This study examines the characteristics of the marker crude oils that play important roles in the international oil market and analyzes the problems of and alternatives to Dubai oil, which is the marker crude oil for Asia. One of the solutions to solve the problems is to improve the PRAs’ price-assessment methodologies for Dubai crude to prevent price distortion. Another solution is to examine new marker crude oils capable of replacing Dubai oil.
In addition, strategies for implementing each solution through international cooperation are proposed. The main contents of this study are summarized as follows.
To examine the characteristics of the major marker crude oils, the daily price volatilities of four crude oil varieties—WTI, Brent, Dubai oil, and Oman oil—from 2007 to 2016 were examined. All four varieties were found to have similar price volatility patterns. However, the price volatilities of WTI and Brent, which are the marker crudes for the U.S. and European markets, were slightly higher than those of Dubai and Oman, which are the markers for the Asian market. The synchronicity between the prices of marker crude oils was analyzed by correlation coefficient estimation and the cointegration test. The rolling correlation coefficient between Dubai oil, Oman oil, and Brent was very high, while that between Dubai and WTI declined sharply over a certain period of weakened synchronicity. By conducting the cointegration test for the entire target period, it was found that the prices of Dubai oil and the other marker crude oils were in a long-term balanced relationship. However, the test conducted to examine the granger-causality between the Dubai oil price and other marker crude oil prices showed that the prices of other marker crude oils (WTI, Brent, and Oman) influence the price of Dubai oil, but the reverse was not found to be true. The test also proved that changes in the price of Oman oil, which traditionally has not been recognized as an independent marker crude oil, lead to changes in the price of Dubai oil. This may be seen as reflecting the status that Oman oil has gained in the international oil market.
Dubai oil, an Asian marker crude, has the following problems. In particular, it does not satisfy the basic requirements of a marker crude oil, such as appropriate production volume and supply stability, diversity in seller and buyer composition, and wide acceptability. Even with such shortcomings, Dubai oil still serves as the Asian marker crude oil, because PRAs evaluate and disclose its price. However, there are several problems with the Dubai oil price-assessment process.
First, the price assessment of Platts, one of the PRAs, is not sufficiently transparent. This can lead to cases where an assessor makes a subjective judgement when sufficient data is not provided, information providers selectively provide distorted data that are favorable to them, or market participants collude with PRAs in the assessment process.
Second, although Platts eWindow, which is the price-assessment system of Platts, has added more alternative deliverables to its Dubai benchmark basket, it has failed to achieve the desired outcomes. In January 2016, Platts added two more crude oils (Al-Shaheen (ALS) and Murban) to the three existing crude oil varieties (Dubai, Upper Zakum, and Oman) as alternative deliverables of Dubai oil. However, rather than leading to the expected increase in liquidity, this addition only undermined the stability of the marker price, as various crude oil varieties with different properties were included in one basket.
Third, the MOC (market-on-close) assessment methodology has its own problems as well. In the MOC method used for the price assessment of Dubai oil on eWindow, an abnormal transaction executed immediately before the market closing time can distort the price. However, the more fundamental reason for the high likelihood of price distortion is that a very limited number of companies is participating in Platts eWindow trading, currently numbering at about 10 companies. Most of these companies are oil-producing companies or trading companies, and Middle Eastern state-owned oil companies and end users are not involved.
Fourth, the time lag of Dubai oil pricing poses another problem. The closing price of Dubai oil is determined at 16:30 Singapore time, which is 10 hours earlier than the determination of the closing price of Brent (ICE futures) (2:30 the following day in Singapore time). As a result, the price of Dubai oil reflects major market events one day later than other marker crude oils.
As such, there are several problems with the Platts-assessed price of Dubai oil, the Asian marker crude.
67
Nonetheless, the Dubai oil price serves not only as the benchmark for the term-contract trading of crude oils in Asia but also as a refence for the pricing of petroleum products and various derivatives in the market. Therefore, it does not seem feasible to change the market order, centered as it is around the Dubai oil price as a benchmark.
Therefore, in the short term, efforts should be made to solve the problems of Platts’ price-assessment process, while in the long term, it is desirable to find an alternative to replace Dubai oil as a reference.
