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The Oil Market


Searching for a Benchmark is like Searching For a Dead Man

DATE:oct 2013...

Benchmarking History

Basically, the "price discovery" in the oil industry is based on benchmark formulae, through which the prices of other crudes, of different qualities and locations are assessed. The idea dates back to the (Click here )1928 Achnacarry castle agreement where the major oil companies (mostly American) agreed to end decades of price war by giving their crude of different locations equal opportunity to compete in all markets, with the price of crude oil in the US Gulf as a basing point. The price of other crudes should be equal to "this price" plus the transportation cost from the Gulf to the final destination regardless of production location of the crude.

From 1928-1971, this benchmark was fixed by agreements and did not change thanks to the gold standard at $35.

The 1970s, as USA left the gold standard, the nominal oil price was fixed by OPEC's Arabian light as a benchmark, in consultations with the major oil companies, best described as a period of "Pricing by Consent". Other crudes with different qualities and locations were priced accordingly.

Towards the end of 1970's, "Spot Market Pricing" was developed by private reporting agencies as a result of oil discoveries in the North Sea, which was quickly adopted by the independent oil companies who had only these spot market prices to dispose of their new crude oil findings. This undermined the "Arabian Light" benchmark formula, and eventually, replaced it completely by the mid of 1980's.

Now, we have only the remains of that period in the form of the OPEC basket price which is the statistically-weighted average of the spot prices of representative OPEC crudes, and not used for pricing or as a benchmark. Also in the 1980's, IPE introduced petroleum products into the Futures Market, and later crude, making price discovery easy and transparent, and is likely to undermine the efforts of the private agencies in preserving the Brent structure.

In 2000's, still Brent, with its dwindling supply, and WTI remained the benchmarks, but more and more crude (the latest arrival is Urals, soon will be more), are coming on the exchanges, at different locations, making "direct price discovery" without the benchmark formulae easier. This trend will eventually send benchmarking to the recycle bin.

This was a very simplified account of the pricing and the futures market that started as paper or dry barrel, governed by speculators and is now a very liquid and transparent market with more "Exchanging Futures for Physical" (EFP), acting as active Spot Market for both crude and products.

But still , this is basically speculative market,Sending prices within few months (see graphi n 2008) from $70 to $145, down to $35,back again to $70Therefore,, even in the futures market a "spot price" is needed for speculators to speculate against and to settle paper barrels However, the futures market is beginning to develop its own "settlement price" based on its own " dated delivery" ((EFP) ,

The market trend today is for More crude with different qualities, locations, and availability enter the floor of the local futures market directly making the price discovery for these crude easier and transparent . Benchmark is no longer needed to assess their market values

It is not an issue of who will control the Spot Market in the coming years , , The victory for the futures market is forgone conclusion .The real issue is,can benchmarking avoid going into the recycle bin?... as more and more crude enter the local Futures Market where the crude are produced , traded,and shipped on the electronic board, directly with its quality, location, and availability

 tadawal Take the new exchanges , Like Dubai DME , although small ,but growing fast soon we wiil see other crude like Basrah, iran heavy, kuwait export and others showing up on the futures exchanges.If this trend continues then the need for a benchmark to assess their relative values is no longer necessary.Benchmarking was designed to give equal opportunity and avoid price competition as we saw . and was not designed to reflect changes in USA in crude production.

Redesigning The Sport Formulae through a new basket of crude is beating around the wrong bush . Basketing is the last nail on benchmarking cuffing. The days for spot market are numbered or may have already ended , the inescapable fact is Benchmarking is on its way out and will be replaced by trading directly on the futures.

The search for the Benchmark for the crude oil market Is like a search for a dead man even if you find him,he is dead anyway