The Crude Report: The Brent basket’s burden: Part 2

Author Argus

The staple crude oil price benchmark Dated Brent needs reinforcements, but how should the North Sea maintain its status in the global oil markets?

In a recent informal poll run by Argus, voters were asked how the Brent basket should be bolstered – by adding US crude or new Norwegian grade Johan Sverdrup. In this episode of The Crude Report we take a look at how voters responded.

brent-basket-burden-2-image 

Transcript

James: Hello. And welcome to the latest edition of The Crude Report. This is a weekly podcast from Argus Media in which we try to shine a bit of light on some of the big issues of today in the global crude market. My name is James Gooder, and I'm VP for crude in Europe and Africa. And I'm very pleased to welcome back to the pod, Michael Carolan, who is our global Crude Report editor. Hi, Michael. How are you doing? 

Michael: Hi there, James. Happy to be back. 

James: Good. Well, today, we're going to follow up on our most recent podcast. There've been a few in the interim, but what we were doing was talking about the future of the Dated Brent benchmark, or what we call at Argus, the North Sea Dated price. This is a daily index which is used in much of the world to price crude at various differentials, premiums, discounts, and is in lots of very important contracts. And it's been a very controversial year for the Dated Brent price. There were some changes that were suggested, and the market remains very divided. 

In our last podcast, we let you know that we were running a poll, an informal poll, of course. This is not the way things are decided in the crude world. But we ran a poll about which of two possible outcomes the market would prefer. And I can say that there was a vocal response to this question, some strong opinions voiced. The question we asked was, should the Dated Brent benchmark, with its dwindling production and falling market liquidity, be boosted by the addition of US crude into the European benchmark? Or should a new-ish grade from Norwegian waters, that's Johan Sverdrup, be the solution? Michael, what was the outcome of the poll? 

Michael: Well, surprisingly, it was... Johan Sverdrup was the more favored option. I say surprisingly because in conversations we've had with the main players in the North Sea physical market, there is, if not support for WTI's inclusion, then a certain resignation that that is the direction of travel. But of course, Brent goes much wider and deeper than just this particular smallish trading community. And maybe the survey shows that the wider community exposed to Brent could be in favor of a different solution. 

James: Yeah. That's a good point. I mean we are talking about different constituencies here. There's the North Sea Trading Club, if you like, whose activities set the various constituent parts of Dated. And then there's the rest of the world which uses these things in long-term contracts out of Russia, out of West Africa, and the Med, and so on. So, it's really lots of different people involved. 

I mean it is interesting, as you say, that Johan Sverdrup was the preferred option. There is certainly a group of companies that favor that. They say that, well, the North Sea benchmark should reflect the price of North Sea crude. And Johan Sverdrup is the largest single stream in Northwest Europe. That's right, isn't it? 

Michael: It is, by quite some distance now. The capacity of Johan Sverdrup has recently been increased to 775,000 barrels a day. And this was from Equinor just last week. So, that should be by the end of 2022. I mean, by that stage, it's going to tower over every other grade in the North Sea. 

James: Absolutely. As a companion to this broadcast, we have put together an explainer of some of the issues. So, we will link to that in the transcript of this podcast. So, you can find the details there and see some representations of what it would mean. But, essentially, we have this large grade in the North Sea. Other grades have been bolted on to the benchmark over the years. It used to be just Brent. Now, we have Forties, Oseberg, Ekofisk, Troll, and now, potentially other grades put into this basket. It seems to be an obvious solution geographically. But what are some of the objections to the addition of Johan Sverdrup, Michael? 

Michael: Well, the main one is it's a matter of quality. Johan Sverdrup is both heavier and sourer than the other grades in the basket. And therefore, it trades at a much lower level. We've run some numbers. We tried to look at how Johan Sverdrup could be included in a benchmark. Is there existing mechanisms we could use? The quality premium is already part of the Dated calculation. These are there to bring Oseberg, Ekofisk, and Troll down towards the level of Brent and Forties, which trade a lot lower. 

So, we've looked at, could we use the same mechanism to bring the value of Johan Sverdrup up, and basically used recent trade-based data to adjust it in that way. And using a similar mechanism, it does work. So, we've run numbers using gross product worth data rather than trade. But from what we can see, it does yield an acceptable result that wouldn't be a major change in the value of Dated, but it would bring in much more volume and many more price signals in establishing the price. 

James: That's interesting. I mean I think we mentioned on our last podcast the fact that if, according to our calculations, you were to bring WTI into the basket, it would most likely, based on past market behavior, it would become a key part of the benchmark setting process as it tends to be discounted to clear into Europe and trades that are very competitively low level. And it would be setting the benchmark as much as half of the time. Would that be the case with Johan Sverdrup as well? 

Michael: No, because we'd be effectively adjusting the difference in trade. Although there'd be a lag, it'd be trade from the previous months which would use the quality adjustment for the coming month. But that would basically wipe out the difference. We'd probably end up with a marginally lower benchmark, but really no more than 5%, 10% of the time. 

