An Anatomy of the Crude Oil Pricing System
The Physical Base of Dubai and Oman
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- Bu səhifədəki naviqasiya:
- Figure 18: Dubai and Oman Crude Production Estimates (thousand barrels per day)
- Figure 19: Spread Deals as a Percentage of Total Number of Dubai Deals
- The Price Discovery Process in the Dubai Market
- Figure 20: Oman-Dubai Spread ($/Barrel)
- Figure 21: Dubai Partials Jan 2008 - Nov 2010
- Oman and its Financial Layers: A New Benchmark in the Making
- Figure 22: daily Volume of Traded DME Oman Crude Oil Futures Contract
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The Physical Base of Dubai and Oman In the early stages of the current oil pricing system, Dubai benchmark only included crude oil produced in Dubai‟s fields. The volume of Dubai crude production has dropped from a peak of 400,000 b/d in the period 1990−95 to under 120,000 b/d in 2004, with production hovering around 90,000 b/d in 2009 i.e. there are about six cargoes of Dubai available for trade in every month (See Figure 18). The most recent (unofficial) figures suggest that Dubai‟s production may have fallen further to 60,000 b/d i.e. less than four cargoes a month with few of these cargoes sold under long-term contracts. Thus, though Dubai cargoes may be offered sporadically on the spot market for sale, it rarely if ever does trade. The 62
government‟s decision not to renew the oil concession in 2007 also meant that Dubai no longer satisfies the ownership diversification criterion. The low volumes of production and thin trading activity render the process of price discovery on the basis of physical transactions not always feasible. In a sense, Dubai has turned into a brand or index which represents a sour basket of mid sour grades. 87
The rapid decline in Dubai output has increased the importance of Oman in pricing crude oil in the East of Suez. Oman has some of the characteristics to enable it to play the role of a benchmark such as the volume of physical liquidity. In 2009, Omani crude oil production reached 815,000 b/d compared to an average of 760,000 b/d in 1990-1995. The production is not subject to OPEC quotas as Oman is not a member of OPEC and there are no destination restrictions. On the other hand, Omani crude oil production is almost totally controlled by PDO, an upstream operating company which is responsible to all the equity producers for optimising production and delivery through Mina Al Fahal. PDO is owned by the Omani government (60%), Shell (34%), Total (4%) and Partex (2%). This structure has remained stable since 1977. There is an array of foreign and private domestic oil companies operating outside PDO, but these constitute a small share of total oil output. In 2009, PDO accounted for more than 90% of the country‟s total crude oil production.
Source: Leaver, T. (2010), DME-Oman: Transparent Pricing and Effective Risk Management in a New Era, Presentation at the Asia Oil and Gas Conference, Kuala Lumpur, June.
Unlike Brent, very few financial layers have emerged around Dubai. Attempts to launch a Dubai futures contracts in London and Singapore were made in the early 1990s, but such attempts did not succeed. Instead, the informal forward Dubai market remained at the centre of the Dubai complex. In the early stages of its development, producers with entitlement to production used to place their cargoes in the forward market. Being a waterborne crude, Dubai shared many of the features of the forward Brent market with some institutional differences such as the process of nomination, the announcement of the loading schedule, and the duration of the book-out process (for details see Horsnell and Mabro, 1993).
