41
Chapter 4. Problems of the Asian Marker Crude Oil
42 analyzed.
2. Pricing Method of Dubai Crude Oil A. Priority in Data Use
Platts collects and utilizes various information, including data publicly available on eWindow as well as non- disclosed data collected through the internal evaluation process. In other words, Platts uses bids and offers and the prices of concluded transactions disclosed through eWindow as well as over-the-counter and non-disclosed transaction information.46 Data other than those obtained through eWindow are collected through various channels, including messaging software, telephone, email, and fax. Trades on eWindow, however, form the most important means of price assessment.
Figure 4-2. Screen Layout of Platts eWindow
Source: Platts (https://www.platts.com/ (retrieved August 25, 2017)
Platts has adopted a market-on-close (MOC) pricing methodology for Dubai crude oil and various petroleum products.47 Based on eWindow, an online market, a pricing methodology that uses the market closing price or MOC is selected. Specifically, the MOC pricing methodology valuates oil prices based on information on transactions executed immediately before market closing (16:29, Singapore time), among all bids, offers, and prices of concluded transactions executed during the 30 minutes before market closing (16:00-16:30).
Platts has its own guideline on the criteria and priorities for selecting data for reasonable pricing. According to this guideline, Platts first looks at information on completed transactions, which is disclosed to the market, and the evaluation team uses the information on buy and sell orders after reviewing its appropriateness. In the event there is no order or transaction information, Platts collects similar information in the market, information on past transactions of the same product, and information on the relevant market.48 We will now take a closer look at the priorities of Platt’s data use.
In the price-assessment process, Platts first considers information on bids, offers, and concluded transactions that is disclosed to all trading partners. This means that non-transparent bids and offers may be excluded from the
46 Dalseok Lee (2016), p.52.
47 eWindow’s operations and priorities in the use of information described here is prepared based on information from Platts (May 2016 and January 2017).
48 Ministry of Strategy and Finance and Korea Energy Economics Institute (2013), p.70, and Dalseok Lee (2016), p.52.
43
evaluation process. For example, a bid higher than a disclosed offer or an offer lower than a disclosed bid may not be reflected in the pricing. In addition, each bid or offer price is considered only when the trading counterparty is given sufficient time to sell or buy at that price. Otherwise, the price may be deemed unfeasible.
In its final pricing process, Platts places greater weight on transparent, fully verifiable market information. It generally assesses the market price between the bid and offer disclosed to the market at the closing time, according to the MOC methodology. This is to make sure that the price tradeable at market closing is reflected in Platts’
pricing.
When data on bids, offers, and concluded transactions are unavailable, Platts uses verifiable data reported during market trading hours, including wholly or partially verified transaction prices, notional transaction prices, and other market information. In such a situation, it may take into account the price difference with the general price of the product, blending, and shipping cost. In addition, Platts analyzes the relationships between various products and considers the results in its pricing of products when there is only a small amount of data in the market.
When there is no or only a small amount of transaction data, it normalizes all other available data (e.g., data on transactions in the relevant markets) that may be relevant to the price assessment. In this case, it considers representative transactions completed at market closing, as used in the MOC method, and additional bid and offer information submitted at this time. Platts’ evaluation team adheres to the principle of confirming all reported bid, offer, and transaction information directly with the relevant entity.
Platts’ MOC guideline aims to prevent the distortion of final pricing and eliminate unverified inputs while excluding one-off and non-repetitive transaction data from the pricing process. Of course, it is possible for a one- off transaction to reflect the market price. However, such a transaction should be assessed in comparison with a broad array of similar transactions. For example, if a buyer decides to take an offer but stops buying the volume re-offered by the same seller at the same price level, the buyer is judged to have failed the repeatability test. As such, if the seller does not resell, the seller is judged to have failed the repeatability test. Therefore, such transactions may not be fully reflected in pricing.
In addition, bid or offer prices based on unverified price resistance or price support line may not be declared. In addition, if the price change is drastic, rather than gradual, the transaction may be concluded at a price that is not sufficiently verified in the market. In this case, the actual market price may be determined to be somewhere between the last bid price and the contracted price.
