Dated Brent gets another makeover
The world’s most important Fob oil benchmark will get a new Cif element from October
Dated Brent is without doubt the most influential and iconic oil benchmark price. But, since 2002, its name has been misleading, as a decline in production from the Brent system has seen other grades added, initially Forties and Oseberg in 2002, followed by Ekofisk in 2007 and Troll in 2017.
The Brent market has also become more complex, as the arrival of the Buzzard field—with substantial quality difference to the rest of the Dated Brent fields—into the Forties system in 2007 required a sulphur de-escalator to be introduced. Quality premia for Ekofisk and Oseberg were introduced in 2013 and revised in 2014, while a Troll premium will be added in April this year. The window length has also changed, from 7-15 days to 10-21 days in 2002, to 10-25 days in 2011 and to 10 days-one calendar month forward in 2015.
But these changes, while necessary to maintain sufficient barrels available to trade to ensure the liquidity that underpins robust price discovery, did not alter the core structure of the assessment as a free-on-board (Fob) North Sea price. February's announcement by price reporting agency S&P Global Platts that it would, from October, include offers for the five Brent grades on a costs, insurance and freight (Cif) Rotterdam basis, with an adjustment for freight to provide a comparable Fob value, in its assessment marked a significant change in direction for the benchmark.
The main driver of the change, as with previous tweaks to the pricing methodology, is to increase the volume of assessment-relevant barrels and increase the data available to price assessors. A cynical view is that the inclusion of Cif Rotterdam bolsters the volume and data without ever setting the price, thus being a largely cosmetic change-asked directly if it had back calculated to see if the Cif Rotterdam prices it has assessed since 2017 would ever have set the Brent price, Platts admitted to having done back calculation but ducked whether a Cif offer would have been price setting.
In an oversupplied market, the Cif Rotterdam market could offer an "escape valve" for cargoes initially unable to find a home, says Olivier Lejeune, an oil market analyst at the International Energy Agency (IEA), arguing that offers could then be sufficiently aggressive to be price-setting.
Platts has been a muscular facilitator of tactical changes to maintain the resilience of the Brent benchmark, in the view of Colin Bryce, co-founder of consultancy Energex Partners. The inclusion of Cif offers is another of these tactical changes, rather than a purely cosmetic exercise, says Bryce, particularly as Platts could have done nothing and waited for the arrival of the Norwegian Johan Sverdrup field which, while of substantially different quality to the crudes in the current Brent basket, will significantly boost North Sea oil production later this year.
A key question is whether the inclusion of the Cif offers from the five fields is a destination in itself, or a stopping-off point on the inclusion of Cif pricing from non-North Sea fields delivered into the Amsterdam-Rotterdam-Antwerp (ARA) area, or even to the evolution of Dated Brent into a Cif, rather than Fob, benchmark.
Platts itself acknowledges that the inclusion of North Sea Cif data is an "enabling step" and raises the possibility of including further grades, including those from outside the North Sea, "should it become necessary". It says that, in its consultation process with the market over the inclusion of the North Sea Cif offers, it received a wide range of suggested additional grades, some of them obvious choices, but others that it had not previously considered contenders for inclusion.
Lejeune is convinced that getting the market used to Cif data within Brent, ahead of introducing other Cif ARA delivered grades, is "part of the intention". As North Sea production declines but ARA remains an oil import and refining centre, the transition to a Cif benchmark for Europe "becomes more relevant" and is likely to be "very much the initiative for the long-term", he says, pointing out that all of Europe's major refined products benchmarks are already Cif assessments.
While Russian Urals, West African Bonny Light and Azeri CPC Blend have previously been seen as potential additions to Brent, the arrival of significant volumes of US Gulf Coast export volumes in ARA in the last few years have made it the most discussed potential new inclusion in the Brent basket.
New North Sea price
Platts notes that it is already assessing US shale oils Eagle Ford 45 and Midland on a Cif ARA basis, which will offer it insight into how Gulf Coast crude prices in the European market. Competing price-reporting agency Argus Media, which has ambitions to win the Brent benchmark away from incumbent Platts, has already gone a step further and introduced in February a New North Sea Dated price, a variant to its Platts copycat North Sea Dated that includes the five North Sea Fob grades, but also the price, adjusted from Cif to Fob, of six non-North Sea crudes, Nigeria's Bonny Light, Escravos and Qua Iboe, BTC Blend, Algerian Saharan Blend and WTI.
For seven consecutive trading sessions between 15 and 25 February, the WTI component was the lowest, price-setting element of the Argus assessment, at a discount to Dated Brent that topped 80¢/bl on four occasions, according to a March paper for the Oxford Institute for Energy Studies (OIES), authored by OIES research associate Adi Imsirovic.
"US oil exports, once loaded on a ship at the US Gulf Coast, essentially 'becomes Brent' in the sense that it is of similar quality, but also because Brent is the main pricing reference point for exports both to Europe and Asia," says Imsirovic. And volumes of WTI arriving into Europe may grow from a current 700,000bl/d, taking it close to or even above the 920,000-bl/d Brent-relevant production in April.
As such, Imsirovic sees Platts' move as "likely to be just the first step towards the full inclusion of WTI into the same contract as well", arguing that its addition "could increase
liquidity, prevent spikes in Dated Brent, and hence provide an effective 'cap' on its price and allow the negotiated differentials to Dated Brent for other grades to remain more stable".
Others are less convinced. "Including wider Cif grades [in Brent] becomes difficult due to cargo size, cargo programming and many other discontinuities," says Energex's Bryce. "My view is that the industry will have more need for a WTI Fob Houston marker than for Brent to embody these barrels in a Cif Rotterdam BFOET+."
