The Brent benchmark, the world's premier oil price index, has undergone the biggest change in its near half-century history.
Argus Crude editor Michael Carolan joins Crude VP James Gooder in the podcast to discuss how this change affects the price and what users need to watch to understand this new benchmark iteration.
Transcript:
James Gooder: Hello and welcome back to The Crude Report. This is a regular podcast from Argus Media covering happenings in the international crude markets, and regular listeners to this podcast will know that we've been covering in some detail the changes to the Dated Brent or North Sea Dated benchmark, one of the most crucial prices for oil in the world, over recent times. And now that the change that we've long been discussing - that is, the inclusion of US WTI crude delivered into Europe into the North Sea Brent basket - now that that's happened as of a month or so ago, we thought it would be a good time to catch up and see what has been the initial impact of this latest and most radical change to the benchmark and whether it's having the desired effect. Now, of course, the problem that this change was supposed to address is the declining physical volumes in the Dated benchmark, and I'm very pleased today to be joined by Michael Carolan, who's our crude editor for the Argus Crude report, to discuss in some detail what has been going on. So Michael, welcome to the podcast.
Michael Carolan: Thank you, James.
James Gooder: Good to have you with us. Tell us, has this change - long-awaited, long telegraphed by the Argus podcast and other services - has it had the desired effect of bringing more volume into the benchmark?
Michael Carolan: Yes, very much so. And as you said, the key problem it was addressing was this decline in volumes of North Sea grades, Brent, Forties, Oseberg, Ekofisk and Troll. Now production of those crudes has been declining for years, dropping below 1,000,000 barrels a day for the combined five in 2017. And it was just 712,000 barrels a day last year. So that's just one cargo a day. And in August this year, there's just 565,000 barrels a day of those North Sea benchmark grades loading. So we're well below a cargo a day. So you can see why the decision was taken to add another grade to the basket. Now, by contrast, almost 1.7 million barrels a day of US crude has been making its way to Europe this year. The vast majority of that has been light, sweet, WTI crude. So US crude was really dwarfing the North Sea benchmark for crude in volume terms this year.
James Gooder: It really is, just in terms of the sheer volume of crude, and I guess that that that huge flow of US crude has essentially replaced lost flows from Russia, which was a similar volume even though the quality is quite different. So tell me, we have talked about the volume of physical crude, but has this been reflected in trade because of course, these benchmarks are more about the volume of information rather than the volume of crude.
Michael Carolan: Again, the answer is yes. In the daily trading window which is used to trade and assess benchmark grades, in June there were 13 WTI cargoes which traded on a delivered Rotterdam basis and that compares with just five cargoes of the other five grades combined. And to put that into context there were nine trades for the benchmark grades in all of April and just four in March. So the increase since WTI’s inclusion has been really quite dramatic.
James Gooder: Wow.
Michael Carolan: But of course, at Argus we don't just use trades to set the price. We also take firm bids and offers. And here again WTI I is really dominating. So the 94 bids and offers for delivered WTI in June, that's apart from the trades that occurred. So to put that into context, there were just 35 bids and offers for the other five grades combined. So the volume of information which PRAs (Price Reporting Agencies) like ourselves have in establishing the price of WTI on a delivered Rotterdam basis is really quite large now.
James Gooder: That's remarkable. A remarkable turnaround, and certainly that was the desired effect, right? But of course, the Dated benchmark, the complicated instrument that it is, is not just based on the trades of cargoes or the bids and offers. There's also the forward contract which establishes the kind of outright price element. And those cargoes are trading as differentials to the forward contract or to an adjusted version of it through the CFDs (contracts for difference) - without going too far down the rabbit hole, has there been a similar impact in terms of the forward contract, which of course also can be satisfied with WTI?
Michael Carolan: Absolutely, and if anything, the impact on the forward or the cash market has been even more marked. And just to explain for listeners, the forward market is a way of securing the delivery or the sale of North Sea cargoes for future months and forms the underlying basis of North Sea Dated. So it's a key part of the Brent process and the volume of trade in this forward or cash contract has basically ballooned in June 19.8 million barrels of this contract traded or 28 full cargoes. And that's just in the last minute of the of the assessment window, up to 4:30pm, and it's more than doubled last year's monthly average and is the highest volume for any month since 2016. When you buy these cargoes through this market, you don't actually know what crude you're going to get until the month before delivery. So it could be Brent Forties, Oseberg, Ekofisk or Troll or now of course WTI. And we've seen in the last two months, it's been almost exclusively WTI delivered into this contract.
James Gooder: Hmm.
Michael Carolan: Thirteen cargoes have been allocated through this chains process in June while only one cargo of Forties was chained and no cargoes of the other four grades were chained, so it's pretty much guarantees that WTI will dominate the Dated process in the coming month or so as well.
James Gooder: Wow. So I mean, it sounds like not only has, you know, US WTI Midland crude ridden to the rescue of the North Sea benchmark, but it's also kind of replaced it, right? But, I mean, is it fair to say that on the face of it, the introduction of WTI has been a success at least in the terms that the market had set for it?
Michael Carolan: Well, I think you're right. It depends how you define success. There's no doubt at all it has improved the volume of trade underpinning the benchmark, which was the main objective of including WTI. But there were other objectives and like boosting participation, for instance, this WTI trade has been dominated by the usual suspects in the MOC (market on close). So one of Trafigura, Gunvor, TotalEnergies or Vitol have been involved in most days. There have been no new entrants and smaller players have remained almost entirely absent from the process. So there's been more volumes, but it's the same companies doing the trade.
James Gooder: Right. So I see. And so we've kind of a bigger volume but not a deeper market.
Michael Carolan: Exactly.
James Gooder: And it does sound, you know, as we're saying that WTI is dominating this benchmark now to the detriment perhaps of other grades. I mean, is it fair to say that Brent itself is no longer relevant to the setting of Brent?
Michael Carolan: Yeah, I mean, there was an argument of Brent hasn't been relevant for a while, but basically WTI is taking up most of the focus now and that that's unsurprising - the Dated benchmark as you know is priced by the lowest grade in the basket. And historically that's been Forties as it's a more sulphurous grade than the others and that has tended to dominate for that reason. But now WTI is undercutting all of those grades and is generally cheaper. So traders tend to focus on the grade, which is likely to set the benchmark rather than other grades.
James Gooder: Hmm..
Michael Carolan: And that's why WTI dominating now, as Forties dominated in the past, and grades like Brent and Ekofisk, and Oseberg particularly, have a limited impact.
James Gooder: I mean, one of the things we heard leading into this was that WTI because it was high quality light sweet crude - you know very low sulphur, very high specific gravity - because it was such high quality crude, it was unlikely in fact to set the benchmark. So it's interesting that it is cheaper than, as you say, what is a relatively sour crude like Forties. Is it perhaps because WTI is now trading in a prompter window, it's trading much closer to delivery in order to compete with those North Sea grades which of course are trading for loading 10 days to a month ahead, whereas previously people of course were trading WTI much further forward like 30 to 60 days ahead, so a WTI cargo deliverable into the Dated market is probably already on the water right? It's already crossing the Atlantic.
Michael Carolan: Exactly, the prompt nature of it is quite key here. So we've been assessing WTI for some time and WTI until this summer traded more than a month out. So it didn't really match the Dated assessment window, but now it's moved forward like you say into the assessment window 10 days to a month ahead. And 10 days ahead - that's probably a cargo that has been on the water for a week or so. It's borderline distressed.
James Gooder: Yeah.
Michael Carolan: Prompt cargoes of WTI, they're valued quite a lot lower than cargoes loading two weeks out. So and we've got a real structure in the WTI curve, which is not necessarily reflected in the curve for the North Sea grades. But I would say that the reason WTI is lower isn't just being more prompt, it is just the sheer volume of it. We don't have these volumes in the North Sea and that they command a premium because of that, whereas WTI with, you know, one and a half million barrels a day coming over, there's just plenty to choose from.
James Gooder: That's right. And of course, there's no loading programme, so you don't know how much - there can always be more, right?
Michael Carolan: Exactly.
James Gooder: So that's interesting. And that brings us to one of the major concerns about this, that several people have voiced, which is that including WTI in Brent is not only, you know, keeping the benchmark alive, but it's in fact impacting the price of Brent and of course, Brent is used as the basis for most of the trade in the Atlantic Basin and further afield in, in Asia too. So what is this doing to the price of Brent? Does it represent something different now?
Michael Carolan: Yes, as expected WTI has been lower than the other grades for most of the time, and as the lowest priced grade it has set Dated most of the time, so there's the 22 trading days in June and WTI set Dated as the lowest price on 18 of those days and that's had an inevitable effect on price. Now as you know, we added WTI to our Dated assessment in the summer. We also launched an illustrative Dated price called Dated BFOET and this excludes WTI, so we can, in effect, see the difference that WTI is having on the benchmark by comparing these two prices.
James Gooder: Right. And what's the spread?
Michael Carolan: Well, looking at that, WTI’s inclusion has made Dated an average of $0.20 a barrel lower in June than it would have been if WTI wasn't part of it, and that spread was as wide as $0.65 a barrel on one occasion. So that's really quite a marked effect considering the crude market has been relatively stable in the last month or so. So our warning has always been that Dated would be lower if WTI is included and it seems that we were correct. And the point about the prompt nature of it…
James Gooder: Wow.
Michael Carolan: …in the 10 days to a month ahead window, it could get lower still. If prompt WTI cargoes start dominating the benchmark, all of a sudden we've got borderline distressed cargoes setting our global benchmark.
James Gooder: Right. And I guess you know the way crude trades is that differentials or spreads to that benchmark and I suppose those might be expected to adjust accordingly, but the only way you know by how much they should adjust, I suppose, is by looking at that spread between North Sea Dated and Dated BFOET.
Michael Carolan: Exactly. I'm I would encourage listeners and readers of the crude report to keep note of that spread because we are the only ones offering it. And it is bound to change over time.
