WE’RE GOING TO NEED A BIGGER TANK

Sale and purchase contracts are likely to need some revision before the ink has dried on supply commitments for 2016. Also those who have hedged their operating revenue or have financed capex based on the forward oil price curve of one of the existing benchmarks – Brent, Dubai or “WTI” – better familiarise themselves with the concept of basis risk. Because it is all change again in the world of price benchmarks.

 

Dubai

We wrote back in September about the Chinese dominance of the Dubai price benchmark and mentioned that the Dubai basket, then Dubai, Oman and Upper Zakum, was likely to be boosted to include Al Shaheen. (“https://ceag.org/the-battle-of-the-benchmarks/”)

This is now the subject of an industry consultation with the addition of Murban as well as Al Shaheen to pad out the volume even further to dilute the dominance of China. It is unlikely that the traders who exited the market like scalded cats in August will be tempted back that easily.

 

Oh no! Not Brent Again!

Brent is again up for re-definition as production of the four basket grades that make up “Brent” – Brent, Forties, Oseberg and Ekofisk – continue to decline and need another transfusion of oil to keep it going a bit longer.

There is a meeting scheduled for 17th December to discuss which oil to add next.  Ideas continue to circulate about adding increasingly disparate qualities of oil from different geographic regions to the basket. My heart sinks at the very thought! We are already in a pickle over appropriate quality differentials for the four reasonably similar oils in the Brent basket. Bringing in oil that is even more dissimilar from further-flung regions is storing up even more quality differential trouble and adds in a freight distortion that might have to be resolved by subjective freight differentials too.

I fear that what may be proposed to sort Brent’s problems is some form of contract that requires foreign grades of oil to tranship through Sullom Voe, the loading point of Brent, in order to become part of the Brent basket. I can envisage that idea being seductive to anyone who has never been involved at the sharp end of trading.

The logic might run as follows: Sullom Voe is the loading point of Brent, so to keep the Brent brand name active, foreign grades of oil should sail up to Sullom Voe, discharge oil into under-utilised facilities at Sullom Voe to be load onto ships as part of the forward Brent (Brent / Forties / Oseberg / Ekofisk) market. With North Sea production declining even more sharply than previously anticipated because of low oil prices and with West of Shetland oil migrating to Rotterdam (witness Schiehallion) Sullom Voe has under-utilised assets that will require the payment of prohibitive abandonment costs to shut down.

There is a line of argument that suggests that using the Sullom Voe facilities to tranship “foreign” oil through the North Sea to support the Brent benchmark brand of price index may solve the problem. It won’t. For example, how much African, Caspian or South American oil is refined in N. W. E. and is brought as far north as the Shetlands by the natural pattern of trade? Not a lot, because when it comes to shipping oil around the globe fundamental freight and inter-regional oil price differentials inform the basic economics of decision-making and dictate where oil is refined and traded.

So let’s hope that the December 17th meeting avoids the obvious trap of asking the market to ship oil to where there happens to be empty tanks rather than to where the refineries and the seat of demand are located.

 

An Ideal World

It would be great to be able to start again with a whole new benchmark that works in today’s and tomorrow’s circumstances without the constant need for tinkering.

The characteristics of an ideal benchmark would be:

  1. A large volume of production, such that it is difficult for any party to “corner the market”;
  2. A large number producers to prevent one company, whether a NOC, an oil major or a large independent, controlling supply;
  3. Stable quality that does not have any particularly difficult physical attributes, so that the grade can be bought by a large number of refiners;
  4. Good loading terminal logistics with enough storage to accommodate a number of days of production with sufficient flexibility to handle operational changes and shipping delays;
  5. Sufficient  jetties with capacity to load a range of tankers to optimise freight and promote inter-regional arbitrage;
  6. A transparent lifting schedule so that all buyers and sellers can assess the changing availability of cargoes on an equal footing;
  7. Standardised, transparent general terms and conditions of trade, so that companies can buy and sell repeatedly on back-to-back terms; and,
  8. A benign host government that does not intervene in either price or supply.

