Editor's note, March 21st 2014: Barack Obama has just struck at the inner circle of Vladimir Putin. One of the people he singled out for sanctions is Gennady Timchenko, who was until this week the joint owner of Gunvor, one of the world's largest oil-trading firms. The United States Treasury claims that Mr Putin has investments in Gunvor—though the company denies that it has any outside shareholders. In 2012 The Economist published the following detailed investigation into Gunvor's activities.

We published a letter from Platts in response to this article in our issue dated May 12th 2012. You can read the letter here.

FEW people outside Russia have ever heard of Gunvor—and Gunvor would probably prefer it that way. It is the world's fourth-biggest oil trader, and at its peak handled roughly a third of Russia's seaborne exports of crude oil. We suspect that Gunvor has been driving down the price of Russian oil. An investigation by The Economist into Gunvor's trading in Urals crude, a benchmark blend in north-west Europe, suggests that such a strategy could have helped the firm buy oil in Russia cheaply and, in theory, earn inflated profits when it sold the same oil on the international market at full price.

Spot markets for oil are virtually unregulated so the law allows Gunvor considerable freedom of manoeuvre. Yet any fall in Russia's revenues could have harmed the country's citizens, who benefit from oil taxes. Moreover, the spot markets have become the subject of official concern. In March, after a request from the leaders of the G20 (including Russia), the International Organisation of Securities Commissions (IOSCO), a forum for regulating financial markets, issued an appeal for ideas on reforming oil-price reporting. One of its aims is to “ensure the integrity of [the oil markets'] price assessment”. If our suspicions are well-founded, Gunvor's Urals trade would show how vulnerable oil markets are to distortion.

Nobody but Gunvor itself knows for sure whether it set out to move the Urals price, as we suspect. The firm is adamant that it has done nothing wrong.

So we have no proven case. But we do have a set of suspicious circumstances. Under Vladimir Putin, who was elected Russia's president in March and will be sworn in next week, Gunvor has grown from a small, virtually unknown company into the most important trader of Russian oil (see article). Before Russia's presidential election, Gunvor attracted criticism from opposition protesters for making money out of the country's oil and for being based in Switzerland. Given Gunvor's political sensitivity and that Russia needs to get the best price for its oil, Mr Putin should look into the Urals market.

Our investigation has three parts. The first is based on public data, which show that over a period of years Gunvor's trading was repeatedly associated with falls in the market price for Urals crude over a few days or weeks. The second is our analysis, which founds our suspicion that Gunvor intended to drive the price down temporarily in this way. And the third is the related question of what such a strategy might have accomplished.

The “Urals blend” includes much of the 5m barrels a day or so of crude oil that Russia exports. The sellers are oil producers, including Rosneft, Surgutneftegaz and Gazprom Neft. The buyers are European refiners such as Hellenic and INA and the refining arms of oil companies such as Royal Dutch Shell and Total. In among the buyers and sellers are the trading companies, such as Glencore, Vitol—and Gunvor.

The way of the window

Most of the Urals spot trading takes place in private and is not reported. The published price for Urals oil is set by Platts, part of McGraw-Hill, a media company. Platts writes about the market in its daily Crude Oil Marketwire, a representative summary containing the day's most noteworthy public bids, offers and trades.

Platts sets its daily price using the bids, offers and transactions that are published on its systems. Its reporters can consider trades at any time in the day, but what counts is the last half-hour of trading, which ends at 4.30pm sharp London time, when the price is established. Platts invites parties to disclose open bids and cargoes for sale in the lead up to a 3.45pm cut-off, after which it accepts no new bids or offers. Starting at 4pm, it watches the dealing in the half-hour “window”. It uses its knowledge of the market plus the prices of these trades, bids and offers to establish the published price for the day.

This system, known as the “Market-on-Close” (MOC) methodology, has many advantages. Instead of relying only on the subjective impressions of reporters telephoning around for news from their contacts, it also uses a formal mechanism to help establish a price at the same time each day. It brings together buyers and sellers who want a part in forming the published price. It avoids the drawbacks of average prices, set over the whole trading day, which tend to be too high in a falling market and too low in a rising one.

Platts is alive to the danger of companies playing games. If its reporters think trading is manipulative or unrepresentative, they have the power to exclude any bid, offer or deal from their reckoning of the published price. As far as Platts is concerned, there has been nothing in the Urals trading to suggest that Gunvor or any other company has systematically been misleading the market. “It is our view”, Platts said in a statement, “that no single company has the ability to determine market prices on its own within Platts MOC assessment process.” Platts believes that its safeguards and the normal market dynamic between willing buyers and sellers create “a natural check and balance” against transactions that distort the price.

But any system can be played to advantage. Urals is a thin market in which the typical day's Crude Oil Marketwire features only one cargo on offer, one buyer that has expressed an interest, or one completed trade. We think that, contrary to Platts's assurance, in such a market it is possible for a trader to direct MOC prices. On behalf of The Economist, Edward Osterwald*, a consultant who is an oil specialist with many years' experience in central Europe and Russia, used public data from Crude Oil Marketwire to analyse Gunvor's behaviour. The Economist's analysis began in January 2005, shortly after Rosneft had taken control of Yuganskneftegaz, and finished at the end of May 2009, when a libel case between us and Gunvor was pending (the case was settled out of court). We also applied some statistical tests to the data.

Gunvor almost only offered and sold oil in the Platts MOC window. That is because it buys oil off the spot market under tender on long-term contracts with Russian producers and thus has a lot of oil to sell. Its sales in the window were concentrated in bursts, typically lasting several days. But its activity struck The Economist as different from that of other firms, because the bursts very often coincided with a fall in the market value for Urals crude.

On the face of it, that behaviour is odd, because a trader like Gunvor is normally equally interested in a high selling price and a low purchase price. And yet its trading activity commonly—if temporarily—drove down the spot-price assessment.

In the four years and five months that were analysed, the Crude Oil Marketwire featured a total of 1,218 bids for cargoes, offers of cargoes and trades within the Platts assessment. Of these, 412 involved Gunvor—more than twice as many as any other trader and nearly nine times more than the average. That is in line with its status as the market's biggest trader. Remember, though, that Platts's MOC assessment contains any particular bid, offer or deal only because the parties want it known. Some, like Exxon Mobil, rarely confirm trades with Platts. Gunvor chose to trade in the window often and heavily.

MOC execution

What effect did this have? Nearly all Gunvor's trades within the window were sales or offers to sell (see chart 1). In those four years and five months, Gunvor sold or offered oil 399 times and bid or bought oil just 13 times. In other words, Gunvor was responsible for half of all the sales and 40% of all offers in the window. By contrast, Gunvor accounted for only 3.1% of buys and 0.7% of bids. Gunvor makes its offers not in a steady stream, but in bursts. Thus in 2007 Gunvor's reported trading activity was concentrated in 13 bursts spread over the year. “The usual effect of Gunvor's activity on the price was to depress it,” says Mr Osterwald, who was head of oil and gas for Arthur Andersen in central and eastern Europe, the Middle East, India and Africa. “This is the opposite of what a normal commercial seller would wish to achieve.” The spot price of Urals is measured against “forward-dated Brent”, the benchmark for much of the world's oil, based on oil from the North Sea priced for delivery on a set date in the future. Urals tends to trade at a discount to Brent, because it contains more sulphur and more heavy hydrocarbons, neither of which refiners prize. The “price” is the size of this discount. During 11 of the 13 bursts in 2007 of Gunvor's trading in the window, as identified by the Crude Oil Marketwire, Urals fell against forward-dated Brent. In ten of the corresponding periods when Gunvor was absent or virtually absent from the price-setting mechanism, Urals recovered.

