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Fight to keep Brent oil benchmark fit for purpose

As the world’s oil traders descend on London this week, the hot subject will be how to keep North Sea Brent, the benchmark for the global oil price, fit for purpose.

S&P Global Platts , the oil pricing agency, is trying to execute the biggest overhaul of North Sea oil trading in a decade, with plans to rejig how prices in the region are set ahead of a projected drop in the supplies of the crudes that underpin Brent.

The adjustment that Platts has put forward is provoking fierce debate among oil traders who are coming to the UK capital for the annual round of conferences and parties that make up International Petroleum Week.

While drily technical, the Dated Brent physical price assessments by Platts influence billions of dollars in trades, with the benchmark referenced in about two-thirds of global oil deals. It also underpins billions of dollars of trading in futures, options and other derivatives.

“Today the benchmark is working fine, but we’re looking to safeguard it,” said Dave Ernsberger, global head of energy pricing at Platts. “We need to look ahead to the next 10 years.”

On Monday, Platts announced it would add another crude production stream — from the Troll field operated by Norway’s Statoil — to ensure that there are enough cargoes in the physical trades it assesses to accurately reflect the state of the market.

It is also investigating a more radical plan to account for a possible larger drop-off in North Sea output over the next decade that would allow oil delivered from as far afield as west Africa and Central Asia to contribute to setting North Sea prices.

Any mis-step risks undermining Brent’s role at a time when the removal of curbs on US exports of domestic oil gives Brent’s rival benchmark, West Texas Intermediate, growing international clout.

Given the amount of money at stake, traders are nervous and urging Platts to proceed cautiously.

From January 2018, Troll will join the existing basket of crudes known as BFOE — Brent, Forties, Oseberg and Ekofisk — that provide the physical supplies to the Brent futures contract on the Intercontinental Exchange (ICE). Forties, Oseberg and Ekofisk were added over the years to supplement declining supplies of Brent, but no new grade has been added in 10 years.

While Troll will add about 200,000 barrels a day of deliverable supply, which feeds into the daily price assessment of BFOE, some traders have doubts. Before the announcement some had provided feedback in consultations saying they would prefer tweaks to the existing price assessment methodology that aims to reflect the differing qualities of the existing four crudes.

If this is not addressed first, one source at a big North Sea trader said, the introduction of another grade to BFOE could make “an assessment that is unhedgeable, hence not fit for purpose”.

“We don’t see any urgency to add grades today,” he added.

Changes to Brent shifts the balance of power in North Sea trading. The addition of Troll makes Statoil the biggest contributor of supplies to the grades supporting Brent, overtaking Shell.

Some big North Sea traders had expressed concern Statoil would have an advantage in understanding the balance of supply and demand in the region as it sends a large amount of Troll crude to its Mongstad refinery, Norway’s largest.

Platts, which has long been seen as a de facto regulator of the physical market, says it decided Troll was the best fit to offset declining supplies after extensive research and consultation with the industry and it will continue to listen to feedback.

Exchange operator ICE is also playing an active part in the discussions having built its business on the Brent future contract, hiring a consultancy founded by former Morgan Stanley commodity traders in recent months to assist.

Michael Brennan, who ran Morgan Stanley’s oil business, said his company, Energex Partners, had been contracted by ICE to help with “long-term strategic thinking” for the Brent contract to make sure it remained the international standard.

“[The Brent contract] is thriving today, but it’s important to look ahead, particularly as changes occur,” Mr Brennan said. “ICE wants to anticipate what could happen rather than be reactionary in time to come.”

One long-time industry observer, who has closely followed the fate of the main oil contracts, said ICE had seen Brent futures volumes increase faster than its US rival CME Group’s West Texas Intermediate crude contract at the start of the decade.

But recently CME’s WTI volumes have been growing faster, increasing pressure on ICE to make sure any changes to the physical market linked to its future contract are successful.

“While there is a lot of power in incumbency, CME is hot on their tails,” the industry observer said. “ICE is still dominant in benchmarking, but there is clearly an issue for the long term that ICE wants to address more broadly.”

Platts’ longer-term proposal is to move to a system where cargoes can be delivered from further afield into storage in Rotterdam, including crude grades of similar weight and sulphur levels from west Africa and Azerbaijan.

Such a plan is unlikely to be implemented until well after 2020, however, and some expect North Sea supplies to remain more robust than predicted, with the recovery in prices to $55 a barrel already attracting investment back to mature basins.

Platts said while it would listen to all opinions within the industry, it was essential for someone to show leadership.

“If the industry is left to itself there will be no decision,” said Mr Ernsberger at Platts.

“This has been a decade-long project to ensure that the Brent benchmark remains robust.”

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