By Economic Forecasts & Opinions
Saudi Aramco, national oil company of the world’s largest oil producer and exporter, decided earlier this month it will drop West Texas Intermediate (WTI) as the benchmark for pricing its oil for sale in the US market.
In January 2010, Aramco will use the Argus Sour Crude Index (ASCI) to price its oil for the market; it’s heavier and has higher sulfur content than WTI. The index, launched in May, uses the volume-weighted average of daily spot sales of the three U.S. Gulf Coast medium sour crudes: Mars, Poseidon, and Southern Green Canyon.
The news instantly sparked speculation that other major producers would follow. Chavez (not surprisingly), reportedly already indicated Venezuela would follow Saudi’s lead adopting the new index. Several Canadian companies, who expect to use TransCanada Corp.'s (TRP) proposed Keystone XL pipeline to send oil sands crude to the U.S. Gulf Coast, have also expressed interest in using the Argus benchmark.
Global Crude Oil Benchmarks
Crude oil benchmarks, also known as oil markers, were first introduced in the mid 1980s. There are three primary benchmarks, WTI, Brent, and Dubai. WTI, lighter and sweeter crude, usually trades at a premium to Brent and Dubai. Benchmarks are used because there are many different varieties and grades of crude oil (around 200 different blends). Using them is a way to give stability and transparency to the global oil market.
While Brent remains the dominant benchmark for oil pricing outside the US, the U.S. oil imports are usually priced off WTI. As much as three quarters of the world's physical oil is priced each day using Brent and WTI. Saudi Aramco has priced its U.S. deliveries against WTI since 1994.
Shifting Energy Landscape
US Gulf oil output, currently at about 1.2mn b/d, is expected to climb to 1.4mn b/d next year and 1.9mn b/d in 2013 boosting spot market trading volumes. This decision by Aramco in part demonstrates the emerging importance of the US Gulf as the new center for price discovery.
Meanwhile, the abandonment of WTI, a longtime standard since the 1980’s, for a five-month-old Argus index by Saudi Arabia is a big deal in the crude pricing assessment world. The move not only highlights some specific problems of WTI, but also signifies ongoing shifts in the global energy landscape, as emerging countries take an increasingly prominent role in the oil trade.
Guilty by Disassociation
In principle, the movement in WTI prices is supposed to reflect supply-demand conditions in the US, the largest consumer in the world, burning almost one quarter of the of the 86.14 million b/d consumed worldwide in 2007. And sour crudes usually should sell at a discount to light crudes such as WTI because the latter are cheaper to refine.
However, distortions caused by logistical or inventory constraints at Cushing, Oklahoma, the WTI delivery and pricing point, can dislocate WTI prices away from North Sea Brent and US gulf crude prices.
Historically, WTI has traded pretty much in line with Brent and gulf sour crudes. But WTI price movement has become increasingly volatile in recent years. The recent inventory glut at Cushing, OK due to the demand slump, coupled with new pipelines transporting Canadian Oil Sands crudes has distorted the WTI price against other benchmarks throwing the global oil market into disarray.
According to FT, In January, WTI, which usually trades at a premium of $1-$2/b to Brent, fell sharply reaching a record discount to Brent at around $12/b. (Fig. 1) In February, the sour, heavier ASCI crudes were even selling at an $8/b premium to WTI. Then, just one month later, WTI had soared and ASCI had fallen to a $6 per barrel discount. This bounce around has made it difficult for Saudi to price its crude competitively and at the same time annoyed its customers.
Guilty Also by Speculation & HFT
Some analysts believe Saudi Arabia's decision likely reflects a "wider discontent" from its customers that want a new benchmark that more accurately reflects true supply and demand. Meanwhile, others blame NYMEX for failing to protect the integrity of the WTI contract as it has become the global speculative vehicle for mega commodity funds like the United States Oil (USO) and
high frequency trading (HFT) strategies.
A Sour Move.. Plus an Eastward Shift
As the North Sea and onshore American wells deplete their reserves, the lighter and sweeter crude supply is also dwindling. The crude we burn is getting heavier and more sulphurous. According to BP, as much as two thirds of the world’s crude oil supply is now sour crude. New refineries with expensive desulpherization units and hydrocrackers are chasing the sour spread, hoping to make higher profit margins by buying cheaper, heavier crude oil. (Fig. 2)
In addition, the underlying oil market is fragmenting, in geography as well as in chemistry. The only growth in the oil markets is now in Asia (think Chindia), while the demand in the developed countries, including the U.S. has already peaked (Fig. 3).
According to energy consultants Douglas-Westwood, the Middle East share of world oil and gas production is expected to grow from about 23% today to an estimated 30% by 2025 (Fig. 4). And a majority of the new and existing Asian and Middle East refineries are set up to process sour crudes. As energy markets are moving east and sour (Fig. 3 & 4), this shift tends to render WTI, which is a lighter and sweeter crude grade, less relevant as a proxy for the price of oil.
