When Shopping, Always Remember to Keep the Receipt!
A mere 6 weeks after completing its purchase of the Forties Pipeline System (FPS), INEOS declared force majeure and shut down this key piece of North Sea infrastructure, throwing the influential Brent market into confusion: Forties makes up about half of the physical supply underpinning the Brent contract.
Speculation is rife about whether INEOS is being overly cautious by shutting down the whole system to deal with what appears to be a minor onshore leak in order to be able to pass back repair costs to the vendor. Others whisper darkly that if the onshore pipeline is showing hairline cracks how much worse must be the much larger web of offshore pipes?
Only the protagonists know, but for INEOS’ sake I hope the deal was done under English law, not Scottish law: as any house buyer knows, under Scottish law it is the responsibility of the buyer to complete all its surveys before submitting a bid, while under English law bids can be made subject to subsequent completion of a satisfactory survey and withdrawn if the survey uncovers any problems.
Calling Oil Lawyers
Irrespective of whether or not the buyer and seller of FPS end up in court over the pipeline closure or have made sensible provisions in the sale and purchase deal for the asset, it looks like it will be a Merry Christmas and an even happier New Year for lawyers in the oil sector as traders reach for their contracts to see what can and cannot be done legally when force majeure is declared.
Producers in the 70-80 fields that use FPS have signed largely similar deals to use the Forties transportation system. These deals give INEOS broad rights to delay, withhold or suspend the delivery of cargoes of Forties Blend when circumstances beyond the control of the operator interrupt pipeline services. Some traders are already attempting to argue that if the operator had maintained the pipeline the cracks would not have appeared and the force majeure would not have had to be declared. INEOS could not have been actually responsible for any alleged shortfalls in the maintenance of the pipeline because it has only owned the asset for a few weeks. But presumably it has taken on the responsibility of the previous owner to keep the FPS in good working order.
But that is only one aspect of the legal quagmire in which the Brent market now finds itself. Readers of these LOL blogs will have heard me point out ad nauseam that the published price of “Brent”, which is a key benchmark for setting about 50-66% of the world’s physical oil, is actually the price of the lowest of a basket of crudes including Brent, Forties, Oseberg, Ekofisk and, for contracts deliverable from January 2018 onwards, Troll (BFOET). The 30-Day forward BFOET market, on whose price the much larger Brent futures contract is also based, allows sellers to deliver any one of these 5 different grades of oil in satisfaction of a forward sales contract.
This 30-Day forward market operates using Shell UK general terms and conditions of trade (GTCs) 1990 edition (SUKO 90), supplemented by the various updates that have been needed over the last 27 years as the forward contract has evolved. The SUKO 90 terms are quite unusual in that they provide for the fact that forward contracts tend to involve cargoes that change hands many times forming long chains of owners starting with an equity producer and ending with an end user who will load it onto tanker for transport to a refinery. These terms state that only the Prime Supplier, an equity producer, and the last FOB buyer, i.e. the buyer that charters a ship to lift the oil, can initiate reliance on the “Exceptions” clause, which is SUKO 90 terminology for force majeure (although there are legal niceties distinguishing between force majeure and exceptions, which are beyond my trading brain). So far, so good. The Prime Supplier of a cargo that has been cancelled because of force majeure can cancel its contract for the forward sale and supply of a Brent, Forties, Oseberg, Ekofisk or Troll cargo if it so chooses, but it is under no obligation to do so.
However a further complication arises because the trader planning to supply a cargo into a 30-Day forward chain may not be a “Prime Supplier”, defined in SUKO 90 as a company with an “equity entitlement” to one of the 5 grades of crude oil. When cargoes of Brent, Forties, Oseberg, Ekofisk and Troll are bought and sold as physical cargoes, i.e. not as a 30-Day BFOET cargo, the contracts rarely use SUKO 90 terms. Instead these physical contracts may use BP GTCS, ConocoPhillips GTCs or Statoil GTCs, depending on which grade is being delivered. So if a trader wants to withdraw a delivery of, say, Ekofisk from a 30-Day BFOET contract because of the Forties Force Majeure, it can find itself meeting resistance because it is, arguably, not a Prime Supplier
So What is the Price of Brent?
Trade in 30-Day BFOET, and in the individual components that make up the Brent basket, is opaque. Traders already nervous about the advent of the European Benchmarks Regulation have been driven further underground: it takes a brave company to provide a price assessment to a price reporting agency in such a confused market, particularly when that assessment is leveraged by forming a key price benchmark for so many contracts -physical, forward, futures and derivative – around the world. No-one wants to risk the wrath of a regulator by guessing at where the price would be if trade was taking place: that’s what got the LIBOR guys into trouble.
So those who rely on Brent price assessments in any of their contracts anywhere in any geographic location would be well advised to examine those prices closely. Just how much data is informing their compilation and how realistic are they?