 

There are no obvious candidates to take over the role of international crude oil price benchmark by ticking all these boxes. But it is not beyond the realms of possibility to create one.

If I had a magic wand I would create an independent storage facility somewhere between Gibraltar and Cyprus, let’s say in good stable old Malta, just for illustrative purposes.  The Med market is a great passing place for oil from the Caspian, the Black Sea, West, North and East Africa, and even the North Sea.

This Malta facility would offer three sets of commingled storage tanks for light, medium and heavy crude. There would be limits on the quality of oil that could go into the three sets of tanks and those quality ranges would define the three blends known as, say, Malta Light, Malta Medium and Malta Heavy.

There would be a value adjustment mechanism, based on cracking or coking, so that there would be a price escalator and de-escalator to apply to individual cargoes to adjust for the extent to which input and output from the tanks varied from the reference quality for each blend.

There would be plenty of jetties and a very transparent schedule of tankers loading and unloading at the port in any given month.

Anyone could put oil in by agreement with the facility operator based on the terminals standard terms and conditions of trade. The depositor would receive a negotiable storage warrant. Anyone could take oil out of the tank by turning up with the storage warrant endorsed to their account. (And, please, let’s have electronic documentation of cargoes, not the parchment and quill pen system we are stuck with because the industry cannot reach consensus on which electronic system to use.)

Traders, hedgers and speculators could trade forward cargoes in any of the Malta Blends the way they currently trade the limping 30-Day BFOE contract. If any company tried to squeeze it or manipulate it they would be foiled by ability of the shorts to supply a much wider range of oils from anywhere in the world of the appropriate quality range.  We could even continue to call it Brent Blend if we wanted to maintain the brand. After all, what’s in a name?

 

Pipe Dream

But let’s not get carried away. This is never going to happen. Markets evolve, they cannot be created by individuals or companies. Even if a new contract idea is workable and serves a market need, players will not trade it if it has been introduced by a competitor or appears to give a competitor some sort of advantage.  And a market with no liquidity or no diversity of participants is no market at all.

Let’s just hope that the 17th December meeting does not try to solve Brent’s current problems by trans-shipping Russian or African oil through Sullom Voe because it happens to have under-utilised tanks that are casting around for a way to avoid decommissioning costs.

With North Sea oil in general and Brent in particular dwindling at an accelerated rate, it would make no economic sense whatsoever to freight oil from other regions up to the Shetland Isles when the seats of oil production and consumption are increasingly located elsewhere. The answer to the benchmark problem lies where the heaviest trade routes are located. That answer has to be promoted by an independent entity without a vested interest in maintaining the unsatisfactory status quo.

 

The Battle of the Benchmarks

On 18th September Platts reported that The International Organization of Securities Commissions (IOSCO) on Thursday said that price reporting agencies had made its recommended operating principles an "integral part" of their practices and said it saw no more need for annual reviews of their implementation.”

Also on 18th September Bloomberg reported that Major oil companies including Royal Dutch Shell Plc and price publisher Platts were told by regulators to redact business secrets from documents obtained during antitrust raids in a sign the European Union may be moving ahead with a two-year-old probe..”

 

A quick recap for those who have not been following this story.

 

 

 

 

So that is the Sound of Another Shoe Falling

With this history in mind the Bloomberg story on 18th September takes on considerable significance and is being regarded as the precursor to “the big reveal” by the Commission of against whom who they intend to take action and for what. The logic is that if the EC was planning to say that there was no case to answer there would be no need for redaction of documents, which was the step taken before the EC made a complaint against Google.   It remains to be seen if the EC will give Platts and the companies providing it with deal evidence as clean a bill of health as IOSCO appears to have given to the PRAs.

Those waiting with bated breath for an outcome must include the participants in a class action suit in the New York courts against a number of major oil companies alleging the manipulation of Brent.