"More complexities will make a wider Cif market more difficult to assess," agrees the IEA's Lejeune. "There will be different qualities, different cargo sizes, different players. There will need to be even more normalisation to make it uniform," he says, suggesting that Platts will be in no rush to make any changes while the market functions relatively well.
But not everyone agrees that Dated Brent is currently in good shape. "Brent is held together with sticking plaster," says Liz Bossley, chief executive of consultancy Consilience. Her main gripe is with the rigidity of the quality premia mechanism, which results in economically illogical outcomes.
Since the introduction of Buzzard, "Brent should be renamed Forties," says Bossley, as the grade was, as the lowest quality, always the cheapest and the preferred delivery by sellers. But certain countries and refineries have a preference for Forties, particularly in China and South Korea, which can see the availability of the grade dry up and need to be replaced with Ekofisk and Oseberg.
However, while economic theory would dictate that Forties in short supply would see its price go up, the quality premia mechanisms ensure that it does not. The problem is likely to be exacerbated by the inclusion of the even more drastically different Johan Sverdrup field. "It is the Emperor's New Clothes, everyone knows it does not work, but they continue with it anyway."
That Dated Brent is more important as a brand, rather than a perfectly formulated physical marketplace is not a controversial view. "What is left of Brent blend crude oil, loading at Sullom Voe terminal, is now just a brand name," says Imsirovic. "The great majority of [futures] open interest is held by participants who view Brent, not as a light sweet crude oil, but as a brand and a venue. They are ambivalent to the detail as long as there is volume and open interest," agrees Bryce.
But Bossley is adamant that underlying problems in the physical market could have an impact on the financial edifice built atop it. Futures contracts are governed by ISDA terms and the potential introduction of WTI crude, arriving on VLCC tankers, into Brent would represent a material change that would allow price re-opener clauses in the futures contracts to be activated on the grounds of a material change. With no such re-openers in physical contracts, the risk of a hedging mismatch is manifest, says Bossley.
Her preferred solution to the quality premia issue is to focus on the various grades' value to refiners. With liquid European products markets giving a clear indicator of value for refinery output, Platts could use a recognised tool such as the Nelson complexity index to construct a "virtual" European refinery based on the average complexity of facilities, against which various grades' assays could be valued.
Market price parity
Platts launched, in August last year, prices for six west African crude grades which do not trade sufficiently regularly to be assessed in the usual way on what it calls a market price parity (MPP) basis. MPP prices calculate value "based on the refining value of the grade". Platts Analytics, the market analysis and consultancy arm of the business, "has analysed the refined product yields for each MPP crude grade in a relevant regional refinery, including input costs such as power usage, chemicals and catalysts, capital and staffing".
Bossley suspects that this MPP approach, once tested in the west Africa space, could be expanded to replace the existing Brent quality premia, with Platts owning and monetising the model used to calculate the differentials.
If the Brent market can be made to work more efficiently without necessarily including WTI barrels on a Cif ARA basis, that leaves the question of how the market prefers to value US export volumes. Much will depend on how sellers prefer to sell, says Energex's Bryce—if on a Cif basis, then Gulf Coast exports will likely be valued on a Brent basis, even without being explicitly in the pricing basket.
But if sales are mainly on a Fob basis, this opens the way for much greater development of WTI Fob Houston pricing, even towards becoming a regional or global benchmark. Exchanges and PRAs have already developed prices and contracts for Fob Houston: Argus and the CME focus on WTI Houston (Permian), while Platts and Ice focus on WTI delivered in the Magellan East Houston (MEH) terminal.
"There is the clear sense of a 'movement' in Houston as companies old and new start trading and exporting, hedging and speculating. This reminds me very much of the scene in London in the late '70s to late '80s when physical North Sea trading developed, leading to other forward markets and the futures and derivatives," says Bryce. "Of course, a Fob Houston marker will only emerge if there is need, plus, as in the case of Brent, a pre-existing forward market creating in time a futures forum, as well as an organising force-like Shell in the North Sea in the early '80s."
Bryce suggests that ExxonMobil, as a very large producer of exportable barrels, could be a key player in helping to pick a reference point to organise tradeable contracts that could morph into an international export marker. But both current options have advantages, in his view—Argus has a stronger quote gathering position in the US Gulf than Platts, but MEH looks a more natural focal point.
Bossley agrees with Bryce that there is a need for a WTI fob Houston marker, for example to value Latin American or other regional grades with a more global seaborne market-relevant price than the domestic WTI Cushing benchmark. The requirements for a focus on one particular storage location and for a market maker are also among her priorities, although she sees US independent Occidental as the most likely candidate.
But Imsirovic notes that, at present, the nascent WTI Fob Houston traded markets "are essentially a differential to WTI Cushing", framing the question of whether WTI Houston can develop in its own right or will always remain a basis market to the dominant Nymex WTI complex.
"WTI Houston pretty much reflects the marginal barrel in the global oil market, so it does have the potential to be a very important benchmark," says the IEA's Lejeune. "Could WTI Houston replace WTI Cushing? It is very hard to say, markets can evolve unexpectedly. But is there any precedent for so much liquidity to move from one trading complex to another? I cannot think of one.
It could depend on Nymex, [WTI Cushing] is their contract. Would they consider switching to promote WTI Houston as the main price? It would be a big risk. It seems unlikely unless there was market consensus that WTI Cushing was broken and, unless Nymex moved to WTI Houston, it could lose the market entirely."
So, it may be that WTI Cushing remains the dominant US benchmark, but WTI Houston establishes an important intermediary step between the domestic US price and the international markets. Bryce, for one, is relaxed about such a prospect. "I am a great believer in complementarity of markers, rather than pitting one against another," he says. "I am sure there will be enhanced value … where there is more than one global marker to use depending on the risk being addressed."