The Battle For The World’s Top Oil Benchmark

Many countries would like to have their own crude grades as international benchmarks that others would price their volumes against, however, only very few countries can boast of such a thing. Brent is the leading world benchmark, the first one to get all the letters in what we should call hereafter MAST (movability, availability, scope and transparency). It was moveable across the planet due to its seaborne location and easy access to export infrastructure, it was available because the governments of United Kingdom and Norway guaranteed their non-interference in the companies' system of operation, it was plentiful because North Sea production was one of the dominant forces in European production growth and it was transparent because relevant companies thought having a retraceable baseline was too noble a cause not to share information about concluded deals.

Throughout the last decades Brent has undergone lots of changes - from being used as a single-source benchmark, it has grown to include first Oseberg and Forties in 2002, then Ekofisk in 2007 and Troll in 2018, all the while battling difficult structural issues such as irrevocable production declines and dropping numbers of reported trade deals in BFOE physical cargoes. Thus, both the scope and transparency elements suffered heavily amidst reoccurring calls for a thorough reform of the benchmarking system. They were, it has to be said, completely legitimate as the whole BFOE basket went from 55.33 million tons of production in 1996 (then UK accounted for 27 percent) to a mere 14.5 million tons by the year 2018 (with Britain just 12 percent).

Source: Norsk Petroleum, UK Oil and Gas Authority.

As one looks at the declining rates of production on the five fields that currently make up the Brent basket, it is reasonable to ask if Johan Sverdrup could solve the lack of traded crude. Johan Sverdrup is the most significant project on the Norwegian continental shelf currently, destined to reach a production plateau of 660kbpd - a quarter of Norway's total output by that time in the mid-2020s. Even though some have anticipated the inclusion of Sverdrup in the Brent basket, it looks increasingly unlikely that this would be the path forward for the next couple of years. Firstly, this would make Brent a predominantly Norwegian pool, minimizing any British impact on it. Secondly and perhaps even more importantly, Sverdrup is a medium quality crude, with a 28 degree API and 0.8 percent Sulphur content, which would heavily skew the mainly light sweet North Sea basket.

Source: ICE.

The case for a prudent assessment reform is fortified by changes in the regional distribution of demand for North Sea grades. Forties is a fitting example - it has always enjoyed high levels of interest in the Asia Pacific region, however, if in 2017 the leading buyer of the crude was South Korea which took in roughly 35 percent of all cargoes, last year (i.e. 2018) witnessed a drastic shift towards China, which now takes in more than 55 percent of all Forties on the market. This creates a potential situation in which the opening of an arbitrage window and robust Chinese demand might skew the oil prices.

Thus, against the background of falling production, decreasing number of trades reported, substantial arbitrage windows that skew the demand picture and the incompatibility of upcoming projects, it is evident that something has to be changed. Last week's International Petroleum Week in London provided a fitting opportunity for both S&P Global Platts and Argus Media, the world's leading crude price assessors, to present their vision of what Brent ought to look like in the future to remain relevant. The core basis of both companies' methodology will remain the same - up until now, it was always the cheapest of Brent, Forties, Oseberg, Ekofisk and Troll on a FOB basis that set the Dated Brent. This premise will remain the same in the future, too, however, the ways forward are quite different.

Argus has already launched its New North Sea Dated on February 15, the crux of which revolves around the inclusion of six non-European crudes to the Brent basket on a delivered Rotterdam basis. Argus has tried to keep the crudes somewhat similar in quality to Brent - Azeri BTC, Saharan Blend, Qua Iboe, Bonny Light, Escravos and WTI are light sweet grades, too. All six new crude types are to be adjusted for freight and timing, with the lowest-priced setting the New North Sea Dated. There remain fears that the inclusion of WTI into the basket would ultimately push prices down and so far the amount of statistical data to judge the validity of this claim remains insufficient to know for sure. Yet it is absolutely certain that the New North Sea Dated would trade lower than the conventional one.

Platts has also envisaged some changes to its Dated Brent price, albeit less revolutionary than Argus and without the inclusion of non-European grades into the basket. From October 2019, Platts will take into account any CIF Rotterdam offers for the Brent basket of crudes, adjusting it for freight and sailing time. Platts points out that the delivered Rotterdam prices will not form part of the benchmark and will be relevant only when a particular cargo is traded around. With a gradually increasing freight adjustment factor to the deliveries, Platts intends not to include cargoes that are traded from onshore storage - meaning Rotterdam storage - and that only offshore storage at the crude grade's loading points' would be taken into account.

The lack of revolutionary zeal on Platts' part is due to the fact that it is their assessment which forms the basis of North Sea Dated trading, Argus' is largely irrelevant therefore they can allow themselves ambitious experiments with the inclusion of grades that might be supplied to Europe, yet are far from becoming its staple diet. The UK-registered firm understands this, hence Argus' intention to promote WTI Houston as the world's leading benchmark, i.e. the one which should be used universally and which is under Argus' control. Further complicating matters, Argus has been sold to US capital recently and the rumor goes that it is influenced by US elites to peg much of the crude world's trade to a US basis.

WTI Houston is without a doubt a very promising ambition, however refiners and traders alike are too conservative in this respect to move along a murky path, the end of which is far from being obvious. Thus, the future of benchmark price assessments remains open - on the one hand Platts is working to make a wider concept out of it, as well as to make it more liquid, without solving the underlying issue of physical volumes gradually disappearing from the markets. Argus is pushing forward to use WTI Houston across all the globe, an assessment that would be theirs, yet the market participants' readiness for this is still under question, especially in Europe. It should be a very interesting battle of benchmarks in the future.