 

What is Happening Now

What may or may not have happened in the past is all very interesting, but for market participants it is what is happening now with benchmarks that is the most immediate cause for concern. One consequence of the IOSCO and EC investigations is that many companies have shied away from giving any data to PRAs at all, in case it comes back to bite them in the future. The less data that informs assessments, the less objectively representative of the market are those assessments likely to be.

The Platts Dubai price assessment is the spinning plate most likely to fall first, although Singapore gasoline is also wobbling alarmingly.

The market was deeply worried in August when it became apparent that out of a total of 78 Dubai cargoes, 72 were held by China Oil, allegedly all purchased through the Platts e-window. [Oman and Upper Zakum are deliverable grades against the Dubai contract]

 

August Dubai Market

 Cargoes        Oman           Upper Zakum Dubai  
Unipec-Chinaoil 37 10 1
Shell-Chinaoil 6 8
Vitol-Chinaoil 5 1 1
Gunvor-Chinaoil 1
Reliance-Chinaoil 1
Totsa-Chinaoil 1
Shell-Mercuria 1
Vitol-Mercuria 1
Unipec-Mercuria 2 2        Total
  51   24   3   78
             

 

The price of Dubai leapt from $0.45/bbl below Brent to more than $2.50/bbl above Brent as this situation unfolded. Platts is consulting industry to establish whether the addition of a new grade, Al Shaheen, will dilute the Chinese power to play such a dominant role in the market. This is being seen by some as a sticking plaster for a haemorrhage.

But in the meantime the viability of Dubai as a benchmark is being further undermined by the disappearance of the trading houses and many of the major companies from the Dubai market. Refiners who are buying any oil anywhere based on the Dubai benchmark had better fasten their seatbelts. It’s going to be a bumpy ride.

Trading Matters

In this the silly season, while the world (except hard-working consultants) are off on holiday, two little press releases have slipped by almost unnoticed: Maersk announced that it will be seeking permission to close down the 7,000b/d  J-Block Janice field next year because of falling oil prices; and,  the Johan Sverdrup plan of development for Phase 1 received final consent by the Norwegian Ministry of Petroleum on 20 August 2015.

To most traders these announcements are very frustrating because they stop at the good bit- what are the trading implications?

 

Oil Assets Shutting Down – the Example of Janice

Janice is a field feeding into Ekofisk Blend, which forms part of the hugely influential, but dwindling Brent, Forties, Oseberg, Ekofisk (“BFOE”) oil benchmark basket price, known and used by non-traders around the world as benchmark “Brent”.

In 2014 Consilience published a study on BFOE called “The Brent Oil Price Marker: Future Prospects” This pointed out that “the whole Brent complex of contracts- physical, forwards, futures and derivatives- relies on the continued production of sufficient physical oil to ensure a flow of deals large enough to provide reliable price discovery and to prevent any company or group of companies dominating the market”.

At that point physical production underpinning the Brent price was already <1 million b/d, i.e. less than two full cargoes. That was before the price of oil collapsed from ~$120/bbl to today’s ~$44/bbl, accelerating plans to shut in any assets, fields or infrastructure that is not paying its way. Janice is only one example of a field falling victim to low oil prices.

I hope that the UK’s new Oil and Gas Authority is paying attention. The OGA was set up earlier this year to preside over declining UK sector production and to squeeze the last cent of value from it. Although it believes that the trading issues associated with declining production of BFOE “are all very interesting” and “the crude marker implications are of at best secondary importance” it may be forced to think differently when the market squeezes that we saw in the 1980s and 1990s start to recur on its watch.

The whole point of introducing the BFOE basket was to call a halt to repeated excruciating squeezes, not to head off some theoretical risk that might never happen.

Production of the BFOE basket is declining at an accelerating rate because of lower prices. Further, we are at risk of pipelines being shut down, not just oil fields. North Sea oil pipelines are in the hands of the private sector. They are Contract Carriage, not Common Carriage like they are in the USA. If pipelines are not making money then the private owners can shut them down and refuse to accept new throughput that might extend an uneconomic life.