James: Interesting. Yeah. Well, I mean I appreciate a lot of this is pretty technical stuff for the non-specialist. But we're always happy to discuss in more detail. As I mentioned, people have some very strong and increasingly entrenched views about this. I know there is a positively committed camp to the Johan Sverdrup solution. But on the other side, there are people who are in favour of bringing US cargos traded on for delivery into Europe as part of the Brent basket. And it seems...it's a bit hard to say, but it seems that the current trend is towards that outcome. Is that fair to say, Michael? 

Michael: Yeah. Well, I mean the immediate plans are unclear, to be honest. There were planned to be a series of workshops this spring and early summer hosted by our competitors, Platts, to come up with a plan for Dated Brent's future. But these, as far as we're aware, have not happened at all. And there's no clarity on when they will be happening. The feeling in the industry is that we need to get people in a room together to thrash this out. And that's obviously not been possible because of COVID restrictions. 

But as things are easing up, perhaps in the second half of the year, we will see some progress on this. Certainly declining volumes of the existing grades in the benchmark. There is a ticking clock here. So, we need a solution fairly quickly. And the solution on the table at the moment appears to be WTI, though how we get that into the mechanism is not clear. 

James: Yeah. I think we covered some of that last time. It is a highly complex question about how you incorporate crude from outside the region into the Brent complex. But that aside, you know, let's see which way the market eventually goes. But there are other possibilities drifting around. Some other ideas are floating to the surface. Of course, any given idea is going to probably favour the proposer of it. And there'll be others who won't be such big fans. 

But some of the suggestions we've been hearing recently, for example, would be to put 100% quality differentials, those quality premiums Michael was talking about on all grades. So, at the moment, it's 60% which adjusts them down to a certain level. But it doesn't really bring them into benchmark setting competition as often as it would. That might bring a bit more liquidity to some of the grades in the basket that you don't typically see setting the benchmark like Troll, for example. 

Another one we were hearing, Michael, was to drop Forties and Brent. That sounds pretty radical. Why would we do that? 

Michael: I mean this is quite an out-there suggestion. But it has merits. There's basically limited and falling production of both of these grades. And that means that they send quite a distorting price signal sometimes. And the feeling is that, as the number of cargos goes down, this distortion will become really a quite volatile part of the Dated price signal. Removing volumes from the benchmark seems an odd way of solving the problem of falling volumes. But certainly, if we get down... I mean Brent is already down to four or so cargos a month. Any lower than that, you got to ask the question, "Why is it there?" 

James: Yeah, exactly. And then also with Forties, there is the question of quality. It does have this kind of varying sulfur level and specific gravity depending on which parts of the system is switched on and off. The Buzzard field, obviously, is quite different to the rest of the blend. Another thing is, you know, this whole futures and forward ecosystem, if you like, around Brent where most of the volume, most of the liquidity in the market is in the futures. Perhaps one possible outcome would be to use the futures as the benchmark rather than this Dated structure which is looking increasingly creaky and perhaps underpopulated by information. 

And then another option, I think, we were hearing quite recently was to change what the futures mean to link more directly to the physical market possibly to even settle against assessments of Dated Brent by companies like Argus and Platts. What do you think about that? 

Michael: Well, I think that suggestion arose because of the trouble of getting WTI into Dated because getting WTI into Dated is one thing, but getting into the forward market which is a key part of the Dated structure, that's the big obstacle. And we haven't heard any reasonable suggestion of how that works. So, one solution is just to remove the forward market. And to remove the forward market, then ICE Brent has to settle directly on Dated. But whether one PRA's Dated Brent is enough to settle ICE remains to be seen. It could be that they look for a combination of prices in some way to do that. Because, of course, you still need a link to the physical market for ICE Brent. 

James: That's right. And, of course, there is a precedent for this kind of combining of price reporting agency assessments and things like the UK tax code for non-arm's length transactions and all of that. 

Well, clearly, we don't have a solution today, but these are some of the options that are floating around. I hope this is...hope to clarify some of them a little bit. I mean, basically, to sum up, it feels to me like there are many possible ways to improve this Dated price. There's not yet a consensus. The most likely outcome, as it stands, which is to include some US crude, WTI Midland quality into the Dated basket without changing the forward elements, I mean that seems the way that we are drifting towards. But that's fraught with difficulties and may lead some of the large crude exporters, particularly in Russia who might object to the use of a US index to set their crude export sales to move to something else. This could really fracture the way benchmarking works. 

Anyway, thanks very much for your help today, Michael. It's very interesting. And thanks, everybody, for listening. Of course, as I said, there's
an explainer available to make some of this very complex information digestible in a visual way. And also, we'll continue to look at it very closely. And all of the prices that we're talking about are available in the Argus Crude Report, of course. So, please have a look there. Any feedback is very welcome. 

So, thanks very much, Michael. And we'll see you again. 

Michael: Thanks, James. 

James: We'll see you again soon. Cheers.

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