Oil trading may be carried out now by silent algorithms more than the traditional brash traders in their coloured jackets. But the world oil pricing system is undergoing probably its biggest shakeup since the Brent futures contract was introduced in 1988. Now Abu Dhabi, with the launch of its Murban grade of crude on a futures exchange, has stepped into the fray.
Oil has since the 1980s been priced on three benchmarks: Brent from the UK North Sea, used as the standard for most international sales; West Texas Intermediate (WTI) from the US, with a futures contract launched by the New York Mercantile Exchange (Nymex) in 1981; and Dubai.
Middle East national oil companies usually set the selling prices for their various crude grades on a monthly basis, as a premium or discount to one of these benchmarks, depending on the destination. Brent and WTI are light, sweet (low-sulphur) crudes, traditionally prized as easier to refine and yielding more valuable products for refiners, while Dubai is more typical of most Middle Eastern crude, medium-gravity and higher in sulphur.
The Dubai Mercantile Exchange (DME), a joint venture with Nymex (now the Chicago Mercantile Exchange, CME), began operations in 2007, and offers a futures contract based on Oman’s crude oil exports, on which Dubai now bases its oil sales too. Geographically and in quality, DME is a better reflection than Brent of the market for Middle East crudes to Asia, and last year, Saudi Arabia began basing its Asian sales partly on DME.
Since the early 2000s, this tripartite basis has come under increasing strain. Firstly, production of Brent has steadily declined, and other varying qualities of UK and Norwegian crudes have had to be added as deliverable against the benchmark. Now even foreign imported crudes from as far afield as Russia, Azerbaijan, Nigeria and the US may be included to maintain Brent’s liquidity.
Secondly, US oil production has soared on the back of its shale developments, and at times this year, it has even been the world’s largest oil exporter on a gross basis. It exports very light, low-sulphur oil, while it imports heavier grades to get a suitable blend for refining. But pipeline bottlenecks have led to the inland pricing point of WTI in Oklahoma disconnecting from waterborne crudes, necessitating supplementary markers.
Thirdly, Asia, led by China, India and Japan, has extended its ever-growing role as the world’s biggest oil importing region. These countries have been seeking lighter crudes, partly because of the greater availability from the US, partly to serve their demand for petrochemicals and gasoline (petrol) for transport, and partly to produce low-sulphur marine fuels ahead of next year’s pollution control regulations for ships.
In April last year, the Shanghai International Energy Exchange (INE) launched a futures contract based on imported crudes, including Abu Dhabi’s Upper Zakum along with grades from Dubai, Oman, Iraq, China’s own output and others.
This was an understandable development, but I warned at the time that Arabian Gulf states should be concerned that they might lose control of the pricing of their key commodity to their biggest customer.
Russia might have worried about this too; it has twice attempted to launch futures for its crude, but without success. Now the St Petersburg International Mercantile Exchange, Spimex, is planning for online crude auctions, a potential first step to more transparent pricing for Russian oil, which is currently dominated by traders.
At last week’s Adipec conference, the Intercontinental Exchange (ICE), the parent of the New York Stock Exchange, announced the launch of the ICE Futures Abu Dhabi (IFAD) exchange, which will host a new futures contract based on Abu Dhabi’s flagship Murban grade. Nine companies have taken equity stakes in the exchange, including European oil producers such as Shell and Total, Asian firms PTT (Thailand), PetroChina and Inpex (Japan), and trader Vitol.
Murban is a light sour crude, with an API gravity of 40.5 and sulphur content of 0.8 percent (Brent is a bit heavier, at 38 API, but with lower sulphur at 0.45 percent). Out of Abu Dhabi’s total production of about 3 million barrels per day, Murban accounts for 1.65 million bpd, of which 1.1 million bpd is exported. Its output should grow over the next decade. The delivery point at Fujairah, outside the Strait of Hormuz, improves supply security.
Murban will now be traded freely, instead of limited to originally nominated destinations, and will be priced on a forward basis rather than retroactively as before, where buyers would only find out the price of their crude after taking delivery. These moves are “improving the grade’s medium- to long-term trading value”, as Inpex’s president Takayuki Ueda observed.
More importantly, the futures contract is another cog in Adnoc’s move towards a more market-centric and commercially-minded approach, with the expansion of its trading and oil storage activities. Vitol’s chief executive Russell Hardy said it would “facilitate hedging and enable the development of a strong, complementary financial market, which will benefit producers, consumers and traders.”
The Murban benchmark will not be contradictory to DME Oman or China’s INE; instead, the three should be complementary. The greater diversity of traders and customers will limit the potential for manipulation.
Launching a new physical benchmark is not easy: it takes time to establish trading liquidity, iron out delivery mechanisms, and address concerns such as the impact of Opec cuts. But there is a clear market need for something like Murban futures, to maintain the integrity of international oil pricing in a time of tumultuous change.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis