What oil price?
Just like the mythical free lunch, there is no such thing as the price of oil. That’s not to say oil isn’t priced; just that there is no single price.
Of course, there’s no single price of petrol, either, and you may well pass by several gas stations in search of a better deal. But in the oil markets there are not only differing grades (such as in density and sulphur content) in different locations, but now additionally very substantial discrepancies between the key benchmarks.
It used to be that the average analyst would know of WTI and Brent, separated fairly consistently by a dollar or two per barrel, the former higher than the latter. Dubai Fateh and Saudi Light might be in the mix too, quoted by the IMF’s international financial statistics and world economic databases. The Opec basket would be in the frame of awareness, but rarely discussed in terms of price.
In recent times, however, WTI and Brent have veered far apart, denying a convenient sense of approximation for any imprecise mention of oil prices.
There are apparently more than 300 types of crude oil, over half of them traded internationally. Pricing is an involved process, entailing price reporting agencies (most prominently Platts and Argus) in a central role.
Given that range, the price of a particular type is normally set at a discount or premium to markers according to calculated differentials which are periodically adjusted.
As Bassam Fattouh of the Oxford Institute of Energy Studies has explained, the benchmarks “are used by oil companies and traders to price cargoes under long-term contracts or in spot market transactions; by futures exchanges for the settlement of financial contracts; by banks and companies for the settlement of derivative instruments; and by governments for taxation purposes.”
Many surrounding financial layers have emerged in the past two decades, which have also become central to price identification. However, it remains unclear “whether the paper market drives the physical or the other way round”.
Though difficult to disentangle, nevertheless movements of spreads over time “are broadly consistent with changes in demand and supply,” a Reserve Bank of Australia paper recently maintained.
To the layman, it’s notable that global oil is priced according to samples forming less than five per cent of total production. Oil companies do that by reference to the export destination, Saudi Aramco using Brent in relation to Europe, Dubai-Oman for Asia and the Argus Sour Crude Index (ASCI), in place of WTI since 2010, as regards the US.
The WTI-Brent duopoly resulted from issues of output volume, trading liquidity, and stable institutional regimes. Still, neither -- both being ‘light’ and ‘sweet’, i.e. higher grades -- represents anything like the average barrel of oil. Most of the world’s output is lower-graded ‘medium’ or ‘heavy’ and ‘sour’, the Arabian Gulf’s included.
While their levels differ, however, their direction -- exceptional distortions aside -- may be in some sort of harmony. A 2011 study by China Petroleum University found that the main crude oil benchmarks are ‘co-integrated’, the world oil market unified rather than regionalized. WTI and Brent prices led the East-of-Suez markets: Dubai and Oman.
As Dubai’s production has declined, since 2007 the DME-Oman futures contract series has entered the fray. Although building noticeable volumes, however, it still needs to recruit the region’s producers to its cause to become its target of the Asian benchmark. That too might face a challenge from China, where the Shanghai Futures Exchange has announced plans for a contract in both renminbi and US dollars. In the meantime, Brent has been gaining much ground over the rival WTI.
In the past year enhanced oil delivery from North Dakota and Canada has provoked persistent inventory bottlenecks and depressed WTI to levels way below Brent (amplified by concerns for North Sea output). The glut itself is expected to ease, but its effect is thought to be lasting.
Brent has recently become the preferred hedging instrument even for US companies, and assumed pre-eminence in commodity indexes, and now been adopted by the US Department of Energy in its yearly outlook, indicating, according to KBC’s weekly commentary, “that the dislocation of WTI will be an ongoing reality”.
By comparison, a research note by Credit Suisse said last year, “a more realistic measure of the price of oil might well be the OPEC basket, [with] a daily price and a decent history. Unfortunately it is not a traded or tradable instrument. There is no open interest, [or] forward curve.” It is, as they say, complicated. Anyone delving further into this topic without a specialist background will find a truly immense amount of detailed and technical material to plough through for insight, infinitely beyond the scope of this column. Here is merely to suggest that when we refer to oil prices these days, we really should specify.
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