87 One observer argues that the actual production or even non-existent of Dubai crude oil is irrelevant. What is of relevance is that by buying the Dubai brand or index one can obtain physical oil and by selling the Dubai index one has the obligation to deliver physical oil. 0 100
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Currently, the two most important layers surrounding the Dubai market are the Brent/Dubai Exchange of Futures for Swaps (EFS) and the Dubai inter-month swaps markets. The Brent/Dubai EFS is similar to the EFP discussed above but where a trader converts a Brent futures position to a forward month Dubai Swap plus a quality premium spread. This market allows traders to convert their Dubai price exposure into a Brent price exposure which is easier to manage given the high liquidity of the Brent futures market. As in the case of an EFP, the EFS is reported as a differential to the price of ICE Brent. It was not possible to obtain data on EFS volumes, but sources estimate that the volumes of Brent-Dubai EFS and Brent-Dubai swaps in total are about 1,000-2,000 lots on an average day (i.e. about 1 million-2 million b/d) and can easily exceed 2,000 lots on a relatively busy day. The Dubai inter-month swap reflects the price differential between two swaps and thus is different from cash spreads. It allows traders to hedge their position from one month to the next. Dubai inter-month swaps are actively traded in London and Singapore and are central to the determination of the forward Dubai price. The actual volumes of inter- month Dubai is also not available, but traders reckon that about 2,000 lots of Dubai swaps (which includes Dubai outright swaps and inter-month Dubai swaps) trade on an average day. Other sources suggest a higher estimate with the volume of total Dubai swap (the swap leg of Brent-Dubai and intermonth combined) in the range of 8000-10000 lots per day of which around 60% is cleared by ICE or CME. The participants in these markets are quite diverse. Apart from some Japanese refiners, the main players include banks (Merrill Lynch BoA, JP Morgan, Morgan Stanley, Societe Generale), refiners (BP, Shell), trading firms (Mercuria, Vitol) and Japanese firms (Mitsui, Sumitomo). Since 1989, spread deals in Brent-Dubai and inter-month Dubai differentials have dominated trading activity. As seen from Figure 19, while in 1986 outright deals constituted the bulk of the deals in Dubai, by 1989 these had declined to low levels. By 1991, spread deals constituted around 95% of the total number of deals in Dubai with the Brent-Dubai trades playing a central role. In 1991 Brent-Dubai trades accounted for one third of the liquidity and half of the concluded deals with the Brent market providing the Dubai market with the bulk of its liquidity. Given the links with the Brent market, Horsnell and Mabro (1993) argue that „Dubai has become close to being little more than another Brent add-on market‟.
Notes: Spread deals include Dubai one-month spread, Dubai two-month spreads, and Dubai-Brent and Dubai-WTI Spreads. 0 10 20 30 40 50 60 70 80 90 100 1986 Q1 1986 Q2 1986
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The two main oil pricing reporting agencies Platts and Argus follow very different methodologies in their assessment of the Dubai price which on many occasions may result in different Dubai prices. Over the years, the declining production of Dubai has pushed Platts to search for some alternatives to maintain the viability of Dubai as a global benchmark. In 2001, it allowed the delivery of Oman against Dubai contracts. In 2004, Platts introduced a mechanism known as the partials mechanism, to counteract the problem of Dubai‟s low liquidity. 88 The partials mechanism has the effect of slicing a Dubai cargo (as well as Oman) into small parcels that can be traded. The smallest trading unit was set at 25,000 barrels. Since operators do not allow the sale of cargoes of that volume, it has meant that a seller of a partial contract is not able to meet his contractual obligation. Thus, delivery will only occur if the buyer has been able to trade 19 partials totalling 475,000 barrels with a single counterparty. 89 Any traded amount less than 475,000 barrels is not deliverable and should be cash settled (Platts, 2004). 90 Platts allows for the delivery of Omani crude oil or Upper Zakum against Dubai in case of physical convergence of the contract. In other words, the buyer has to accept the delivery of a usually higher-value of an Oman cargo or an Upper Zakum against the Dubai contract. The addition of Oman has created problems of its own. In the Dubai-Oman benchmark, Oman crude has lower sulfur content and higher gravity than the Dubai crude. In some periods depending on the relative demand and supply for the various crudes, the price gap between the two types of crude tends to widen. As seen in Figure 20, the differential is quite variable reaching more than $1.50 in some occasions. As a result of this divergence, many observers have called for the inclusion of another type of crude in the Dubai assessment process which is closer to Dubai than it is to Oman. 91
Figure 20: Oman-Dubai Spread ($/Barrel)
Source: Oil Market Intelligence The price of Dubai is assessed based on concluded deals of partials in the Platts window, failing that on bid and offers and failing that on information from the swap markets surrounding Dubai. Thus, despite the fact that NOCs in the Gulf have large physical liquidity which in principle allows them to set the oil
