x Abu Dhabi, UAETuesday 23 January 2018

Aramco takes war on speculators to whole new index

With oil prices thoroughly decoupled from the fundamentals of supply and demand, Saudi Aramco has decided it is time to nudge the market towards reality.

With oil prices thoroughly decoupled from the fundamentals of supply and demand, Saudi Aramco has decided it is time to nudge the market towards reality. Last week, the world's biggest oil company said that as of next January, it would use the Argus Sour Crude Index instead of West Texas Intermediate (WTI) crude as the benchmark for pricing all grades of Saudi crude sold to US customers. Why that would make a difference takes some explaining, but it boils down to a decision to link Saudi crude sales to a market that the state-owned Aramco can influence through the number of tankers it dispatches towards the US coast.

That is not possible with WTI-based pricing because the delivery point for the US benchmark crude - a tank farm at Cushing, Oklahoma, that can hold between 45 million and 50 million barrels - is landlocked. And the depot is short of pipelines to link it to the coast and the rest of the country. Cushing storage is therefore physically disconnected from the global seaborne crude market, leaving the WTI price more influenced by local delivery bottlenecks than conditions in the wider market.

On the New York Mercantile Exchange (NYMEX), the world's biggest forum for oil futures trading, the main crude oil futures contract is also based on WTI. Its pricing specifically reflects the price and availability of crude at Cushing, which may have little to do with the oil available to and needed by US Gulf Coast oil refineries. That has contributed to the volatility of NYMEX crude prices and created an enticing opportunity for commodities speculators to enter the market for quick profits.

"The Saudis are figuring out they are losing too much money on the volatility of the WTI contract," Carl Larry, the president of the Houston consultancy Oil Outlooks and Opinions, told Reuters. "There are too many speculators pushing the market around and it's becoming too hard to keep track of the real value of crude." The Saudi government has long decried the situation. In September, the kingdom's oil minister, Ali al Nuaimi, said he favoured tighter oil market regulation to curb speculation and reduce price volatility. OPEC and the governments of some oil-consuming countries agreed, but so far there has been more talk than action on commodity market reform. In moving to the Argus index as its reference point for pricing, Aramco has fixed on a basket of US crudes with similar properties to its own. The US and Arabian sour crudes are stickier and contain more sulphur than WTI, and compete to supply the same US Gulf Coast refineries.

In theory, that should give the Saudis a lever to damp speculative trading. At the moment, when oil prices hit peaks, there is not much that even the world's biggest oil exporter can do about it. In summer of last year, Aramco could not find ready buyers for an extra 500,000 barrels per day (bpd) of crude that Riyadh agreed to supply in the hope of cooling prices. The oil ended up in storage, contributing to the swollen stockpiles that continue to hang over the market.

WTI soared to $147 per barrel in July last year despite the early signs of an emerging international oil glut. That was partly because paper traders could buy WTI-based NYMEX futures without fear of being required to take delivery of physical barrels of crude. The upwards price spiral created the illusion of an oil shortage, triggering more speculative buying. When the bubble burst, the problem was reversed. Congestion around the Cushing delivery point exaggerated perceptions of the amount of excess crude on the market. That placed intense downwards pressure on the NYMEX contract for next-month oil delivery. Futures contracts for crude deliveries in later months were less affected, providing a financial incentive for physical oil traders to buy and store oil for future sale.

But as of January, Saudi Arabia will be able to call the bluff of at least some speculators, defined as traders and who buy and sell futures contracts without any interest in owning the underlying physical commodity. That is because the NYMEX has announced plans to launch a cash-settled futures contract tracking the Argus index by the end of this year, and soon afterwards a contract for physical delivery of sour crude. The delivery point for the physical crude contract will be on the US Gulf Coast.

So if paper traders push up the Argus price too fast, an extra couple of tankers of Saudi crude headed towards Texas should quickly persuade them to step back. Indeed, with a huge 4 million bpd of output capacity on hand, Aramco would probably only need to hint at extra shipments to get the desired result. The NYMEX has made several unsuccessful attempts to launch a sour crude contract but with the Saudis on board, this one could succeed. That could do more to calm market volatility than regulatory limits on trading positions.

This matters on Main Street because it could profoundly affect future oil supply and the price of petrol. Oil companies are unlikely to invest in expensive development projects if they have no idea what their crude will be worth. @Email:tcarlisle@thenational.ae