By Gillian Dunks, ZE Datawatch
Sales and purchases of varied commodities affect each country in the world, but few commodities have a global impact greater than that of oil. Price reporting agencies (PRAs) monitor the global oil industry carefully, producing price assessments which are meant to be reflective of the real value of oil resources. An examination of oil price assessments and the methodologies used to create them can reveal much about new trends in the global energy industry. Currently, countries from the Asia-Pacific region, especially China, dominate global oil consumption and are poised to play an increasingly prominent role in the oil sector, which will have an impact on PRA product offerings.
Global Oil Industry Overview: Benchmarks and Assessments
Benchmarks are prices for certain oils traded on the spot market that are taken to be representative of the real value of most oil in a particular region. Four major benchmarks in the global oil industry are:
- Western Texas Intermediate (WTI), the North American benchmark, which is a blend of US domestic streams of light sweet crude oil which share a delivery point in Cushing, Oklahoma.
- Dated Brent, the European benchmark, which is comprised of four crude streams from the North Sea: Brent Ninian blend, Forties blend, Oseberg, and Ekofisk (Platts).
- Dubai-Oman, the Middle Eastern benchmark, which reflects the spot value of Middle East sour crude oil.
- EPSO Blend, the Russian benchmark, which is composed of Russian crude streams from the East Siberia-Pacific Ocean pipeline.
Figure 1 shows NYMEX prompt-month calendar swaps from 2009 to 2013 for three major international benchmarks: Dated Brent, WTI, and Dubai-Oman. Prior to 2011, prompt-month swaps for these benchmarks were closely linked in price. Following 2011, these international benchmarks have varied from one another significantly. As the graph demonstrates, crude oil benchmark prices do not necessarily follow the same pattern; in 2011, a new set of influences and drivers caused price variations.
Figure 1: NYMEX Calendar Swaps for Dated Brent, WTI, and Dubai Oman (2009-2013)
Price assessments of benchmark crudes are published by many PRAs on a daily basis. Assessments are taken to be representative of the real value of physical commodities; they are used by global oil market participants to make trading, investment, and business decisions.
For example, assessments are used by upstream oil sector organizations when pricing crude oil that is transferred from upstream production departments to downstream refineries. Assessments are also used by banks, energy companies, governments, and regulators as reference prices in physical supply and derivatives contracts, for mark-to-market purposes, and as an indication of value for tax assessments; they are also used by risk managers for strategic analysis and planning.
Who Develops Oil Assessments?
The value of commodities like oil is assessed by several PRAs, the most recognizable of which are Platts and Argus Media. Other key publishers of assessments include the Asia Petroleum Price Index (APPI) and ICIS London Oil Report. ICIS provides price assessments and market coverage for seven global regions: Asia-Pacific, Arab Gulf, North Sea, CIS, Mediterranean, West Africa, and the Americas (ICIS Energy). C1 Energy, an energy pricing agency established in China in 2000, also provides assessments for China’s oil and gas markets (About C1 Energy). Other noteworthy PRAs include RIM Intelligence Co. and the Oil Price Information Service (OPIS). OPIS primarily provides assessments for US wholesale petroleum prices (About OPIS).
How Are Oil Price Assessments Created?
Each PRA has unique methodologies and algorithms that they use to generate oil assessments. Platts and Argus, two large PRAs that have been chosen as samples for this report, release the reference points their reporters use to generate assessments on a daily basis. Both organizations publish assessments primarily for physical oil markets.
Central to the oil assessments generated by both Argus and Platts are references to real-time market trades and information received from a variety of market participants within limited time periods (usually one trading day in a particular time zone). Trading days are defined differently for each product and are based on times when markets contain fair numbers of buyers and sellers—that is, when markets are liquid. Both Platts and Argus collect market information from a range of participants, including oil refiners, producers, traders, and brokers. These market participants voluntarily submit lists of oil transactions, including prices, volumes, bids, offers, and counterparties, as well as information on spread values between oil grades, locations, and timings. Argus and Platts accept this information via telephone, instant messenger, emails, and faxes. Platts lists eWindow as an additional software they use to accept relevant market information (Platts Methodology and Specifications Guide).
Market participants submit relevant information to Platts and Argus prior to a strict time cut-off. These time cut-offs differ depending on the organization’s unique assessment calculation methodologies and the product itself. Platts and Argus reporters then analyze all data submitted and apply tests to determine if transactional data should be subjected to further scrutiny. Some assessments must be subjected to an internal review process that requires both organizations to inquire further within a data source’s company to assess the data’s relevance. In some instances, if data is missing or an illiquid market makes it difficult for a reporter to generate an assessment, reporters create assessments based on their own judgment. Both organizations then produce assessments that are time-stamped—that is, representative of trade values at particularly liquid points in the trade day. Platts terms their time-stamping procedure a “Market on Close” (MOC) system.
Although the procedures Platts and Argus follow to produce oil price assessments are somewhat similar, their resulting outputs are often quite different, largely due to the fact that their sources of market information are not the same. Another key difference between the two organizations is the way in which their reporters create oil assessments when faced with a lack of deal evidence. According to a report prepared by the International Energy Agency (IEA ), International Energy Forum (IEF), Organization of the Petroleum Exporting Countries (OPEC), and the International Organization of Securities Commissions (IOSCO) for the G20 Finance Ministers in October 2011, Argus reporters will consider grade differentials of deals done throughout a day, placing them in the context of absolute market price levels and time differentials at their assessment cut-off points. By contrast, Platts reporters will consider information collected throughout the day, with a particular focus on the half hour prior to 1630 PM London time (Oil Price Reporting Agencies).
