Selling Oil from the Gulf / Sheikh Ahmed Zaki Yamani ( part one)

Published November 2nd, 2000 - 02:00 GMT

The subject I shall address is the pricing of oil exported from the Gulf - the rabian/Persian Gulf, I hasten to add, not the Gulf of Mexico. 


In particular, I hope to develop the following theme: namely, that the way in which Gulf oil is sold today - especially by Saudi Arabia, its major producer - renders it unresponsive to prices, surely a serious drawback for any supplier. 


The formula-linked pricing system now in use for West-bound contracts is based on spot prices of crude at the point of delivery, not the point of loading.  


Oil producers in the Gulf are therefore largely price-takers, only able to influence the market via the long-winded, indirect route of adjusting contract volumes.  


Gulf oil continues to be sold in a manner harking back to another era, contributing in no small way to the observed volatility of oil prices with which very few consumers and producers can really be happy. 


At its recent meeting in Vienna, the members of OPEC apparently endorsed - albeit informally - an automatic output-varying scheme to prevent oil prices from exceeding a band between $22 and $28/bbl.  


This is a novel departure for OPEC, promising to speed up the Organization’s output responses in support of both an oil price ceiling and a floor. However, whatever its other difficulties - and there are a few - it seems to me that this scheme cannot work as efficiently as intended unless the major players in the Gulf alter their current method of selling oil. 


As ever, Ladies and Gentlemen, in order to determine what we should be doing next we need to take a few steps back in time to understand why we got to where we are at present. Allow me therefore to review how things were done in my time and how they evolved subsequently. 


Most oil from the Gulf has always been sold on a term-contract basis. The disposal of large volumes of low-cost, "base-load" oil requires regular liftings on agreed terms that remain relatively invariant over time.  


The companies managed this system for decades fairly efficiently on the whole, keeping the amount of spot cargoes on offer below 5 percent of the total oil traded.  


When the state companies took over in the mid 1970s, they retained this system, renaming the contract prices official government selling prices (OGSPs). The oil companies accepted this, because they were worried about the availability of oil supplies that had been previously under their control. 


With the decline in oil demand after the price crises of the 1970s came the discounting of OGSPs and the appearance of more and more "spot" oil, as most OPEC producers competed with each other in a buyers' market.  


This led to two developments. On the one hand, more spot oil meant a growing exposure to the so-called timing risk - the oil price risk between loading and delivery. On the other, Saudi Arabia emerged as the de facto residual supplier, because it refused to sell oil at less than the agreed OGSPs. 


That increasing amounts of oil were being sold on a spot basis, coinciding as it did in the early 1980s with rapidly rising North Sea production, encouraged the evolution of futures markets.  


With more spot oil and price volatility came the need to hedge, and that helped establish the oil derivatives markets as an indispensable component of the oil business. 


Meanwhile, Saudi Arabia's refusal to renege on its commitments and resort to discounting brought its oil exports down to absurdly low levels and compelled me as Oil Minister to introduce netback pricing in 1985. 


Netback pricing was significant in that it did away with most of the pricing risk refiners had faced under the OGSP system. Oil sold on the basis of free-on-board, OGSPs - a loading-point pricing system - had a major drawback: it carried a huge disadvantage if the OGSP was greatly at odds with the gross product worth of the barrel at its destination. 


By switching to netbacks, this particular price risk was eliminated. However - and this is significant in terms of the theme I am developing - what netback pricing also did was to transfer the basis of the pricing system from the loading point to the point of delivery.  


At any rate, because lifting oil from the Gulf was no longer especially risky on price grounds and because other OPEC countries soon adopted the same system, a severe glut developed and the price of oil collapsed in 1986. 


Netbacks were abandoned in that year, but the spot-price-linked, formula-based pricing that succeeded them continues to be applied to term contracts and has lasted till this day.  


What is more, since a lifter pays for Saudi oil depending on where it will be discharged, he faces destination restrictions and is prohibited from selling to third parties.  


The lifter may face less of a price risk than with an FOB-based system, but he has little operational flexibility in what he does with the cargo once it leaves the Gulf. Thus, oil does not always move to where it is most needed. 


Incidentally, the very recent Saudi formula change from Dated Brent to the so-called B-wave is merely tinkering with the price basis and not altering the nature of the pricing system itself.  


Thus, in all essential respects Saudi Arabia continues to sell its oil in a way that requires it to place restrictions on its customers and that contributes to price instability, as I shall now endeavour to explain. 


Saudi Arabia and its fellow Gulf producers account for around 28 percent of world oil supplies - the Kingdom's share alone reaching 11 percent. Yet, when it comes to pricing, Saudi Arabia's customers pay prices that are linked to Brent, West Texas Intermediate (WTI) and Arabian Gulf physical crude flows amounting to only 3 percent of global supplies.  

Source: (cges)  

By Sheikh Ahmed Zaki Yamani  







© 2000 Mena Report (

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