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Viktor Katona

Viktor Katona

Viktor Katona is an Group Physical Trader at MOL Group and Expert at the Russian International Affairs Council, currently based in Budapest.

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The World’s Biggest Oil Benchmark Could Change Forever

offshore rig

For more than a month already, the Brent benchmark has been sourced from five, not four, North Sea Fields. Eleven years after Platts added Ekofisk to Brent, the 200 kbpd Troll is the latest addition to the family, which, however, seems unwilling to take up the BFOET abbreviation. Despite the recent accretion, many analysts claim that time is ripe for a more thorough reform of the Brent benchmark. The underlying reason is that Brent production is falling – to mitigate the effects of this decline first Oseberg and Forties were added in 2002, then Ekofisk, now Troll. However, all of the fields included are well past their peaks – moreover, the Brent legacy field is producing only minuscule amounts of oil, a mere 20 000 tons per year. So what next for Brent?

Graph 1. Brent Benchmark Oil Fields Production in 1971-2016, mln. tons.

(Click to enlarge)

Source: Norwegian Petroleum Directorate, UK Oil and Gas Authority.

After the temporary patch in the form of Troll, the oil community’s next step will be the addition of the potentially 660kbpd (first phase will reach 350kbpd) Johan Sverdrup field, the sooner the better for Brent. Johan Sverdrup will be the most significant phenomenon of the UK/Norwegian shelf in the 2020s – the largest North Sea discovery of our century so far with an estimated 2-3 BBbls of reserves, Sverdrup will account for a quarter of Norway’s shelf output. The name itself is a reflection upon the importance of the field – initially, there were two fields found in 2010, Avaldsnes and Aldous, which were merged together under a famous Norwegian politician’s name to give symbolic weight to its development. Phase one of Sverdrup’s development will start in 2019, with the second set in motion from 2022, reaching peak production by 2025-2026. Related: How Far Can Venezuela’s Oil Production Fall

Norway (and the Brent, too) was lucky that Johan Sverdrup is an overwhelmingly oil-containing field, almost 97 percent of it is oil, because most of its recent major discoveries were gaseous. Beyond Johan Sverdrup, absent any giant oil field discoveries in the North Sea, a dilemma is inevitable: in order to keep the physical side of Brent intact (i.e. keep the benchmark in direct relation to physical deals, avoiding the more speculative scenarios), Brent must move either to the east or to the far north. Far north would imply adding more Barents Sea fields, with the balance heavily tilting towards Norway, whilst going east would be tantamount to adding Urals to the Brent benchmark. Adding Urals is by no means the figment of this author’s imagination, Royal Dutch Shell has been promoting this idea despite initial obstinacy.

If the Brent benchmark is to move out of its traditional region, the North Sea, geographic vicinity of new additions should be a logical precondition. The markets Brent and Urals serve are roughly the same – Baltic Urals’ main export destination is the Netherlands. Quality-wise they are different – Brent is a light, low-sulphur grade, whilst Urals is a medium heavy, mid-to-high Sulphur content grade. This might not necessarily be a problem – for instance, oil from the Buzzard field which flows into the Forties Blend, is of exactly the same quality parameters (31-32° API, 1.4-1.5% sulphur), moreover, since 2013 a quality premium system is in place to compensate for quality misbalances. In case of Oseberg and Ekofisk a quality escalation has been successfully implemented, de-escalation could work similarly well.

Yet Urals might face a lot of hurdles to become a part of Brent – to evaluate this, one has to look at the attributes a benchmark ought to possess. Substantial production is the utmost prerequisite (oddly, the one Brent is most liable to), apart from it, the grade should be consistent, impartial in that no monopoly can dictate or bias prices both on the demand and supply side, and should be widely traded amongst many actors. Hypothetically, there are many grades which fit the description, amongst them several the production of which surpasses manifold that of the North Sea now, however they lack one key ingredient which became the staple of Brent – transparency. Transparent deal reporting was key to Brent becoming so global, and is the main prerequisite to others joining it – even though Brent has suffered some losses due to cargoes being shipped to buyers, mostly Asian ones, which prefer keeping their trades confidential.

It is in this respect that Urals loses out – most of the deals are formula-bound with pricing details kept confidential. Therefore in order to include Urals into Brent, most of Urals or a specifically designated part of it should be brought to light. Making all Urals deals transparent is by no means a prerequisite – for instance, more than a third of oil produced at the Troll field is being fed by the operator Statoil to the Mongstad refinery in Norway and the overwhelming majority of Brent supplies to Asia remains confidential. Related: The U.S. Oil Boom Is Attracting Canadian Drillers

This, however, should be done with the consent of Russian authorities, which, however, is unlikely to go along with it because it has been cherishing the idea of delinking Urals from Brent for more than a decade. Even though in case of Urals being included into Brent Russia would gain a massive influence boost because the physical volumes of the former exceed the latter, Moscow wants to tackle the issue at its discretion (unlikely to succeed as market participants prefer status quo). Political tensions between the West and Russia have been running high, yet they must understand it is in each other’s interest – the next best thing to Urals are West African grades, even more distant and less transparent than the Russian grade.

This will not be easy as there are other issues at play, too. Royal Dutch Shell did not change mind regarding the inclusion of Urals to the Brent basket for nothing. Shell used to be a major player in the North Sea, and even though no one had sufficient clout to manipulate Brent prices, the Anglo-Dutch company was closest to this. After the inclusion of Troll and even more so after the assumed addition of Johan Sverdrup Norway (to be more precise, Statoil) will become the leading voice in the North Sea. Thus, the shifting sands of politics and rows between corporations might lead to a situation where the reshaping of Brent is put on a back burner.

By Viktor Katona for Oilprice.com

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