Iosco's 43-page report dialed back from early suggestions that price-setting agencies be regulated. It opted instead for nonbinding guidelines urging the entities, among other things, to publicize their methodology, keep audit trails and base prices on actual transactions whenever possible.

"It is an instruction manual for how to make bricks—the price reports—without straw—a large set of representative transactions," said Craig Pirrong, a finance professor at the University of Houston.

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There is one stick that Iosco is threatening to wield: If, after 18 months, regulators find that the new principles haven't been followed, further action might ensue. As Jacqueline Mesa, director of the office of international affairs at the Commodity Futures Trading Commission, told me: "It's not 'Abide by the rules and you are done.' It is 'Abide by the rules and we'll take a very hard look at how you are doing.'"

Hard look or not, the price-reporting companies have what they wanted for now. Their case against regulation, spelled out in their comments to Iosco, is twofold. First, as journalistic enterprises, they believe they shouldn't be overseen by financial watchdogs. And secondly, they maintain that a rule-based regime would damage the market by deterring participants from reporting prices—an argument echoed by big oil groups.

It is true that, unlike Libor-setting banks, Argus and Platts don't benefit directly from oil trading and that competition among price providers makes it more difficult for malpractice to fester.

But the main reason why the price-reporting groups prevailed is simpler: As a grouping of national regulators, Iosco had neither the expertise nor the authority to police a global market that operate in the shadows.

For governments looking to bring order to the likes of banking capital, derivatives trading, and even Internet privacy, the path ahead is as clear as freshly drilled crude oil.

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