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

Published November 2nd, 2000 - 02:00 GMT

This situation has been described as an inverted pyramid, with a huge volume of contracted oil being priced on the basis of a tiny amount traded at the apex of the pyramid. For this the Kingdom blames the oil market, but in truth the fault lies as the saying goes "not in the stars but in ourselves". 

 

Saudi Arabia sells almost all of its oil on a term basis into three main geographical regions - North America, Europe and Asia-Pacific. From time to time it sells the odd cargo on a delivered basis - as it is rumored to be doing just now in the Caribbean to take advantage of the Vienna agreement.  

 

On the whole, however, Saudi Arabia mostly sells contracted oil to its established customers under strict destination restrictions for the reasons I mentioned earlier. 

 

What also has to be taken into consideration, Ladies and Gentlemen, is the obvious fact that Saudi Arabia is a key member of a price-supporting cartel.  

 

Because of its very nature, OPEC has become over the years the oil market's marginal supplier and the Kingdom the key incremental producer within this system. 

 

Unlike an ordinary market, in which marginal supplies respond to prices, up or down, here we have a situation in which the marginal barrel is determined largely by OPEC's decisions.  

 

The marginal barrel is thus not directly responsive to price. Furthermore, what the Gulf producer gets for his barrel is set in distant markets at the point of delivery. 

 

As for these markets, much more Gulf oil is contracted to move East (62 percent) than West (31 percent). Oil demand in the East has of course been growing at a faster rate over the years.  

 

Asian refiners, however, tend to pay monthly average prices for their crude and sell into regulated markets, where they can pass through crude price changes more readily than in the West.  

 

This reduced price risk makes them more likely to contract Gulf crude supplies over longer periods, leaving Gulf oil going West to act as a residual supply in the Atlantic Basin. 

 

Regular oil flows from the Gulf going East and irregular Gulf flows entering the Atlantic Basin means that the WTI and Brent markets are more volatile than they otherwise would have been.  

 

This in turn makes Gulf oil more susceptible to price volatility emanating from the Atlantic Basin than need have been the case. Ladies and Gentlemen, we have arrived almost by accident at an obvious solution to the whole problem of how to sell Gulf oil. 

 

Had Saudi Arabia and its fellow Gulf producers been selling more oil on a spot basis, oil pricing would not have resembled an inverted pyramid. Please note my emphasis on "more" oil.  

 

I am certainly not advocating spot sales of all the exportable oil, for term contracts at spot-related prices perform a key function for any oil producer. 

 

Offering spot cargoes on a tender basis at the point of sale in the Gulf, without destination restrictions or bans on third-party sales, would have a number of consequences.  

 

First of all, marginal oil would flow eastwards or westwards depending on the differential needs of each market, and the uniform spot prices would reflect this. Secondly, Gulf oil sold on term contracts would be priced on the basis of average spot prices that represented the true worth of the barrel to the lifter at the point of sale in the Gulf and not at some distant destination. Thirdly, OPEC's intended use of automatic volume adjustments to keep oil prices within a band would be facilitated.  

 

Saudi Arabia, for example, would be able to sell spot cargoes directly to those who most needed the additional oil, instead of rationing these few cargoes arbitrarily among its many term lifters. 

 

The emergence of a more liquid and representative spot market in the Gulf would certainly be timely, for the internet era has made it is easier to trade oil than ever before.  

 

As it happens, we already have the Miami-based PEPEX internet exchange, on which players can trade physical oil and products, while the InterContinental Exchange, offering internet-based trading in over-the-counter instruments for crude oil and products, is just around the corner. 

 

Of course, as the spot market took off in the Gulf a new price risk would appear, just like North Sea crudes bought spot today represent a price risk for US refiners. To meet this price risk a futures market would evolve for Gulf crudes, offering hedgers a means of covering such a risk.  

 

Incidentally, such a development is almost upon us, for as you know NYMEX is offering from May onwards a futures contract based on an Omani-Dubai monthly-average price index. 

 

NYMEX hopes this contract will help stimulate a hedging market for crudes going East. I hope so too, especially as NYMEX is our sponsor today. However, I am compelled to utter a word of caution.  

 

Unless Saudi Arabia and the other Gulf producers overcome their fear of spot and futures markets, interest in this contract will remain lop-sided, dominated by commercial buyers of futures. The question then becomes one of whether there will be enough non-commercials (or speculators) to provide counter-party liquidity for this specific market. 

 

Ladies and Gentlemen, perhaps I have sapped too much of your energy - and there is a most stimulating afternoon to come. I shall therefore end my talk right away by trying to pull all these different strands together as concisely as I can.  

 

The way oil is sold in the Gulf is not only an anachronism - it is actually destabilizing. It distorts the market between East and West and leads to greater price volatility than otherwise would have been the case. Furthermore, it denies the Gulf producers a role in oil pricing commensurate with their importance in the global oil industry. 

 

Surely it is time for the Gulf producers to deliver oil directly to those who need it most at prices that reflect this need. Flourishing spot and futures markets in the Gulf are not something the producers there should be afraid of, but a development to be welcomed. 

 

In this way the fulcrum of oil pricing will gravitate to its real home, the Gulf, where almost 30 percent of the world's oil supplies originate anyway. After all, as John Sculley of Pepsi Cola and Apple Corporation once memorably said ... " ... the best way to be ready for the future is to invent it ." 

Source: (cges)  

By Sheikh Ahmed Zaki Yamani  

 

© 2000 Mena Report (www.menareport.com)

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