WTI to Remain A Global Key
At its inception about five months ago, ASCI said it will use WTI as a basis for its price assessments. So, in essence, by switching to ASCI, U.S. Saudi marketed oil will still continue to price its Gulf crudes, at least in part, based on WTI.
In addition, NYMEX WTI futures are the most traded energy contracts and thrive on liquidity. So, WTI should continue to have a key role in spite of the Saudis move to ASCI, in part because of WTI's liquid NYMEX derivatives market.
However, if an active OTC or futures market based on ASCI eventually arises, then the dynamics could change. Both the CME and ICE have said that they will launch futures contracts tied to the Argus index. Of course, gaining volume and traction on a brand new financial product is an entirely different matter.
This benchmark change most likely will be a battle between the exchanges (CME and ICE) and the index providers (Platts and Argus), and not represent a dramatic change in the dynamics of the U.S. crude market in the medium term.
Speculation Knows No Benchmark
Realistically, crude oil is the most widely traded and speculated commodity in the world. Logistic and storage issues at Cushing aside, without a fundamental financial reform on a global scale, speculative price distortions will still occur regardless of the commodities exchange or benchmark.
WTI Problem Is Not New
For market participants, the periods of dislocation for the WTI do not pose serious problems. Exporters like Saudi Arabia can overcome pricing issues by adjusting their price differentials, while traders can hedge the dislocation risks by resorting to various other financial instruments. In short, the system has created mechanisms to deal with its own problems.
In the environment of high oil prices like last year, exporters seem to be happy selling their oil using less than perfect benchmarks. That is, a pricing system, however flawed or problematic, can survive unchallenged as long as market players have an interest in its survival.
So, Why the Change of Heart by the Saudis?
Taking this into consideration, in the context of growing Gulf States’ discontent with the U.S. monetary policy, and EIA data showing Saudi crude exports to the US plunged to a 22-year low in August, this move seems to be another effort by the Saudis to move away from dollar dependency and its relationship with the U.S.
In addition, it signals Riyadh’s total loss of faith in one of its oldest allies and trading partners. This should not come as a surprise in light of the IMF`s repeated slams against the dollar, and the U.S. government’s continued printing and spending binge. Furthermore, it also seems to suggest Saudi’s trying to push and eventually take control of the world crude oil trading volume. Or perhaps this is all part of a bigger movement towards a New World Order which many financial powerhouses, including George Soros, have advocated?
# it's only after you lose everything that you're free to do anything #
Economic Forecasts & Opinions
More spread for (their) refiners. Pretty obvious.
Maybe the Saudis are moving away from the WTI benchmark simply because they are running out of the light sweet crude.
Great post ab; thanks for laying this all out to us to understand the price discovery protocol and now its changes. Little by little, the US centric markets are ending as the status quo is changing.
I think that your underlying assumptions about the oil market are maybe a little out of date and you are at least one paradigm shift behind.
NYMEX's WTI contract has been an appendage of the Brent/BFOE contract for years now. It is the price of maybe 60 to 70 cargoes of Brent/BFOE quality crude oil which sets the global benchmark, and it is the arbitrage on ICE ( which is woned lock stock and barrel by the middlemen) between BFOE and WTI which dragged the WTI price around with it until recent events finally finished off any credibility WTI still had.
Futures markets are the tail, not the dog. Systemic manipulation has been going on in the Brent/BFOE physical/OTC complex for years, and was transmitted to the WTI market by the arbitrage available on the ICE trading platform. This manipulation is now entirely out of control. It was IMHO responsible for the 'spike' last year and is responsible for the bubble now.
Essentially what is happening is what Mike Riess calls 'macro' market manipulation. In this case, producers - who are able (unlike speculators) to store oil for nothing in the ground - are able to borrow money from funds via intermediaries, and to lend oil to the funds in return.
We are seeing the physical oil market price (and it doesn't take that much money in the BFOE market these days) gradually pumped up with borrowed money. The same thing is happening in the other asset classes - particularly equities. The correlation between WTI and the S&P was almost perfect recently, and last year we saw pretty much all of the other commodities spiking in the same way at the same time. This proves beyond doubt that supply and demand for the physical commodities had nothing to do with the spike, and that another factor was at work.
That factor is the shape of the yield curve at the zero bound. ie at the moment the forward curves on commodities react almost precisely in lockstep to movements on the forward curve on money.
In the oil market, I believe that it is BP and Goldman who have maintained a mutually profitable understanding for anything up to 15 years, and in this play are combining to lead the arbitrage between money and oil. Other players will probably be making similar moves as best they can.