To make the oil price-assessment process of the PRAs more reasonable, from a short-term perspective, measures to monitor the process and secure liquidity should be implemented, and an environment in which the PRAs can be kept in check should be created.
First, because the possibility of price distortion still exists in the PRA assessment process, due to the lack of transparency of its qualitative-assessment methodology and arbitrary and subjective judgment, an IOSCO- centered continuous monitoring framework should be set up. It is also worth considering disclosing the PRAs’
qualitative-assessment methodologies and having them validated by the market and regulatory authorities, as long as such disclosure does not seriously undermine the PRAs’ interests. However, it should be noted that, if regulations and oversight are excessively tightened, high-quality market participants and information will leave the market, undermining the reliability of price assessment. Increasing the liquidity in the Dubai oil price assessment system is thus the most realistic way of eliminating the possibility of price manipulation and maintaining Dubai oil’s status as a marker crude oil. To this end, it is necessary to add more varieties as alternative deliverables to the Dubai benchmark basket and diversify the composition of market participants. However, given the fact that the majority of Middle Eastern oil producers do not allow spot trading and the difficulty of adding more regional varieties as alternatives, the inclusion of offshore crude oils that are resalable and of similar quality to existing crude oils should be considered.
Second, the creation of an environment to contain the market dominance of the PRAs is one way of responding to the information monopoly held by the PRAs and a small minority of market participants and promoting reasonable price formation. To this end, the establishment of an energy data hub (EDH), giving all market participants low-cost access to all data without discrimination, should be considered. An EDH is an institution that collects actual transaction information and standardizes the collected information before releasing it to the market. It would be desirable to establish an EDH through an international public-private partnership involving a number of countries and energy-related companies in the region. Another option is to open a crude oil futures market that reflects the properties of the Middle Eastern crude oils that are mostly traded in Asia. A liquidity-rich futures market has a transparent and objective pricing process, and the arbitrage between spot and futures leads to efficient price formation in the spot market. Moreover, if crude oil is traded in the Asian futures market on an all- day basis, like WTI and Brent, the problem of the time lag in pricing could be solved as well.
In the long term, the crude oil varieties that have the most potential to replace Dubai oil as a marker include:
Russia’s ESPO, DME Oman futures, China’s INE crude futures, and Brent, which is the current marker crude for Europe. However, all these varieties have their own weaknesses. The production volume of ESPO is on the rise, and its production site is located in geographical proximity to South Korea, China, and Japan. However, Russian state-owned oil companies dominate its supply, and its demand is excessively concentrated in China. DME Oman futures contracts have a larger production volume than other varieties and meets the criteria for global crude oil futures. However, state-owned oil companies in the Middle East, including those in the oil-producing countries, and global financial investors have not yet participated in Oman futures trading, and its transaction volume falls far short of the standard. China’s INE crude oil futures contracts do not meet the global futures trading standard, with their transaction currency set as the Chinese yuan, rather than the U.S. dollar. And there is uncertainty as to whether the INE crude oil futures market will be launched successful and operated smoothly. Finally, Brent is currently the most widely used marker crude. However, it has difficulty accurately reflecting the supply and demand situation of Asia, and it is a light sweet oil, while Asian refiners favor medium sour oil from the Middle East.
As such, the crude varieties mentioned above have not been fully qualified to function as marker crude oils of Asia. However, the recent move by Iraq to replace the pricing reference that has been applied to its crude oil with the DME Oman futures price is noteworthy. Ultimately, it is expected that the pricing-determination system of Asia, which uses Dubai oil as a benchmark, will be maintained for the foreseeable future. In the long term, discussions on candidates for a new marker crude oil should exclude varieties that are likely to be excessively
68
influenced by particular countries. Oil varieties whose pricing is likely to be under the serious influence of particular oil-producing countries, as well as those that may be under influence of particular oil-importing countries, are beyond the scope of our interests. In this respect, Russia’s ESPO and China’s INE futures do not seem to be reasonable alternatives.
The issues reviewed and alternatives presented in this study can be implemented through international cooperation frameworks as follows.
