The Crude Report: Changing the Dated game

Author Argus

Last week’s expected announcement that Argus competitor Platts would add WTI into the Dated Brent basket starting July 2022 took a surprising turn when it was also revealed that the assessment will become a delivered-Rotterdam benchmark.

In this episode of The Crude Report, Argus Crude editor Michael Carolan and Argus vice president James Gooder explains how this fob to cif change will affect not just crude oil markets, but also gas and LNG markets that also use Dated Brent.

Brent: Why Argus is sticking with FOB North Sea 

Transcript

Michael Carolan: Welcome to The Crude Report, Argus' podcast series on global crude oil markets. My name is Michael Carolan. I'm the editor of Argus Crude here in London, and with me today is James Gooder, vice president of Argus. Welcome, James.

James Gooder: Hi, Michael, thanks for having me.

Michael: It's been quite a week in the crude market. The headline seems to have been price reporting agency Platts adding US crude WTI into Dated Brent. Wasn't that an Argus idea?

James: Well, it certainly is not a new idea. And we've been, as you know very well, we've been running a price where WTI is added into the Brent basket to see how it worked the past couple of years. So anyone who's listening to this and is wondering what the impact of the change like that would be, only has to look at the Argus reports.

But I don't know if that was the headline. That was one of the headlines, but that was widely expected: Platts to telegraph this change back in December. They've been consulting with the market, and what the market was expecting. At the first ever virtual IP Week that just took place last week was that Platts, you know, as the premier publisher of a Dated Brent price would confirm the addition of WTI, and that would be implemented in due course.

But what they actually said was, as well as that, "We're going to change the Dated Brent benchmark from a fob, free on board basis at the terminals of the North Sea, to cif basis: cost, insurance, and freight." And that's a different way of trading, that's trading on delivery, and delivery into Rotterdam and support in that part of the world. So that elements really caught the market by surprise. And I think that is what's triggered a lot of the controversy we've heard in the past week.

Michael: Okay, so the big picture here is the change from fob to cif. Sounds like a rather technical change, that stuff's interesting to pricing nerds like you and me. What does it mean? And what are the implications?

James: Well, I can't deny it that maybe we are deeper into this than some. But this really has impact across the oil business and beyond, like anybody that's exposed to Dated Brent prices. And that's not just oil. That's lots of other things. Let's have a look at some of those. I mean, the change is from fob to cif, as you say. So the first difference is that this benchmark, instead of being the most competitive crude being priced in the North Sea, which could be taken to Rotterdam, but it could also be taken to South Africa, or the US, or Singapore, or China, it's competition amongst producers, if you like. The alternative now being offered is a cif price, and that's competition into Rotterdam. So forget what the Chinese want or the US buyers, it's all about what's the most competitive crude arriving in Northwest Europe.

For one thing, the cif price is always higher than the fob price – almost always. It should be because it includes shipping, right? It's the delivered price in the same way that if you pay for an Amazon parcel at your house, you don't pay what it costs in the shop, you also pay what it costs to deliver to you. So there's that element, this will mean a higher benchmark than it would have been otherwise. There's also the question of who's playing in this market. So if you have delivered, setting the price, then the optionality is all about who can get a cargo to meet that delivery window. And if you are on a fob price, it's all about who wants to cargo most to take it to whichever market in the world, the arbitrage suggests you should. So it's a change in trading behavior, and in trading participation.

But the implications of all of this are really wide reaching. Dated Brent is baked into numerous long-term contracts, both supply contracts, from majors to refiners, from producers to buyers, but also into the upstream contracts, the E&P contracts that can last for decades. And if you were to say from one day to the next, "Well, that is not a fob contract, it's a cif contract," then all the expectations that came with that contract have ended. And there's definitely a case that they could be reopened or legally challenged by somebody who felt that they were losing out by this change. There's also the fact that tax authorities both in the North Sea, in the UK, and Norway, as well as in other parts of the world, Russia, Nigeria, just to name two, using Dated Brent when they're coming up with tax formulas for the oil sector. All of those will be open to challenge and legal question.

And then it's not just oil. And it's not just crude. I mean, of course, the real value of oil products is what they are worth relative to crude and many of those margins or those crack spreads between crude and products are calculated on a Dated Brent basis, and are used by refiners and others to work out the value of their assets many years into the future. All that will change. The way that a refinery runs, and choosing which crude to run, which crudes to consume, a lot of that is based on a Dated Brent base model. And then beyond the oil, we're talking about long-term gas supply contracts, both pipeline gas and liquefied natural gas, LNG. All of these may have Dated Brent elements that, again, there's a material change in value. Price reporting agency has gone beyond what it normally does, which is to report, but to set the price, if you like, to decide what the price includes and what it doesn't. It's got very far-reaching implications.

Michael: So it's obviously a huge change. How has the market reacted to it?

