Saudi Aramco, national oil company of the world's largest oil producer and exporter, decided earlier this month it will drop West Texas Intermediate (WTI) as the benchmark for pricing its oil for sale in the US market. In January 2010, Aramco will use the Argus Sour Crude Index (ASCI) to price its oil for the market; it's heavier and has higher sulfur content than WTI. The index, launched in May, uses the volume-weighted average of daily spot sales of the three U.S. Gulf Coast medium sour crudes: Mars, Poseidon, and Southern Green Canyon. .... In principle, the movement in WTI prices is supposed to reflect supply-demand conditions in the US, the largest consumer in the world, burning almost one quarter of the of the 86.14 million b/d consumed worldwide in 2007. And sour crudes usually should sell at a discount to light crudes such as WTI because the latter are cheaper to refine. However, distortions caused by logistical or inventory constraints at Cushing, Oklahoma, the WTI delivery and pricing point, can dislocate WTI prices away from North Sea Brent and US gulf crude prices. Historically, WTI has traded pretty much in line with Brent and gulf sour crudes. But WTI price movement has become increasingly volatile in recent years. The recent inventory glut at Cushing, OK due to the demand slump, coupled with new pipelines transporting Canadian Oil Sands crudes has distorted the WTI price against other benchmarks throwing the global oil market into disarray.
In January 2010, Aramco will use the Argus Sour Crude Index (ASCI) to price its oil for the market; it's heavier and has higher sulfur content than WTI. The index, launched in May, uses the volume-weighted average of daily spot sales of the three U.S. Gulf Coast medium sour crudes: Mars, Poseidon, and Southern Green Canyon.
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In principle, the movement in WTI prices is supposed to reflect supply-demand conditions in the US, the largest consumer in the world, burning almost one quarter of the of the 86.14 million b/d consumed worldwide in 2007. And sour crudes usually should sell at a discount to light crudes such as WTI because the latter are cheaper to refine.
However, distortions caused by logistical or inventory constraints at Cushing, Oklahoma, the WTI delivery and pricing point, can dislocate WTI prices away from North Sea Brent and US gulf crude prices.
Historically, WTI has traded pretty much in line with Brent and gulf sour crudes. But WTI price movement has become increasingly volatile in recent years. The recent inventory glut at Cushing, OK due to the demand slump, coupled with new pipelines transporting Canadian Oil Sands crudes has distorted the WTI price against other benchmarks throwing the global oil market into disarray.
Another sign that we're running out of the good stuff and doing with less good substitutes. In the long run, we're all dead. John Maynard Keynes
But no-one bothers about that because the BFOE complex is making everyone too much money, at the expense of people who know they are losing but wrongly blame the futures market for the loss.
As I said to ARG in another thread...
It's far from heresy, ARG, and lots of people agree with you: but I regret that I think you, and they, are under a misapprehension. The futures markets are the tail, not the dog. Systemic manipulation has been going on in the Brent/BFOE physical/OTC complex for years, and was transmitted to the WTI market by the arbitrage available on the ICE trading platform. This manipulation is now entirely out of control. It was IMHO responsible for the 'spike' last year and is responsible for the bubble now. Essentially what is happening, I think, is that producers - who are able (unlike speculators) to store oil for nothing in the ground - are able to borrow money from the funds and to lend oil to the funds in return. Just as is happening in the other asset classes - particularly equities - we are seeing the physical market price (and it doesn't take that much in the BFOE market these days) gradually pumped up with borrowed money. The correlation between WTI and the S&P was almost perfect recently, and last year we saw pretty much all of the other commodities spiking in the same way. This proves beyond doubt that supply and demand for the commodities had nothing to do with it, and that another factor was at work. That factor is the shape of the yield curve at the zero bound. ie at the moment the forward curves on commodities react almost precisely to movements on the forward curve on money. In the oil market, I believe that it is BP and Goldman who combine to lead the arbitrage between money and oil, but everyone else will be doing the same. The necessity to be in both the physical/OTC and the futures to avoid getting screwed in one or the other is the motive behind the move by GLG (hedge fund) into the physical market. It is probably also why Occidental acquired Citigroup's Phibro trading unit, and why Vitol acquired some Petroplus infrastructure assets recently. It is only those participants capable of making and taking delivery who can affect the physical market price, which in turn affects the futures price - and not vice versa as you, and almost everyone else, assume. I managed IPE Gas Oil contract deliveries for six years - of anything up to 800,000 tonnes in the second half of the contract month - and while I kept a close eye on who was doing what in Europe's biggest game of 'chicken', no broker in his right mind allowed investors unable to make or take delivery to participate in the 'spot' month. The reason being of course that if the client cannot perform, it is the broker's arse on the line to the clearing house. The fact is that for producers trying to hedge energy prices (in dollars) then funds whose purpose is to hedge the dollar priced in energy (ie 'energy inflation') are precisely the genuine liquidity needed in the futures market. It is the Wall Street Refiners in particular who are causing the problems in league with one or two producers - quite possibly the Saudis, which may help to account for their wish to move from the WTI futures contract, where the Brent/WTI arbitrage had broken down badly. I believe that a practical first step to solving the problem is a big breath of transparency.
