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Adnoc joins the trading party

The Middle Eastern NOC’s new trading venture adds to the oil market’s evolution, and potentially to the pressure on middlemen

Abu Dhabi's state-owned Adnoc inked a deal with Eni and Austria's OMV in late January that gave the European IOCs stakes in both its refinery arm and in a new trading venture to manage refined product exports.

Eni will take a 20pc stake in Adnoc Refining and OMV 15pc, although no information has been given on whether the trading venture will have the same ownership structure. Physical and derivative trading is slated to begin in 2020 "when all necessary processes, procedures and systems are in place".

According to Adnoc, Eni and OMV will provide it with know-how, operational experience and support to accelerate the development of the trading joint venture, enabling all partners to optimise their systems and better manage their international product flows.

Once operational, the trading joint venture will help guide Adnoc Refining's activity and operational decision-making, says the firm, in order to secure for Adnoc the best possible value from its refining and trading activity. The trading joint venture will "expand its global presence over time".

Adnoc is hardly the first NOC to become more involved in trading. Depending on one's definition of exactly what constitutes a national oil company, a swathe of firms where there is a significant state influence-from Malaysia's Petronas and Indonesia's Pertamina in southeast Asia, through China's big three Cnooc, Petrochina and Sinopec, Norway's Equinor in Norway to Mexico's Pemex and Brazil's Petrobras-have gone through the process of becoming less bureaucratic and more commercially focused.

Trading involves not just a series of vanilla transactions at the best achievable price

Russia's Rosneft tried to accelerate its process by buying the oil trading arm of US merchant bank Morgan Stanley in 2014, only for US regulators to nix the deal. It has instead tried to "get trading into its DNA" through expertise housed in its TNK-BP acquisition, says Steve Jones of the boutique energy advisory, Energex Partners.

But, while Africa's oil firms show little signs of achieving oft-promised commercial efficiencies, the Middle East is the current focus of a trend of much greater NOC involvement in the trading market. These firms "are increasingly active on their own account", says a market source based in Dubai. "Aramco Trading is a very active spot trader." In late February, reports emerged that the Saudi firm may be opening a London trading office to further its expansion.

Oman Trading International is another example of a Middle Eastern NOC becoming more involved in the spot market, initially as a joint venture with Swiss trading house Vitol before Oman Oil took full control.

The genesis of NOC interest in getting further into trading goes back as far as the 2000s, says Energex's Goran Trapp, when trading firms began making huge amount of money, both by their own historical standards and even compared to IOCs and NOCs. This fostered an internal debate on why NOCs should not do more of their marketing themselves, rather than let the traders do it.

And this has driven a trend throughout the current decade where having assets and optimising around them has become a more popular business model than asset-light pure trading. "Margins in physical oil trading are paper thin right now," says the Dubai source. "If you are competing against someone with a system, then that can be a challenge. You really need to have somewhere from where you can guarantee the oil is coming out and somewhere you can bring it in."

“Trading has a culture of personal responsibility” – Jones, Energex Partners

But Trapp cautions against simplistic thinking that, if you hold the assets and you "magically" add some more activity, you will be able to reap benefits comparable to the previous margins enjoyed by trading houses.

For NOCs, acquiring true trading capabilities is "a quantum leap", says Trapp. This is because trading involves not just a series of vanilla transactions at the best achievable price, but "a whole spectrum of activity". What trading houses do in terms of monetisation of opportunities and optimisation in contracts is much more sophisticated than, largely, what NOCs are doing, which is more about moving from fob to cif on supply, and vice versa on procurement, and some transport and logistics optimisation. Trapp terms it more of "an industrial model", rather than a genuine trading model.

Mindset is another key challenge in NOCs, where there has traditionally been little of the sort of risk/reward incentives to encourage entrepreneurialism or risk-taking. "Trading has a culture of personal responsibility, delegated in a big way to individuals, under the correct risk mandates. In NOCs, decisions typically have to go up a bureaucracy and come back down again," says Jones.

In theory, a partnership between an NOC and a trading house or IOC, such as the Oman and Abu Dhabi deals, should bring benefits. The NOC brings the assets and the system, the trader brings capabilities and the platform to execute. But examples of where the model has proved effective in practice are scarce, particularly over the long-term.

In a shorter time horizon, it is clear that some NOCs have benefitted from knowledge transfer and a 'jump-start' on their journey towards being more trading focused. But the foundations for lasting partnerships are more difficult.

"It is essential to have transparency, openness and trust, and that is not easy," says Jones. Achieving the right balance and a sense that each side is getting a fair share of the value created is tricky, particularly on the NOC side, where there are often suspicions over being taken advantage of.

And, again, culture can be a barrier. "For a trading organisation, there is a slightly different risk appetite compared to an industrial organisation. The NOC may get it in theory but, practically, the organisation may not buy in. You need to be clear what the objectives are and then to be judged on that basis. You need the correct risk mandates and risk controls. And it needs to have acceptance across the whole organisation," says Trapp.