In the short term, the improvement measures intended to solve the problems of the price-assessment process must address two major areas: comprehensive matters related to PRA price assessment and matters related to Platts’ Dubai oil price assessment. To improve the PRAs’ price assessment, it seems that mobilizing the existing international coordination system established by the G20 may be effective, as it is a framework through which IOSCO, IEA, OPEC, and IEF can all cooperate with the G20. Regarding matters related to Platts’ Dubai oil price assessment, it is necessary to utilize regional multilateral energy councils, such as the Asian Ministerial Energy Roundtable and Northeast Asia Energy Council
Regarding marker oil replacement, as a long-term countermeasure, DME Oman futures, despite several weaknesses, are likely to partially replace Dubai oil. This was well illustrated in Iraq’s attempt to change its oil- pricing benchmark to the DME Oman futures price in August 2017. However, for crude oil-importing countries, it would be better if oil-producing countries in the Middle East diversify the marker crude oils they use in their export price-calculation formula, as different pricing could promote competition among the Middle Eastern oil- producing countries. Therefore, it is more reasonable for Asian importers to individually engage in discussions on matters related to the replacement of the marker crude with Middle Eastern oil producers through bilateral consultation bodies, rather than multilateral consultation bodies, between oil-producing and oil-consuming countries. This strategy should be carefully pursued so as to avoid conflicts with the Gulf Cooperation Council (GCC) member countries, including Saudi Arabia. Still, securing a stable supply of crude oil from major oil- producing countries in the Middle East is a priority for the energy security of South Korea.
69
References
Ministry of Strategy and Finance and Korea Energy Economics Institute, “A Study on the Global Energy Cooperation Plan at the G20 Level.” December 2013.
Dalseok Lee, “Significance of Crude Oil Futures Listing on the Shanghai Futures Exchange and Korea’s Countermeasure.” KEEI Occasional Research Report 15-11, June 2016.
Dalseok Lee and Namjin Roh, “Strategies for the Oil Industry in the Future: Crude Oil Procurement,” KEEI Basic Research Report 10-24, December 2010.
Sunghee Choi, “The Effect of Business Diversification on Oil Price Exposure: A Case Study of U.S. Oil Firms in Consideration of Oil Price Structural Breaks,” Korea Energy Economic Review, 14-2, KEEI and KREA, September 2015.
Adelman, M. A., “International oil agreements.” The Energy Journal, 5 (3), 1984, pp. 1-9.
AlMadi, M. S., and Zhang, B, “Lead–lag relationships between world crude oil benchmarks: evidence from West Texas Intermediate, Brent, Dubai and Oman.” International Research Journal of Finance and Economics, 80, 2011, pp. 13-26.
Andrews, D. W., Lee, I., and Ploberger, W., “Optimal changepoint tests for normal linear regression.”
Journal of Econometrics, 70 (1), 1996, pp. 9-38.
Argus Media, “Methodology & Specification Guide” www.argusmedia.com, August 2015.
Bai, J., Perron, P., “Estimating and Testing Linear Models with Multiple Structural Change.” Econometrica, 66, 1998, pp. 47-48.
Bai, J., Perron, P., “Computation and analysis of multiple structural change models.” Journal of Applied Econometrics, 18, 2003, pp. 1-22.
Bossley, L., “Oil Benchmarks: What next?” Oxford Institute for Energy Studies, March 2017.
BP, Statistical Review of World Energy, June 2004, June 2016.
70
CME Group, “NYMEX Rulebook (Chapter 200, Light Sweet Crude).” 2009.
Choi, S., “Industry–level exchange risk exposure of US multinationals: evidence from the Mexican and Asian financial crises.” International Journal of Monetary Economics and Finance, 6 (4), 2013, pp.
309-324.
Energy Charter Secretariat, “Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas.”
2007.
EI (Energy Intelligence), Oil Market Intelligence, January 1991-June 2017.
EI (Energy Intelligence), Petroleum Intelligence Weekly, December 28, 2015, August 31, 2016, November 21, 2016, January 16, 2017, February 13, 2017.
EI (Energy Intelligence), World Crude Oil Data Analytical Tool 2014-2015. 2015.
Energy Intelligence Research, The International Crude Oil Handbook 2009, July 2009.
