Saudi Aramco seeks solution to crude problem

The Times

Saudi Aramco is worried about the price of oil, so worried that it has turned its back on a long-established benchmark — West Texas Intermediate (WTI) — used to price crude oil sold in the United States.

But it is not worried about the price so much as how it gets it. Aramco is switching from WTI, the benchmark blend of crude that is traded in the NYMEX futures exchange as US Light Sweet Crude, to ASCI, a price index of Gulf of Mexico crudes published by Argus.

Sellers always want more and Aramco is no exception. The Saudis are fed up with WTI because its price is highly volatile and the spec bears little relation to the heavy, sulphurous crude oil that they sell.

The Argus index is based on a weighted average of actual prices paid for three crudes pumped out of the Gulf of Mexico — Mars, Poseidon and Southern Green Canyon. These are “sour”, or high-sulphur, crudes, more like Aramco’s Arab Light, so the Argus price index makes a better match. Moreover, WTI has been behaving in a silly way; sour crudes should sell at a discount to light crudes because the latter are cheaper to refine. but WTI has been all over the place in recent years. In February, WTI was in such a slump that the sour, heavier ASCI crudes were selling at an $8 per barrel premium to WTI. Only a month later, WTI had soared and ASCI had fallen to a $6 per barrel discount.

Aramco found itself unable to price its crude properly. The Saudis don’t trade oil but historically sell it at fixed discounts to WTI, set in advance. With WTI bouncing around, the Saudis could not price their oil competitively against rival sour crudes. Customers were annoyed; by the time that cargoes arrived from Arabia, WTI’s oscillations could make Saudi crude dirt cheap or horribly dear. Aramco’s solution is to ditch the North American benchmark.

This is an earthquake, small on the Richter scale, perhaps just a tremor, but nonetheless a movement in tectonic plates that signals much bigger deeper changes ahead in the energy market.

The switch reflects two technical concerns and a wider and deeper concern about market fragmentation. WTI has a specific problem: the delivery point of the crude is inland at Cushing, Oklahoma. WTI cannot be exported, so gluts cannot be cleared and bottlenecks lead to droughts. It’s a totally inadequate proxy for energy prices in North America — the lion’s share of US crude is supplied from wells in the Gulf of Mexico and from Canada — but WTI remains the benchmark for the most widely traded oil futures contract: US Light Sweet Crude.

The second technical point is that most of the world’s crude is not light, or sweet. As the North Sea and onshore American wells deplete, the crude we burn is getting heavier and more sulphurous.

If you pump 50 litres of diesel into your petrol tank, your day will be ruined and you will end up with an expensive problem. So much is obvious. Fuels differ in specification, price and application — but the same is even more true of crude oil.

Most of the world’s refineries were designed to take lighter, sweeter crudes, which are now in short supply. According to BP, as much as two thirds of the world’s crude oil supply is now sour. New refineries with expensive desulpherisation units and hydrocrackers are chasing the “sour” discount, hoping to make more profit margin buying cheaper, heavier crude oil. A refinery such as Shell’s Stanlow plant in Cheshire is designed to process expensive North Sea crude; it is no wonder that Shell wants to sell its last British fuel plant.

The final question is whether WTI and Brent are any longer meaningful benchmarks and proxies for the price of oil. Energy markets are moving east and south, North Sea crude is being displaced by Russian crude.

If you believe in perfect markets, it matters little that a global price indicator for energy is buffeted by the level of storage tanks located in an obscure town in Oklahoma. The price is the price — WTI futures are the most liquid traded energy price and markets thrive not on rationality but on liquidity.

Still, there is no doubt that the underlying oil market is fragmenting, in geography as well in chemistry. The only growth in the oil markets is in Asia, but while American refiners hedge their crude prices in an effort to squeeze every last penny of margin, Asian refiners don’t yet hedge their exposure.

They take the price offered by Saudi Aramco, an organisation that still refuses to auction its crude. The Saudis, pillars of the Opec cartel, blame speculators for oil market volatility but they are doing nothing to create more transparency, preferring to hitch their wagon to the bucking bronco in the NYMEX exchange, while complaining about the bumpy ride.

Having made its protest with ASCI, Aramco needs to go further and sponsor a new crude market facing east. Dubai Mercantile Exchange is assiduously courting the Saudis, hoping that Aramco will sponsor its sour crude contract. The Saudis don’t like to be the first movers, but they are stirring.

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