On Adnoc's latest attempt to crack the code of trading joint ventures, there is some scepticism over its prospects. The main question mark is over its choice of partners-while Eni and OMV have long-established trading presences, neither are considered on the cutting edge of that particular specialism.

“It is essential to have transparency, openness and trust, and that is not easy” – Jones, Energex Partners

Middle Eastern NOCs are not the only actors getting more involved in trading on their own part. Asian crude buyers are also getting in on the act. "Asian traders are becoming more sophisticated ad less conservative," says the Dubai source. "They are entering the market more frequently than they used to, playing a more active role in the day-to-day trading of crude, and doing it more for themselves rather than using trading houses."

A key driver of this is greater choice of supplier, as the shale oil revolution pushes previous Atlantic Basin importers to the US to look east and US exports themselves look for Asian markets. Would-be Asian buyers thus have options from the US Gulf Coast, west Africa, the North Sea, the Middle East and southeast Asia. "The Asian consumer has never been better placed to buy spot crude and has probably never had so much choice," says the source.

But Energex's Jones has doubts over whether Asian buyers have evolved of their own volition, or because their traditional buyers are now keener to offer them structures more sophisticated than basic term contracts. Adnoc's 2018 deals with the operator of India's strategic storage reserve for access to its facilities, and ultimately to the Indian domestic oil system, are an example of a traditional seller's more innovative approach. ""It is our firm hope that we will be able to convert this framework agreement into a new mutually beneficial partnership that will create opportunities for Adnoc to increase deliveries of high-quality crude oil to India's expanding energy market," the firm's CEO Sultan al Jaber said on the December signing of a second preliminary agreement.

More western hemisphere price-linked barrels going east also motivates Asian buyers to become more involved in global crude markets. "The more WTI and Brent price risk they have, the more they need to be involved in the market, compared to if they only have Dubai-related volumes," says Trapp. "If they want to remain just Dubai price takers, then someone else will take the risk for them, and take a margin from that."

The rise of greater trading activity from both Middle Eastern sellers and Asian buyers poses obvious challenges to the business model of trading houses, who would have traditionally taken the middleman role. But this is not their only challenge, as greater information transparency and immediacy also erodes one of their historical edges.

Many trading houses have responded by tweaking their business models, looking to build to full, or at least partially full, value chain companies. They have snapped up assets, or done deals giving them access to assets or creating 'asset-like' structures.

While this switch may have ensured the survival of the major traders, it has also brought challenges. They have become bigger, more mature and much more visible compared to years gone by, and more formalised in how they do business in certain places. As a result, they must think about the exposure they might receive now for doing transactions that they would have done in the past- not necessarily illegal, but which might not stand up to retrospective scrutiny.

The largest traders' greater circumspection in areas where there is substantial political, reputation or credit risk clearly offers opportunities for smaller niche players. But Trapp cautions that these geographical or grade/product specific niches will never be sufficiently big to compensate for the decline in wider opportunities for middle-ranking traders. Given the ever-increasing back office and technology costs, many face a stark choice between the heavy investment needed to be able to compete on the global stage or shrinking to be more narrowly focused specialist operators.

Cargo tracking has played a key role in democratising real-time information flow and reducing the advantage that trading houses, with their network of port agents and other well-placed on-the-ground informants, previously enjoyed. "You can count the barrels and you can work out if the arbitrage looks open or closed," says the Dubai source. "The transfer of information these days is so fast, and the market is so efficient, that the margins are not there. That might ultimately impact on the risk appetite of some traders."

Trapp acknowledges that cargo tracking is one aspect of oil trading's information revolution, but points out that, given the potentially unreliability of initial destination indications, it is far from a perfect tool in predicting near-term crude flows. While the cargo trackers themselves are beefing up their AI capabilities, the largest traders are investing in-house in their analysis heft in search of a slight advantage in pre-empting shifts in flows and arbitrages- and furthering the trend that playing in the global crude market increasingly requires the deepest of pockets.

The more general smartphone and social media-led information explosion is at least as influential as cargo tracking, Trapp contends. Areas of the world, and the producers or consumers located there, that used to be at a significant disadvantage due to a disparity of information with networked traders, are seeing that gap close and those geographies shrink almost to the point of non-existence.

In one of the trading houses' traditional roles, providing financing in exchange for preferential contractual terms, there is more transparency around those opportunities, more companies competing for those opportunities and shorter durations for any exclusive relationships. "In the past, traders used to make money on a relatively small number of big contracts with high margins. Now it is all about a high volume of smaller deals with much smaller margins," says Jones.

But, while times are tough for traders, there are no reports of widespread liquidations or exits from some or all markets, although credible sources report that most firms have one or more problematic desks somewhere in their operations. However, attempts by traders to raise financing from strategic investors are not proving easy in the changed environment.

The current owners of one or two smaller firms have recognised the need to find a bigger platform, says Jones, and are looking to sell. Indeed, discussions between near-to-death smaller trading companies and NOC type firms, where an investment could offer the NOC a step into trading, are believed to be ongoing. But, if the search for investment fails, the exit strategy for some of these traders may have to be to wind down.

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