The Argus Media energy markets presentations which take place every year at this time were hosted at the London Hilton and, as always, their senior executives offered a thoughtful and perceptive analysis of past and future energy market trends.
While the oil markets presentation ranged from the effect of the Ukraine war on trading patterns through forecasts of demand and supply for the near future, the “elephant in the room”, as it was referred to by Euan Craik, concerned the impact of forthcoming changes to the methodology of assessing the price of Dated Brent, the world’s leading international crude oil price benchmark.
With attendant further complexity and not a little market dissent, decisions have been made and come the early summer, the price assessment will include WTI, in addition to the existing North Sea grades that make up the Dated Brent basket.
In fact, given the way the calculations work, it is likely that WTI will set the price for the majority of the time. This will represent a significant change from the status quo where Brent prices largely responded to production and consumption forces in one specific geographic location, to a situation where production and consumption are geographically bifurcated (WTI moving further afield with greater regularity than N Sea crudes) and , consequently, its price may become more influenced by specific regional factors in some faraway places.
This will likely result in an increase in volatility in Brent prices-a bonus for speculators but an expense for hedgers and risk managers.
In addition, it is to be hoped that the very necessary convergence between the physical/cash world and the futures contract used to hedge physical exposures (ICE Brent) will continue as was so that hedging can be perfected via the futures market liquidity provided by that platform.
There are some other tricky issues that may not have yet penetrated the psyche of all the users. None is more relevant than the revelation by Argus Media that modelling of the Dated Brent basket using the existing formula versus the “new” formula (over the last 4 or so years), has shown that the “new” formula including WTI would have led to Dated Brent being priced at levels up to $5USD below actuals.
What might be the reaction of the sell side if, going forward, their Dated Brent-related sales contracts result in a significantly discounted return?
Given that WTI is, arguably, likely to set the basket price most of the time, is not this then Dated WTI that is being established and, therefore, is this not reasonable grounds for a wave of renegotiations and an ensuing contractual stramash? Tricky indeed and potentially a realistic prospect.
Dated Brent has already suffered a Ukraine War-related blow as a result of the (as pointed out by Argus) “evaporation” of Urals, a crude which is priced by reference to Dated Brent. How many more blows can Brent take?
Brent has been the towering cumulus of international crude oil pricing for more than 40 years- the whole period of crude oil trading as a competence. This will be well illustrated in an important book, edited by Adi Imsirovic, and due to be published by Palgrave in June (Brent Oil-Genesis and Development of the World’s Most Important Oil) and, incidentally, featuring a contribution from Argus Media Chairman, Adrian Binks amongst others.
Perhaps it is timely, in advance of the change of basket calculation. But does it presage the end of an era?
Article written by Colin Bryce