In a market where the price is broadly stable over a long period of time, the size and number of day-to-day price increases should roughly match the size and number of day-to-day price falls—and that holds true for Urals. However, an analysis shows that Gunvor's pattern of trading has a predictable effect (see chart 2). On more than 80% of the days when Gunvor was selling in bursts in the Platts window, Urals fell against Brent. On more than 75% of the days when it was not, Urals rose. Interestingly, Gunvor's behaviour reversed in March 2009, right at the end of the four years and five months we looked at. In each of the next three bursts of heavy use of the window, over the following two months, Gunvor bought oil and the price relative to Brent rose. Mr Osterwald says this was the first time he saw Gunvor bid in the window. We do not know why its behaviour changed. We are left with the first half of a detective story. There is a set of striking trades that we suspect were part of a trading strategy—after all, Gunvor was present in the window only because it chose to be. If so, what was it trying to achieve? This leads to the second step of our account, where we leave behind the public domain. Nobody except Gunvor knows why it chose to trade as it did. During the past two years we have repeatedly asked Gunvor to explain its trading to us. However, Gunvor declined to comment for publication. Therefore, from this point onward, we depend on inference and speculation.

Window shopping

People close to the Urals market suggest two theories for Gunvor's behaviour. One view—and this is put forward by Gunvor itself—is that the company was simply behaving commercially. It was, the argument goes, selling into the window to establish a fair benchmark price for the far larger quantities of oil it was selling in private. Eager to shift oil, Gunvor saw the Platts window as the place where buyers congregate. Platts and Gunvor argue that the price is determined by any number of objective factors, such as economic growth, the weather, shipping markets and so forth. To reduce everything to Gunvor's trading, they say, is nonsense. In this view, Gunvor was not driving the market down, but following it down, selling oil when the price had started to fall, because waiting would only mean a still-worse deal.

This may be so, but we remain suspicious. We have reasons for thinking that the price fall was often caused not by objective factors, such as changes in the economy, but by Gunvor itself coming into the market. We analysed Gunvor's trading using a statistical technique called a Granger causality test, which helps to distinguish cause from effect. To see how the test works think of two sets of statistics for rainfall and the sale of umbrellas. The Granger test compares these to show which, as a rule, comes first, the rain or the umbrellas. Here, it is easy to see that shops tend to sell more umbrellas after people start to get wet—or, to put it another way, that rainfall causes the sale of umbrellas.

Our statistical analysis shows that, in this technical sense, Gunvor caused the Urals price to fall, because it generally started its burst of selling and offering cargoes before the market turned down. Rarely did a falling market lead Gunvor to start selling. It was as if Gunvor's sales and offers were a signal for Urals to fall against Brent.

Perhaps Gunvor was using objective factors to anticipate a bearish market—like someone who has seen the weather forecast and buys an umbrella while the sun is still shining. But Gunvor tended to sell and offer oil without other companies piling in. Either the rest of the market was in fact not bearish or Gunvor was undercutting the price so much that others did not think they would make money selling through the window. Whichever, Gunvor was more eager to sell than other companies.

Gunvor's analysts might have had their own private forecasters who could spot objective factors that other traders did not. You might then expect Gunvor to have sold in the window when others did not. If so, Gunvor's forecasters were not much good. Although they were right some of the time—as you would expect—the price usually started to recover when Gunvor stopped selling. Indeed, more often than not the price often recovered a fair bit: the pattern was especially pronounced early in our analysis (see charts 3a and 3b).