James: Well, of the people that we spoken to, pretty unanimously with surprise, and varying degrees of anger, I don't think that's too strong a word. The biggest complaint that we've heard is that, as well as the plan itself being very large change to digest, and perhaps not even workable, we can talk about the implications of the forward contract separately. But what they were presented with was not what they were consulted about. That's the biggest complaint we've heard, there was a lack of consultation, and also a breach of trust. People like certainty in these markets, they like predictability. If you're taking a position many months and years down the forward curve, what you don't want to be told is that position is...it means something else now, because you will have made a lot of decisions, whether investment, or asset planning, or production. A lot of these decisions are based on these kinds of forward curves. And if the value changes, then all of those decisions have to be rethought.

So there's that breach of trust element and the lack of certainty. And the risk is that this kind of uncertainty could undermine liquidity in the instruments and derivatives that are linked to the Brent markets. Ice Brent futures, most of all, is one of the world's premier oil hedging instruments along with Nymex WTI. And what Ice Brent futures mean depends on what the physical market against which it ultimately cashes out means as well. And so what the exchanges will be afraid of is a lack of liquidity or a lack of confidence in those forward contracts, and a fall in volumes, and thus income for them. So there's a big risk that a lot of the hedging elements of all of this will be a lot more risky than they were. And ultimately, that means higher prices. Because if you can't manage your price risk efficiently, then the consumer will be the net loser in that scenario.

So the reaction, as I say, has been surprise, anger, to the extent that there has been discussion of switching away from Platts Dated Brent to other competing indexes. Of course, I should point out that we're competing in this space as well with our North Sea Dated price, which has a very similar methodology. So at the moment, we're absorbing that feedback, we're providing a listening ear, and deciding what we need to do next to respond to the market's demand.

Michael: Are there examples of price reporting agency making a unilateral change like this in the past?

James: This kind of thing has happened a few times, and it causes great upheaval every time it does. And there may well be very good reasons for the change, good theoretical or kind of methodological reasons why such a change is necessary. But as I say, it's the lack of preparation, the lack of consultation problem. A couple of times I can think of those in the mid first decade of this century, 2005, '06, Platts tried to encourage the US Gulf coast crude market to trade in its window, market on closed methodology. And that market is pretty well happy with the way things were set up. So instead of going along with that change, they switched over to Argus, and we continue to use all the volume weighted average assessment, which is what they told us they wanted. That was a big change.

And then the year after that, there was a bit of an upheaval in the North Sea, where again, it was Platts that made a unilateral decision to remove Forties crude from what was then a basket of three, Brent, Forties, and Oseberg. Because they felt that with the change in spec or the change in quality, rather, of that grade with the addition of the Buzzard Field to Forties stream, that the sulfur was too high for it to be considered a light sweet crude anymore. This caused great consternation and great upsets, just as the last week's announcement did. And for a few short weeks, the market began to trade on an Argus basis because they felt that they understood what our benchmark represented. And it's what they had anticipated. Everybody knew the change with Forties was coming. So there was no need to kind of artificially price that change out of the benchmark.

But then perhaps were persuaded by various market participants to backtrack on that change, a sulfur de-escalator was added at the suggestion of market participants to kind of stabilize the value of Forties. And that's been in place ever since. So that was one of those occasions where the incumbent was encouraged to step back from a radical proposal.

Michael: So is there anything Argus can do to calm the markets on this occasion?

James: Well, we are the challenger in benchmarking, and we are the backstop, if you like. So it's important that we are clear about what our methodology represents. And that, of course, is all available on our website. And we're very happy to discuss it with people in detail. We will continue to publish Argus North Sea Dated based on FOB market assessments, just as we have since the 1980s. That's not going to change, we can make that guarantee. It may be in time as the market evolves that we want to include other grades beyond the Brent, Forties, Oseberg, Ekofisk, and Troll in the basket at the moment.

And those grades could include heavier North Sea crudes, like Johan Sverdrup and Grane, adjusted for quality in a similar way that Forties is adjusted today. And possibly, as well as, we could include delivered crudes from outside the region. Again, this is something we've been experimenting with for the past two years. So grades like WTI Midland, of course, but also perhaps other light sweet crudes, Bonny Light from Nigeria, or other crudes. There are certainly plenty of crude around, that's not the issue. But we would adjust those back to a fob North Sea equivalent basis.

Now, we see, we agree that it's important to make sure that benchmarks are well maintained, that they have to be improved and developed over time to capture maximum liquidity, and all that, and retain the market's confidence is the most important thing. But we agree with some of our correspondents that the changes need to be gradual, and they need to be consensual, and they need to be flagged up well in advance. Otherwise, the price reporting agency itself becomes a source of volatility. And I think there's enough volatility in the world without us adding to it.

Michael: Thank you very much, James, for your explanation. That's been great. I imagine we'll be revisiting this topic in the near future.

Now if you're looking for more news and analysis on issues such as this, or you want access to our North Sea Dated assessment, consider subscribing to the Argus Crude service. You can find more information on this service on our website at www.argusmedia.com. Thanks for tuning in this week. And we look forward to you coming back for the next episode of The Crude Report.

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