Differences in assessment calculation methodologies amongst PRAs, particularly methodologies relating to oil derivatives contracts, have sparked some international concern. For example, the 2011 G20 Leaders Summit in Cannes requested that the IOSCO assess the role of PRA assessment calculation methodologies, as these assessments have impacted physical oil markets, broader financial markets, and the global economy. The IOSCO subsequently published a report in October 2012, Principles for Oil Reporting Agencies, that identified two major problems with the methodologies employed by both Platts and Argus: selective reporting measures—that is, a reliance upon voluntarily submitted data that may not necessarily be complete—as well as opacity and variations in assessment methodologies, particularly many organizations’ reliance upon the judgment of reporters when assessing illiquid markets. Some of the IOSCO’s recommendations for PRAs included an increased emphasis upon concluded transactions when creating methodologies, enhanced audit trails, an avoidance of conflicts of interest, cooperation with regulatory authorities, and external auditing. Despite these concerns, many participants in the global oil industry continue to rely upon the assessments produced by Platts, Argus, and their contemporaries, as the assessments produced by these organizations are very closely aligned with real market trends.
The Asian Oil Market: Demand for New Assessments
Many Asian countries—specifically China and Japan—lack the domestic crude oil supplies necessary to sustain their populations’ daily demands. As such, China and Japan, along with many other countries on the Asian continent, consistently have high rates of oil consumption compared to other countries. In September 2013, China became the world’s largest importer of crude oil, eclipsing the United States (EIA STEO). With China’s growing transportation sector, the country’s liquid fuel consumption is expected to double by 2040 and to surpass that of the United States by 2035 (EIA).
As the graph below demonstrates, China’s oil consumption has been increasing since 1991. By contrast, its domestic production of all oil products has only increased ever so slightly. Because Chinese demand continues to outstrip domestic supply, China has historically imported large quantities of oil (EIA China).
Figure 2: EIA’s Chinese Oil Production and Consumption Graph, 1990-2013
Amongst all countries in the Asia-Pacific region, China in particular is poised to expand into the global oil market. In November 2012, the State Council of China’s cabinet announced that they were revising administrative regulations on futures trading, which included clauses to allow overseas institutions to enter the market. At the time, the Chinese State Council claimed that these revised clauses left room for overseas investors to participate in futures trading of crude oil, which the government plans to introduce soon (China Revises Regulations on Futures Trading). Increased futures trading of crude oil will no doubt be facilitated by platforms such as the China Financial Futures Exchange (CFFEX), a platform founded by Shanghai Futures Exchange, Zhengzhou Commodity Exchange, Dalian Commodity Exchange, Shanghai Stock Exchange, and Shenzhen Stock Exchange in 2006 (China Financial Futures Exchange and NASDAQ OMX Sign MOU).
Despite the high volume of crude oil being transported to countries such as China and Japan, no Asian oil benchmark exists as of yet. Most oil consumed in the Asia-Pacific region is supplied by Middle Eastern downstream providers and is assessed according to the Dubai-Oman benchmark. As such, some market participants have argued that the Asian benchmark should officially be made Dubai-Oman, as this benchmark accurately reflects the price of the product consumed in many Asian countries. Other market participants feel that Brent crude should be used as the Asian benchmark, as Brent crude is a mature, very liquid international benchmark.
The expanding Asian oil market also necessitates new oil assessments that are more reflective of trades, bids, and offers made in this region. ZE’s DataWatch magazine makes frequent reference to a high volume of modified or new oil assessments that attempt to take into account the price of crude imported and exported in this region. For example, from May 1, 2014, Platts will relocate many of their Asia crude assessments from RI (London-close crude assessments) to RP (Singapore-close crude assessments) in the Platts Market Assessment database to reflect “the fact that those assessments represent the value of crudes at the close of trading in Asia” (Platts Proposes Relocation of Certain Asia Crude Data). In other words, Platts has updated its assessment calculation methodology for a variety of Asian crude assessments to reflect the high volume of trades conducted during the Singapore trading day as opposed to London’s trading day.
Further, on October 1, 2013, Platts requested feedback on a proposal to discontinue its entire range of domestic and China fuel oil and dirty tanker assessments as a result of the declining Chinese domestic fuel oil market (Platts to End China Fuel Oil Assessments). Organizations like Platts and Argus continue to increase assessments of imported Asian oil, as Asian domestic supply is certainly in decline. More assessments will likely continue to be developed for the Asian oil market to reflect this region’s increasing industrial growth and subsequent need for imported oil.
The world’s most highly populated countries are located in the Asia-Pacific region. Many of these countries are rapidly industrializing; the volumes of energy they require to sustain their demands and to support burgeoning infrastructure are enormous. Assessments providers will continue to develop new assessments and modify existing assessments if their assessment prices are to be accurate reflections of the real value of physical oil. Moreover, it is likely that an Asian benchmark will soon be established, given the high consumption of global oil resources in this region.