The necessity to be in both the physical/OTC oil market and the futures to avoid getting screwed in one or the other is the motive behind the move by GLG (hedge fund) into the physical market. It is probably also why Occidental acquired Citigroup's Phibro trading unit, and why Vitol acquired some Petroplus infrastructure assets recently.
It is only those participants capable of making and taking delivery who can affect the physical market price, which in turn affects the futures price - and not vice versa as almost everyone, and particularly the politicians, seems to assume.
I managed IPE Gas Oil contract deliveries for six years - of anything up to 800,000 tonnes in the second half of the contract month - and while I kept a close eye on who was doing what in Europe's biggest game of 'chicken', no broker in his right mind allowed investors unable to make or take delivery to participate in the 'spot' month. The reason being of course that if the client cannot perform, it is the broker's arse on the line to the clearing house.
The fact is that for producers trying to hedge energy prices (in dollars) then the funds, whose purpose is to hedge the dollar priced in energy, (ie 'energy inflation') are precisely the genuine liquidity needed in the futures market.
It suits the Wall Street Refiners just fine to see these funds forced out of the futures markets into OTC swaps. It is these investment banks in particular who are causing the problems in league with one or two producers - quite possibly the Saudis, which may help to account for their wish to move from the WTI futures contract, where the Brent/BFOE arbitrage with WTI had broken down badly.
I believe that a practical first step to fixing this totally dysfunctional market is a big dose of transparency.
Fat chance of that.
Wow, great work 126535 and asiablues. Quite a fascinating market.
Great summary. Hope to see more of your posts in the future.
thanks for sharing this. perhaps this post is a 1st step towards that unattainable ideal. it definitely made the manipulation much more clear for a novice to see, for sure....cheers
Has anyone shown an interest in dropping CRYMEX?
They just incorporate the mining companies into the fraud and pay them under the table. Under the table gold is going for 1350 an ounce and gold dealers are still able to charge massive spreads despite whatever small controlled spreads are printed on the exchanges.
"under the table gold for $1350 an ounce"??
Care to elaborate on that? If true, that's an article in itself!
Migration away from US-dominated world financial markets continues.
China may not be able to sell their Treasury holdings, but there is no reason they cannot slow their buying of additional Treasuries, and gradually diversify into other currencies.
Between Saudi new indices, and their encouraging others to begin to find a new currency (or weighted basket of same), we see the same in oil.
And India buying all the IMF gold they can find.
The Chinese are both patient and smart; they won't make the same mistakes as they made in 2006 and 2007. I hadn't categorized Saudis there, but perhaps they are distancing themselves from their financial masters.
It will get ugly, US. And Obama, Geithner, Bernanke and Summers are leading the destruction of the dollar, and ultimately, your way of life.
Joe C from Wash DC
Pumped out.
Migration away from US-dominated world financial markets continues.
China may not be able to sell their Treasury holdings, but there is no reason they cannot slow their buying of additional Treasuries, and gradually diversify into other currencies.
Between Saudi new indices, and their encouraging others to begin to find a new currency (or weighted basket of same), we see the same in oil.
And India buying all the IMF gold they can find.
The Chinese are both patient and smart; they won't make the same mistakes as they made in 2006 and 2007. I hadn't categorized Saudis there, but perhaps they are distancing themselves from their financial masters.
It will get ugly, US. And Obama, Geithner, Bernanke and Summers are leading the destruction of the dollar, and ultimately, your way of life.
Joe C from Wash DC
Good research....I still have Charlie Maxwell's Barrons article on my desktop for reference. This rates up there. Oh and Gyuri Schwartz is not to be followed anywhere but back to the USSR.
The oil Sheikhs were stating that there was enough oil in the market at the top in june 2008.
'We are also mindful of the position of producers that there's already enough crude available on the market. OPEC President Khelil, Algeria's oil minister, told SUSRIS last month that "supply and demand are in equilibrium" and that "increasing production is not going to reduce the price."
It was against this backdrop that the Saudi Council of Ministers concluded on Monday that "the current increase in oil prices is unjustifiable in terms of oil data and market fundamentals" and called for a "meeting involving representatives from producing and consuming countries and companies active in the production, export and sales of petroleum to take into consideration the high prices, their causes, and how to objectively deal with them."'
http://www.saudi-us-relations.org/articles/2008/special-reports/080609-o...
Saudis have ditched the WTI in no small part due to the shenanigans that Wall Street/US Govt. engaged in last year to crush its price. Sorry, dollar-bugs - that wasn't "deflation". This news taken in conjunction with China outright REJECTING Wall Street's fraudulent derivative contracts and talks of stopping oil-pricing in dollars are clear indications - to those who are not brain-dead i.e., and are paying attention - that slowly but surely pillars of support are being removed from under the corrupt US Government-Wall Street alliance.