88 A market was developed in the 1980s to trade Brent partials but with the development of the Brent futures market, the market became redundant. But trade in partials is still used by Platts to assess North Sea and Dubai crudes. 89
This is equivalent to a full 500,000-barrel cargo with an implied operational tolerance of minus 5%. 90 Settlement of cash differences that result from undeliverable partials uses the last price assessment of the trading month. 91 The pricing of a crude off Dubai-Oman requires setting two coefficients of adjustment (one off Dubai and one off Oman) and then taking some average between the two coefficients. -1.50
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price, oil exporting countries have avoided assuming this role, shifting the power to set the price to few traders that participate in the Platt‟s window. Oil exporting countries do not participate in the window; they simply take Platts assessment of Dubai and use it in their pricing formula. This transfer of the pricing discovery role to Platt‟s window achieves an important objective as oil exporters do not want to be seen as influencing oil prices: it is the market that sets the oil price, and not oil exporters. On other hand, this transfer of power creates some sort of mistrust in the trading activity in the Platts window. Initially, the shift to partial trading in 2004 has produced encouraging results, increasing the volume of trading activity and hence improving the efficiency of price discovery, reducing the bid/offer spreads, and attracting new players to the market (Montepeque, 2005). However, in recent years, the liquidity in Platts‟ Dubai window has declined to a point when only few deals are concluded during a month (Figure 21). In many days, there is no execution of partial trades. In fact, since October 2008, there has been no execution of partial trades in 50% of trading days (Leaver, 2010). This however does not preclude Platts from producing a value for Dubai, which can be based on bids and offers and/or information from the value of derivatives. Only a few players such as Sietco, Vitol, Glencore, and Mercuria dominate the Platts Dubai window at any one day. On the sell side, large Asian refineries such as Unipec and SK have been dominant. The concentration of trading activity in the hands of few players in the Platts partials market has raised serious concerns that some traders by investing as little as in a 25,000-barrel partial contract can influence the pricing of millions of barrels traded everyday (Binks, 2005). However, market participants who think that prices are being manipulated by a few players have the incentive to enter Platts window and exert their influence on the price. Critics argue that barriers to entry can prevent such an adjustment mechanism from taking place. Figure 21: Dubai Partials Jan 2008 - Nov 2010
Source: Platts The way that Argus derives the Dubai price sheds some light on the links between the various financial layers surrounding Dubai. Argus‟ approach for assessing Dubai is based on deriving information from various OTC markets, the most important of which is the Exchange for Swaps (EFS) and the inter-month Dubai spread contracts. The EFS price is reported as a differential to the ICE Brent futures contract. This allows Argus to identify a fixed price for Dubai in a particular month referred to as the price of Dubai Swap. But since Dubai is loaded two months ahead, the assessed price of Dubai say in the month of 0 50
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December is the forward price of Dubai in February i.e. it is price for delivery of Dubai in the month of February (call it x) 92 . But buyers and sellers are interested in the price of Dubai in December. To derive the price of Dubai in December, the information from the inter-month Dubai spread market is used. Specifically, the January-February Dubai swap price differential is subtracted from x which gives the price of delivery of Dubai in January (call it y). 93 The January-December Dubai swap price differential is next subtracted from y to give us the price of Dubai for the month of December. 94
Once the price of Dubai is identified, the derivation of the Oman price follows in a rather mechanical way, mainly by exploiting information about Dubai-Oman spreads. If Oman partials are traded in the window, Platts uses the price of concluded deals or bids/offers to derive the Oman price. When this is not feasible, the Oman value will be assessed using the Oman-Dubai swaps spread 95 , a derivative contract which trades the differential between Oman‟s OSP and Dubai for the month concerned. The contract is traded over the counter and does not involve any physical delivery. The Dubai-Oman swap price differential will then be used in a formula which links it to the value of Dubai. Similarly, Argus assesses the value of Oman by comparing the value of Oman with that of Dubai. Argus first calculates the differential to Dubai swaps and then adds it or subtracts it from Dubai outright swap to get the Oman forward price. So currently, the assessment of Oman price by PRAs is a simple extension of the Dubai market, where the Dubai/Oman spread provides the necessary link.
