Confusion over a barrel

The latest efforts to stem price manipulation have left crude oil market participants wondering which contracts they should be trading and who will lead the pricing? Joel Hanley reports

The controversy over the liquidity of Brent crude oil trading is showing little sign of abating, as players jostle for position in a market undergoing the greatest upheaval it has seen. With resources starting to dwindle, the number of cargoes loading from the Brent field has dropped from 60 to less than 20 in the past few years (see EPRM August 2002, pages 24–25). And the concerted efforts by market participants to boost choice and cut the chances of price manipulation have led to a split in this well established market. But the problems do not stop there.

The two main camps are pitched around two of the world’s biggest oil firms, London-based British Petroleum (BP) and Anglo-Dutch oil company Royal Dutch/Shell. BP has proposed a new contract for North Sea crudes, under which a buyer can receive oil from either the Brent, Forties or Oseberg fields 20 days before actual delivery. BP hopes this contract – known as BFO – will replace the Brent contract, on which many feel Shell has too much of a stranglehold, as it is the largest equity holder in the North Sea Brent system, producing around 400,000 barrels a day.

Counter-plan
Shell’s counter-plan – known as BF&O – involves the creation of three new forward markets, one for each of the crude oil grades. Both proposals caused confusion after their announcements, following as they did the launch of a similar new pricing methodology by Platts, the London-based energy information provider.

“The market isn’t just divided – it’s utterly confused,” says one oil trader in London, who feels clarity is all-important. “The traders I deal with just want clear prices the market can agree on. On balance, the BP contract looks better for now. The Shell initiative is hard work – it’s a hassle running three books, so I don’t think that BF&O has any real chance.”

August saw experimental trades under BP’s BFO plan being made, with majors such as TotalFinaElf and ExxonMobil getting involved. Some trades have included discounts of 10 cents a barrel from the seller if Forties or Oseberg is delivered.

As even Shell concedes, so far the majority of support has been for BP and its BFO contract. Another London-based trader, who supports the Shell BF&O contracts, says this might seem logical at first glance. “There is more support for BP than there is for Shell, as it’s easier to understand [pricing] when there’s just one contract but, ultimately, it has to be fair and sustainable,” he says.

Shell says it admires BP for bringing a new initiative to the table, but feels its rival’s BFO contract offers little to equity sellers, as the natural optionality means buyers will tend to take the cheapest grade.

“It may be attractive, simple and popular for that reason and it came out first, so those who publicly backed it early will not feel inclined to change horses midstream,” the trader adds. “Combining three grades with three different volatility values may increase North Sea volumes, but it leads to all manner of problems and confusion.”

London’s International Petroleum Exchange (IPE) has also been dragged into the debate, feeling obliged to announce to the oil sector that its Brent settlements for September will be based on the Brent forward cash market, as before. However, as EPRM went to press, no such announcement had been made by the exchange on the position of its October assessments.

The IPE has let it be known that it is watching the situation closely and is prepared to change its settlement methodology, should that be what the market clearly wants. In an announcement on July 9, the exchange said: “The IPE would only implement such a change to the IPE Brent Index calculation provided there are reported cargo trades and intra-day assessments of the same contract type that are verifiable and transparent.”

Potential shake-out
According to one trader, who supports the BP BFO plan, the slow trading market might soon provide the shake-out required. “Confusion is reigning supreme as the market doesn’t know which way it’s going to jump, but I think the combination of the summer doldrums and the uncertainty over which is going to be the most liquid instrument means that only one can survive with sufficient liquidity,” he says. “On balance, the BFO proposal has already got more support than the BF&O plan and will continue to do so.”

One head of energy markets at a Geneva-based trading house says that whatever happens, the BFO-versus-BF&O argument must be resolved soon. “The whole thing has already gone on too long and it’s barely off the ground,” he says. “The best answer would be a compromise between Shell and BP, but I can’t really see that happening.”