July 29, 2021

Game of Price Thrones – A Hectic 2021 for Global Crude Price Benchmarks

So far in 2021, we have seen three major events pertaining to global price benchmarks:

  • Platts’ launch of a consultation period for considering the addition of WTI Midland to the Brent basket, which was recently reinforced by a joint paper published by both Platts and ICE, clarifying that the addition refers to a WTI Midland assessment delivered in the USGC
  • ICE’s announcement about the launch of a new WTI Futures Contract that would start operations in 2022. Additional entities, including Magellan and Enterprise are joining forces with this initiative
  • The new Murban futures contract started operations last March, providing the market with an alternative benchmark for Middle Eastern streams

These events are not isolated, but rather the -belated- response of Price Reporting Agencies and Exchanges to changing market dynamics and infrastructure developments that have clearly made current price benchmarks obsolete. From a global perspective, both major oil futures contracts (WTI NYMEX and Brent ICE) are seriously flawed, and both CME and ICE have been slow to adapt to new market conditions.

The accuracy of global benchmarks is paramount: most producers, traders, buyers, government and private fiscal entities and investors own contracts that are directly or indirectly linked to a global crude benchmark for either a transaction (buyer and seller exchanging physical barrels), payment of royalties, taxes, production sharing percentages, hedging strategies, futures swaps, among others.

But not all streams can become a global benchmark. The minimum requirements for a reliable, useful, meaningful, and accurate benchmark are:

  • It must have significant production volumes
  • The stream needs to be produced by several different entities, acting independently
  • The stream needs to be settled on the basis of day-to-day transparent market transactions 

In addition to the above three main requirements, it is also imperative that the crude volumes being produced by the independent producers are associated with the same region, so the market dynamics of the region are directly captured by the benchmark.

This note provides an assessment of each one the events, as a courtesy to non-subscribers. Current subscribers to our Short-Term Outlook or Global Refining & Products services have access to the more extensive versions of each of these individual market insights.

The Unbearable Lightness of Brent- What is the impact of the proposed changes in the North Sea pricing system

Last February, price reporting agency S&P Platts announced a change in the way their North Sea basket will be calculated as of July 2022, with the addition of WTI Midland to its new Rotterdam CIF North Sea basket. However, just a few days ago a joint paper was published by both the Intercontinental Exchange (ICE) and Platts, which describes in more detail the proposed changes to the Brent basket.

Brent production was above 1.2 million barrels in the 1980’s but has been constantly declining for over 30 years. Currently Brent does not represent more than 70 thousand b/d of crude production, which in the world of global benchmarks is not material – and therefore, does not meet basic requirements for a reliable, transparent price benchmark.

With the proposed change (to be implemented until July 2022) price agency S&P Platts is intending to add more liquidity to their current North Sea basket calculation, while acknowledging the importance of the WTI price and the dynamic Permian Basin activity. The proposed change, however, has several challenges:

  • The change would be expanding an artificial basket, with a component that is not part of the same region, inherently decoupling Brent basket from its real spot value based off domestic market dynamics
  • The inclusion of a WTI Midland price -even if it is assessed at the USGC- adds considerable noise to the North Sea basket because the differences between the two regions is reflected not only by their own supply/demand dynamics, but also by changing freight costs
  • Lastly, but most importantly, the decision to add another patch to the North Sea basket creates a “FrankBrentstein” that has no practical reason to exist. In trying to keep the North Sea basket alive rather than shifting to another regional marker, the rationale seems to be: “if there is no global benchmark located in Europe, then it makes no sense”.

Overall, the S&P Platts’s suggested change, if implemented, will modify the way the current North Sea basket is calculated, from an artificially complex benchmark, to one that is even more complex and artificial, while being less representative of European market dynamics.

These Boots Are Made For Pricing – Implications of The New WTI USGC Futures Contract

Last month the Intercontinental Exchange (ICE), Magellan and Enterprise announced they are joining forces to establish a new WTI futures contract, which would start is operations by mid-2022. The biggest selling point of this new contract is the fact that it is designed for the Houston area, rather than for Cushing, which marks a stark difference vs. the current NYMEX WTI contract.

The backbone of this announcement was the notion that this new futures contract is necessary to avoid the financial anomaly seen on April 20th, 2020, from ever happening again, when prices in the WTI NYMEX prompt futures contract went into negative territory.

