December 4, 2015
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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.



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.