Fattouh, B., An Anatomy of the Crude Oil Pricing System, The Oxford Institute for Energy Studies, 2011.
Fattouh, B., “The dynamics of crude oil price differentials.” Energy Economics, 32 (2), 2010, pp. 334-342.
Garcia, R., and Perron, P., An analysis of the real interest rate under regime shifts, Universite de Montreal, Departement de sciences economiques, 1996.
Gorst, Isabel, “Russia-ESPO: Asia’s Gain, Europe’s Pain.” Financial Times, February 19, 2014.
Hammoudeh, S., and Yuan, Y., “Metal volatility in presence of oil and interest rate shocks.” Energy Economics, 30, 2008, pp. 606-620.
Hatcher, C., Kraljevic, M., “Is the Price Right? A Survey on benchmark pricing by Clyde&Co in association with Commodities Now.” Commodities Now, January 2015.
Horsnell, P., R. Mabro, Oil Markets and Prices: The Brent Market and the Formation of World Oil Prices, Oxford University Press, 1993.
ICE (Intercontinental Exchange), Oil Price Benchmark: Implications & Opportunities, May 2011.
71
IEA, IEF, OPEC and IOSCO, Oil Reporting Agencies, October 2011.
IHS, “Is the Future of Brent Dated as Global Crude Benchmark?” 26 June 2017.
IMF (International Monetary Fund), World Economic Outlook, Housing and the Business Cycle, April 2008.
IOSCO (International Organization of Securities Commissions), Principles for Oil Price Reporting Agencies, Final Report 06-2012, 5 October 2012.
IOSCO (International Organization of Securities Commissions), Implementation of the Principles for Oil Price Reporting Agencies, Final Report 22-2015, September 2015.
Hammoudeh, S., and Yuan, Y., “Metal volatility in presence of oil and interest rate shocks.” Energy Economics, 30, 2008, pp. 606-620.
Johansen, S., Statistical analysis of cointegration vectors. Journal of economic dynamics and control, 12 (2-3), 1988, pp.231-254.`
Liu, J., Wu, S., & Zidek, J. V.. On segmented multivariate regression. Statistica Sinica, 7 (2), 1997, pp.
497-525.
Newbase, ChinaOil: China Oil and Gas Monitor, Issue 662, Week 38, 28 September 2017.
Oilprice.com, “China Revives Plan to Launch Shanghai Crude Oil Futures.” April 18, 2017.
Parra, F., Oil Politics: A Modern History of Petroleum, London: IB Tauris, 2004.
Platts, Methodology and Specifications Guide: Crude Oil, www.platts.com, May 2016, January 2017.
Platts, Dated Brent as a Solution to Pricing of Crude Oil in Asia, McGraw-Hill Companies, Inc., October 2008.
Platts, “FAQ: Dubai Crude.” 2015.
Thomson Reuters, “Inside Oil.” September 12, 2017.
Till, H., Why Do Some Futures Contracts Succeed and Other Fail?, The Herald Institute Policy Brief, January 2015.
72
Weber, F., Eastward Shifting Oil Markets and the Future of Middle Eastern Benchmarks, The Oxford Institute for Energy Studies, July 2015.
Weiner, R. J., “Is the world oil market ‘one great pool’?.” The Energy Journal, 12 (3), 1991, pp. 95-107.
Bloomberg, https://www.bloomberg.com/
BLP, http://www.blplaw.com/
CME Group, http://www.cmegroup.com/
CFTC (U.S. Commodity Futures Trading Commission), http://www.cftc.gov/
DME (Dubai Mercantile Exchange), http://www.dubaimerc.com/
Dubai Petroleum Establishment, http://www.dubaipetroleum.ae/
EI (Energy Intelligence), http://www.energyintel.com/
EIA (U.S. Energy Information Administration), http://www.eia.gov/
EPA (U.S. Environmental Protection Agency), http://www.epa.gov/
INE Rules (Shanghai International Energy Exchange), http://www.ine.cn/
Petroleum, http://www.petroleum.co.uk/
Platts, https://www.platts.com/
PortNews, http://en.portnews.ru/
REGTECH, http://regtechfs.com/
SPIMEX (St. Petersburg International Mercantile Exchange), http://spimex.com/