The futures markets are the tail, not the dog. Systemic manipulation has been going on in the Brent/BFOE physical/OTC complex for years, and was transmitted to the WTI market by the arbitrage available on the ICE trading platform. This manipulation is now entirely out of control. It was IMHO responsible for the 'spike' last year and is responsible for the bubble now.
Essentially what is happening, I think, is that producers - who are able (unlike speculators) to store oil for nothing in the ground - are able to borrow money from the funds and to lend oil to the funds in return.
Just as is happening in the other asset classes - particularly equities - we are seeing the physical market price (and it doesn't take that much in the BFOE market these days) gradually pumped up with borrowed money. The correlation between WTI and the S&P was almost perfect recently, and last year we saw pretty much all of the other commodities spiking in the same way. This proves beyond doubt that supply and demand for the commodities had nothing to do with it, and that another factor was at work.
That factor is the shape of the yield curve at the zero bound. ie at the moment the forward curves on commodities react almost precisely to movements on the forward curve on money. In the oil market, I believe that it is BP and Goldman who combine to lead the arbitrage between money and oil, but everyone else will be doing the same.
The necessity to be in both the physical/OTC and the futures to avoid getting screwed in one or the other is the motive behind the move by GLG (hedge fund) into the physical market. It is probably also why Occidental acquired Citigroup's Phibro trading unit, and why Vitol acquired some Petroplus infrastructure assets recently.
It is only those participants capable of making and taking delivery who can affect the physical market price, which in turn affects the futures price - and not vice versa as you, and almost everyone else, assume.
I managed IPE Gas Oil contract deliveries for six years - of anything up to 800,000 tonnes in the second half of the contract month - and while I kept a close eye on who was doing what in Europe's biggest game of 'chicken', no broker in his right mind allowed investors unable to make or take delivery to participate in the 'spot' month. The reason being of course that if the client cannot perform, it is the broker's arse on the line to the clearing house.
The fact is that for producers trying to hedge energy prices (in dollars) then funds whose purpose is to hedge the dollar priced in energy (ie 'energy inflation') are precisely the genuine liquidity needed in the futures market.
It is the Wall Street Refiners in particular who are causing the problems in league with one or two producers - quite possibly the Saudis, which may help to account for their wish to move from the WTI futures contract, where the Brent/WTI arbitrage had broken down badly.
I believe that a practical first step to solving the problem is a big breath of transparency.
As Jerome says there has been a move to refining heavy and sour crudes, and massive investment in refineries to accommodate these. The result has been that the historic differentials have shrunk.
The need for a benchmark sour crude has been around for ages, and the IPE launched a Dubai benchmark two weeks before Saddam invaded Kuwait... We tried again later. but even then there was insufficient liquidity in the underlying, and production has declined further since.
The deliverable Dubai contract that exists is used mainly by Shell as a means of guaranteeing payment from counterparties with whom they would not otherwise deal....
The contract is not really being used as a benchmark much at all, because it's too easy to manipulate the underlying. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