The above price derivation shows clearly that the Brent futures market sets the price level while the EFS and the inter-month Dubai spread market set the price differentials. These differentials are in turn used to calculate a fixed price for Dubai. In a sense, the price of Dubai need not have a physical dimension. It can be derived from the financial layers that have emerged around Dubai. This has raised some concerns as „calls to use swaps as pricing benchmarks for physicals are at best uninformed as swaps are derivatives of the core physical instruments‟ (Montepeque, 2005). But this neglects the fact that liquidity in Platts Dubai‟s window is thin. In addition, the argument against using swaps is inconsistent with Platts‟ use of swaps (CFDs) in identifying the price of Dated Brent. It is also inconsistent with the fact that at times when no partials are trading, Platts has no alternative but to use the EFS to identify the Dubai price. Another concern is that unlike the WTI-Brent differential which reflects the relative market conditions in Europe and the USA, Horsnell and Mabro (1993) argue that the Brent-Dubai differential does not usually reflect the trading conditions of Asian markets except on some rare occasions such as the Iraqi invasion of Kuwait. In normal times, Dubai crude is more responsive to trading conditions in Europe and the US than the Far East. Specifically, the authors argue that the Brent-Dubai differential reflects better the relationship between prices of sweet and sour crudes. In support of this hypothesis, they argue that when OPEC decides to cut production, these cuts affect the production of heavy sour crudes. As a result, the price of these crudes will strengthen relative to sweet crudes leading to the strengthening of Dubai prices relative to Brent. The recent growth of the Asia-Pacific market and the wide entry of Asian players may have changed these dynamics with the Dubai-Brent spread currently responding more closely to Asia‟s trading conditions making Brent-related cargoes either more attractive (small Brent premium) or less attractive (large Brent premium) to Asia-Pacific buyers, but this need further empirical investigation. Oman and its Financial Layers: A New Benchmark in the Making? In June 2007, the Dubai Mercantile Exchange (DME)
launched the Oman Crude Oil Futures Contract to serve as a pricing benchmark of Gulf exports to Asia and as a mechanism to improve risk management. Figure 22 below shows the daily volume of DME Oman futures contracts traded between June 2007 and September 2010. The figure suggests that the volume of contracts traded is highly volatile, but remains
92 This is referred to as Dubai Third Forward Month. 93 This is referred to as the Dubai Second Forward Month. 94 This is referred to as the Dubai Swap First Month. 95 Oman swap is a derivative of the Platts‟ cash Oman assessment. However, in the absence of bids and offers for Oman swaps, Platts uses the information from the structure of the Dubai forward curve for assessing Oman swaps.
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relatively low. In 2009, the average daily volume of traded contracts amounted to slightly more than 2000 contracts, which is very low especially when compared to the traded volume of WTI or Brent futures contracts.
Source: CME Group
DME‟s Oman futures contract allows settlement against physical delivery of Oman crude. One interesting feature of the DME futures contracts is the large number of contracts that converge for physical delivery in any given month. Figure 23 below traces the evolution of the trading volume and open interest for the October 2010 Futures contract during the month of August. On 31 st August, 2010 the open interest reached almost 21,000 contracts. This is equivalent to 21 million barrels a month comprising more than 80% of Oman‟s monthly crude oil production. By any standard, these are very large volumes to be delivered through futures contracts. For instance, physical delivery on the Light Sweet Crude Oil Futures contract exceeded four million barrels only once in January 1995. Also in contrast with other benchmark contracts, the open interest on the DME contract tends to increase as contract expiry approaches as shown in Figure 21. This represents an important anomaly and implies that the DME contract is simply used as a means to access physical Oman crude oil. This feature sets aside the DME contract from the other successful futures contracts that have evolved around Brent and WTI.
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