The OGA has some choices to make: is it going to become like the FERC and regulate UK North Sea pipeline tariffs? Or is it going to take potentially uneconomic pipeline infrastructure out of private hands to keep it open? We know governments in general can nationalise assets at the drop of a hat, but that is not in tune with the zeitgeist of the current UK government.

But granting enhanced abandonment tax relief in exchange for prolonged production from declining fields and keeping pipelines and terminals open longer than is economically justified is another matter.

 

Johan Sverdrup

The North Sea and the Brent price marker is not just a UK issue. The other press release that slipped by without comment was the approval of the Johan Sverdrup Phase 1 development plan. Ultimately this field is expected to produce ~600,000 b/d, but phase 1 will give us a healthy 315-380,000b/d from the second half of 2016.

The approval confirmed what we already knew- that the oil will be piped to the Mongstad terminal in Norway, adjacent to the refinery of the operator, Statoil. But the tease for oil traders is we still don’t know if Johan Sverdrup field will be commingled with the existing Troll Blend that loads out of Mongstad or if it will be sold as a separate stream of oil. We also don’t know what Johan Sverdrup quality will be other than that it has an API Gravity of ~28o.

Traders need a bit more to be able to establish if Johan Sverdrup has a contribution to make in rescuing the BFOE basket or not, either as part of Troll Blend or on its own account. In the trading world this is of more than “secondary importance”.

 

And Another Thing…..

There has been a bit of schadenfreude surrounding reports that Glencore has been feeling the draft from a tough year in the commodity market. They are probably not alone but the private trading companies, of course, have no obligation to tell anyone if they are on the wrong side of a price move.

Trading companies make an easy and popular target because they can be pretty ruthless in pursuit of profit.  But don’t chuckle too hard if they are having a hard time. The commodity trading houses are the research and development department of the trading sector. They are the ones who push the envelope to find new contract structures to provide financing and hedging solutions for the “real” oil and gas companies. Of course they charge for it. R&D has never been cheap in any industry!

How Not to Sell Crude Oil

What do you do when the world is awash with oil, your biggest customer has suddenly become almost self-sufficient and your nearest competitor is producing a more suitable quality of oil for your remaining market? You ban 113 crude tankers from entering your territorial waters with immediate effect, of course- simples!

This is the curious action taken by the Nigerian National Petroleum Corporation (NNPC) in a letter of 15th July to all Nigerian loading terminal operators. The letter and list of banned tankers, which circulated quickly on the internet and which is reproduced below, claims to have been prompted by a directive from President Muhammadu Buhari. It does not detail the reason for the ban, fuelling speculation that it is an attempt to tighten the country’s grip on its oil trade and to reconcile the quantities claimed on bills of lading with quantities eventually reported as discharged at the ultimate destination.

A bold move from NNPC at a time when it is struggling to find new markets for its light, sweet oil, which used to find an outlet in the US Gulf Coast, but which has been largely displaced by US shale oil. This shale oil blends better with heavier, cheaper Angolan oil than with Nigerian light, sweet oil, robbing Nigeria of even the crumbs from the US table of imported oil. Nigerian Bonny Light, which was priced at a healthy average $2.25/bbl over Angolan Girassol in 2013, has languished $0.20/bbl below Girassol so far this year.

Bonny Price

Source: OPEC

The news landed like a depth charge into the economics of voyage charters and arbitrage deals. As buyers of Nigerian crude in Europe and the Far East, especially India, scrambled to re-arrange their shipping programmes the market remained mystified as the why the particular vessels named have been singled out. Traders are questioning if the list is a complete one or if there are likely to be any additions to the roll call of banned tankers.

Way to sell oil, Nigeria!

Please click on appendices to enlarge.

Appendix 1

Nigerian list of prohibited tankers

Appendix 2

Nigerian under listed terminals

Appendix 3

Nigerian tanker list

nigerian ship list 1

nigerian ship list

nigerian ship list 3