ICE’s message with this new contract is an inherent promise to avoid these kinds of situations in the future, which strictly speaking, is a claim that is hard to honor. Plentiful storage infrastructure in the USGC would not necessarily prevent inexperienced traders from entering into another anxiety rally, given similar circumstances (another pandemic or a similar event that causes oil demand to suddenly plummet in a few weeks).

But beyond that, this is clearly a chess move by ICE that is aimed to snatch the US crude market out of the hands of CME (owner of NYMEX). The WTI NYMEX futures contract has been the prevalent hedging tool in this side of the Atlantic for several years, but has seemingly failed to adapt to new market realities where plenty of US crude production is aimed for exports out of the USGC. Market developments move faster than organizations and the fact that NYMEX has not been able to identify the need to “move” the clearing location from Cushing to the USGC exporting hubs, gives ICE the opportunity for a competitive advantage.

  • One positive side of this proposed WTI USGC futures contract, is that it would finally end the discussion about which one of the several WTI prices to use, instead of continuing to use a disconnected WTI Cushing-based price assessment
  • The very fact that ICE is putting on the table an alternative futures contract that acknowledges the importance of the USGC volume being exported is a big benefit for the US oil industry in general, and it can set the basis for this WTI USGC price to be used worldwide, displacing the flawed Brent price
  • Using the USGC as a price discovery hub has been an obvious option for all Trading Exchanges, but they have failed to provide market participants with the appropriate alternative so far, whereas the Price Reporting Agencies have provided way too many spot options, adding to the confusion of most market participants.

With regards to the challenges on the horizon for this initiative, first and foremost, we see an error in ICE’s communication strategy, by focusing on the April 20th 2020 incident, the focus seems to underappreciate the size of the problem this initiative is actually solving. ICE and its partners might want to rely on this factor for convincing the industry, rather than invoking fear associated with a specific moment in time that is unlikely to be repeated (the negative prices seen in one specific day during 2020).

  • The very fact that major infrastructure entities are directly involved with the futures contract will generate questions related to transparency, commercial equality (pertaining, for instance, to awarding storage or capacity contracts) fair competition, and price signals. ICE might have been better served by receiving support of Magellan and Enterprise without directly involving them in the initiative
  • ICE’s record in terms of pragmatism and reliability to respond to market conditions is not the best: ironically, rather than solving the complicated outlook for the Brent future’s contract (based off a crude that is barely produced by a small number of stake holders, relying on a confusing spot price reported by Platts) it is trying to take advantage of NYMEX’s passivity in the US.

All in all, the announcement is one of the more important commercial developments of the last few years, and if executed properly, it could provide a viable alternative for several crude producers, refiners, and traders, by the second half of 2022.

New Kid In Town- Prospects for the New Murban Futures Contract

The new Murban futures contract started operating last March at the ICE Abu Dhabi futures exchange (IFAD), after several months of delay because of the COVID pandemic. This is an important development for the oil market because it establishes an alternative benchmark for barrels moving primarily from the Middle East to Asia. The benchmark can also be used as a reference for African or even European trade flows.

The influence of the NOCs, however, is one of the biggest challenges that the new Murban contract will face, in the newly launched Abu Dhabi Exchange. The national oil company (ADNOC) is a prevalent exporter of the volume, with at least 60% of production, even though it advertises that nine other entities (holders of concessions in the country) are active participants in the Exchange.

The contributors of additional volume that are providing liquidity to the Murban contract are: BP, GS Caltex, INPEX, JXTG, PetroChina, PTT, Shell, TOTSA (Total) and Vitol, with some of them holding percentages as low as 3% (BP and Total each hold 10% of the production). 

On a one-to-one comparison, the new Murban futures contract (IFAD) is supported by 2 million barrels/day, whereas the Oman/Dubai contract (flagships of the DME) represent around 2.4 million b/d, including volumes from Oman, Dubai and Upper Zakum barrels, which can be delivered interchangeably at the seller’s discretion.

Because of the dominant volume that the regional NOCs hold in these physical transactions, neither the Oman/Dubai contracts (by DME), nor the Murban contracts (by IFAD) represent perfect price discovery options. However, they both represent the best alternatives that the commercial conditions of the region can provide.

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