In the first three-and-a-half years, the market was flat. And in the 12 months to May 2009 there was an overall bull market for Urals, in which the prevailing discount to Brent narrowed, from around $5 a barrel to $1 a barrel or less. If Gunvor had a private forecast it often seemed wrongly to predict a bearish market. When you analyse Gunvor's behaviour in this way, the view that Gunvor has merely been responding to the market is not wholly convincing. If Gunvor's intention was to benchmark the market, the result was mostly to send prices lower. If it came into the window to find better bargains, it tended to get a worse price. If it thought it saw objective factors for thinking that a bear market was on its way, it was alone and often mistaken. As a rule, traders should not be predictable—otherwise counterparties can foresee what they are about to do, and bet against them. Part of a trader's skill is getting the best price. But its approach led Gunvor to sell oil predictably and too cheaply—and hence to leave some profits on the table. You might think that Gunvor was just big and that it had a lot of oil, so it was bound to drive the price down. Yet the markets already knew about Gunvor's size. The question is why Gunvor's appearance in the window was so often bearish. Because we were surprised by what we found, we asked Michael Sayers to review Mr Osterwald's study. As a former head of compliance for ICE Futures Europe in London, Mr Sayers is an expert in overseeing oil markets. In his opinion: “It is inconceivable that [Gunvor] are unaware of the shadow they cast but they continue [to sell] repeatedly throughout the period covered by the study. A rational trader would recognise that their behaviour was not profit-maximising and change accordingly.” Yet Gunvor kept on selling.

Assuming Gunvor was not just incompetent, that leaves the second, less benign, view: that Gunvor knew it was driving the price down and did so repeatedly. How, though, can a company that sells oil profit from a lower price? That is the third step in the analysis. The private nature of commodities trading means it can only be speculative—unless official regulators with the power to investigate take an interest.

Time to look closely

In theory, there are many ways to make money from the foreknowledge that the Urals spread against forward-dated Brent is about to widen temporarily. Gunvor, or related parties, could trade in futures markets—though you might then expect its counterparties eventually to realise that the market was hard to make money in. Or it might trade in other spot markets where prices are predictably connected to Urals.

Gunvor does not just use the Platts Urals window to sell oil, it has also used the published price to determine how much it should pay for the Russian oil that it buys on long-term contracts. In March 2008, for instance, Reuters reported that Gunvor had signed a six-month tender with Rosneft that was based on the price of Brent minus the Platts Urals spread.

Perhaps Gunvor could win an open tender for oil, by driving the Platts price down and offering a generous premium, safe in the knowledge that it would still make money when the Platts price recovered. Or Gunvor might have used a lower Platts price to cut its own purchase costs only to sell it on later at the full price, when the market had recovered. The rate of tax on Russia's oil exports is set partly by reference to average oil prices over a month. By lowering the Urals price, Gunvor could thus also have lowered Russia's tax take.

Gunvor could point out that on any given day it is buying some cargoes of oil in Russia and selling other cargoes of oil on the open market. If so, what it gains by lowering the purchase price of one cargo, it would lose in the sale of another. But volumes matter: if a trader could sell less at the depressed price than it bought, it would make money. Moreover, the oil might not be priced on the day of purchase. If the price for an entire month's oil deliveries could be pegged to the average Platts price for, say, the first two weeks of the month, then a trader could turn a profit.

Gunvor would not have to change the price of the oil it is trading by more than a few cents to make a decent return, because it trades such huge volumes. In the four years and five months we looked at, just 25 cents of extra profit per barrel would be worth more than $200m.

The Economist has two possible explanations for Gunvor's behaviour—that Gunvor was being commercial or that it intended to drive down the market price. Gunvor denies that it has manipulated the market, and Platts rejects the idea that our statistical analysis is a substitute for its own “rigorous market observation and analysis”. But if the second explanation is true, a benchmark for crude has been distorted and the Russian taxpayers might have seen a lot of money depart to Geneva.

IOSCO points out that spot markets like the one for Urals crude are a reference for all sorts of contracts. They can thus have “a high impact on oil-derivatives markets and …broader financial markets and the global economy.” We think it is now time for Mr Putin and IOSCO to investigate.

*Mr Osterwald now works for Navigant, a management and litigation consulting firm.