James Gooder: Yes, indeed. So I mean of course Dated is very important, but not only. I mean there are other parts of the Brent complex which are used very widely, not least Brent futures prices which are traded on various platforms, most volume on the Ice platform. Have we seen any impact on the Brent futures?
Michael Carolan: Yeah, well, one of the concerns people had in the market was that the wider Brent price would become just a European price of WTI. And if that's the case, how do you measure the transatlantic arbitrage? Is it just a question of freight? And we have definitely seen the relationship between Brent futures and WTI futures become closer and more stable. So the front month Ice Brent contract traded at an average premium to the front month WTI contract in the second half of last year of $6 a barrel, and it was the same in the first quarter of this year, but since the start of May when WTI was first added to the basket, that spread has narrowed to just $4.35 a barrel. But the real impact has been on the relative volatility of the spread. So the average daily change in the Brent/WTI spread that we just discussed in the second half of last year was $0.48 a barrel, that narrowed to $0.20 a barrel in the first quarter of this year. And since the start of May, the average daily move is just $0.12 a barrel so the two contracts have become closer, while the relationship between them has stabilised significantly. Now if these trends continue, you have to ask the question what is Brent for? The forward market as we've seen has become a good tool for European refiners to buy WTI cargoes, but how is that Brent? And the closer relationship between the two futures markets does suggest that Brent is really becoming just a European price of WTI.
James Gooder: Yeah. I mean, it's interesting if you look at the old spread that people will look at, which would be the Nymex WTI price versus the Ice Brent futures price that used to be very volatile. As you say, it's become very stable and in fact it's quite easy certainly so far since this change began to take effect, to work out what that spread is by taking the price of WTI at Houston and then adding the freight across the. Atlantic. So as you say, you know Brent has effectively become a European price for WTI, but adding freight to a crude price is not the same as understanding the arbitrage between two different regions, as you say. How do we know whether it's better to send crude to Europe or to Asia if the European price and by extension the Asia price are just derivatives of the same WTI fob price? It really is a more radical change than it even seemed on the face of it, in terms of merging all the existing benchmarks into one, in which, is it fair to say that the kind of real mover is the price at the US Gulf Coast?
Michael Carolan: Exactly, and the price at the US Gulf Coast is two weeks ahead of the price in Europe because that crude has to cross the Atlantic. So it just seems odd to have a Brent price which is now basically WTI plus a couple of weeks and plus a freight price.
James Gooder: Yes, I mean people use what they use, of course, and people are certainly used to using Brent, but I think it's definitely worth understanding that Brent is going to behave differently as a result of this change and that the real action in terms of price discovery of the outright price of crude is at the US Gulf Coast. I mean, one of the things and this is certainly not news to the market because people have been getting more active in that US market as a result of this change or in advance of this change. I mean, we've often promoted on this podcast the Argus-settled price of WTI at various points in the United States, not least WTI Midland, where the crude is gathered first in West Texas, but also Houston where it is piped for either local domestic refining or exports and that's become a really important crossroads for crude for the world. And so that WTI Houston price, we were just hearing has for the first time approached in terms of the trade on the month of July, 1,000,000 barrels a day. That's by far the biggest ever seen in that market. And that's not just domestic players. That's certainly international players getting hold of supply in that market in order then to bring it to Europe or wherever it's most in need. And then we've also seen a huge surge this year in the use of the paper contracts, the derivatives that settle against those WTI Midland and WTI Houston differentials. I mean, across all of the August settled contracts at the US Gulf Coast and that includes Mars as well as a representative medium sour, the daily volume as of late May was something like 12,000 contracts every day on the CME platform, and other platforms are available, but that's the biggest centre for trade of these derivatives. That's up 76% on the previous year to date and that is a huge additional volume and what we hear is that more and more European and Asian companies are getting involved in those US Gulf Coast markets in order to have not only visibility of but exposure to the real outright price of crude which is being set there in Houston and around. So it's been a real transfer, if you like, of liquidity to the US Gulf Coast. I mean, do you do you think, in time, we will see perhaps Brent becoming more of a regional benchmark for Europe rather than the global benchmark that it has been for several years?
Michael Carolan: Well, I mean, while it's tied to WTI, in the way it has become, it's hard to see that happening. So there are alternatives to Brent. I mean we've got our Argus Brent Sour price, which is just North Sea grades. And I just wonder if people want a price for crude in Europe whether Brent is the right price to be looking at it is now. It's a function of US economics, US refining economics as well as US fundamentals. So it will be interesting to see how local refiners look to Brent in the future. Once they understand this relationship it now has with WTI, and it's not necessarily about what Europe is doing at the moment, it's about what's happening across the Atlantic.
James Gooder: Yes. Well, it's a fascinating time to be involved in this in this particular niche, Michael. Thanks very much for all of your thoughts there.
Michael Carolan: Thank you.
James Gooder: And thank you for listening. I've been James Gooder, and please join us again for another edition of The Crude Report.