B. Transactions of Dubai Oil on Platts eWindow
On Platts’ eWindow, Dubai commodity oil is traded on the basis of two-, three-, and four-month contracts. In other words, Platts evaluates actual Dubai oil prices over a three-month period two months after the assessment date. For example, in April, it assesses the bids of offers made in June, July, and August. Accordingly, June contracts are evaluated as nearby month contracts on April 30. On May 1, the nearby month contracts to be evaluated are July contracts.
The base point of the price assessment is the Fateh (Dubai offshore oilfield terminal) FOB, and the transaction is conducted in U.S. dollars per barrel. The bid and offer prices can be changed within a range of 1 to 10 cents.
The trade units are a partial cargo of 25,000 barrels and a full cargo of 500,000 barrels. Platts reflects the bid, offer, and transaction prices of the partial cargo. When the same buyer and seller trade 20 partial cargoes, a full cargo of 500,000 barrels is delivered and received.49
Neither the seller nor the buyer may refuse the delivery or acceptance of cargo under a concluded contract.
However, with mutual agreement, the parties may terminate the contract based on the price published on the last business day of the month. Parties that have traded fewer than 500,000 barrels should settle the contract in cash based on the price published on the last business day of the month. However, with mutual agreement, physical
49 On November 1, 2013, Platts changed its full cargo volume to 500,000 barrels, which was to be reflected in the valuation of the spot prices of Dubai, Oman, and Upper Zakum oils. The previous full cargo volume was 475,000 barrels, which was equivalent to 19 partial cargoes (Platts (May 2016), p.30).
44 delivery may be carried out.
The operational tolerance of the cargo delivered under the FOB Fateh terminal condition is less than 1,000 barrels, and its pricing is based on the Dubai oil price announced on the last business day of each month. For example, the price of the operational tolerance of cargo shipped in July is based on the price announced on May 31. Unless the buyer and seller agree otherwise, the shipment date of the cargo should be specified by the buyer no later than three days before the shipment takes place.
Currently, Platts accepts five oil varieties (Dubai, Upper Zakum, Oman, Murban, and Al-Shaheen), which can be accepted and delivered as a substitute for Dubai oil, which is traded on eWindow. Due to the decline in Dubai oil production, Oman oil was included in January 2002, and Abu Dhabi’s Upper Zakum oil was included in February 2006. Until 2015, alternative delivery had been limited to Dubai, Upper Zakum, and Oman oils. Since January 4, 2016, however, Al-Shaheen (ALS) has been included in the Dubai basket, and Abu Dhabi’s Murban has been included in the Dubai and Oman oil baskets. The production volume of these five varieties is estimated to be 3.6 million b/d, with a tradable volume of 2.4 million b/d.50 However, cargoes with the destination restrictions usually applied by Middle Eastern oil-producing countries in their term contracts cannot be traded.
The purpose of including the five varieties is to increase the liquidity of spot transactions of Dubai crude oil by adding alternative oils to the Dubai basket and to prevent any price distortion or manipulation that could be caused by aggressive buying and selling.51
Meanwhile, in July 2016, Platts decided to introduce a quality premium for Murban crude oil, which is of relatively higher quality than the other four varieties. The quality premium is paid by the buyer to the seller upon delivery under a contract concluded during the evaluation process through eWindow. On the first business day of every month, Platts announces a quality premium for Murban oil cargo to be shipped two months later. For example, the premium for cargo to be shipped in September is announced on the first business day of July in order to reflect the general situation in which two-month crude oil contracts are traded. The quality premium for Murban oil is appropriated at 60% of the price differential between Murban and Oman oils in the previous month, which were declared by Platts. However, if the price differential between the two crude oils is less than EUR 25 per barrel, the quality premium is announced as zero.
In the MOC price-assessment process, offers for ALS, Murban, Oman, or Upper Zakum cannot be lower than the existing bids for Dubai crude. Similarly, bids for Dubai, Oman, Upper Zakum, or ALS cannot be higher than existing offers for Murban crude. If a bid for Dubai oil is higher than any bid for Murban, Oman, ALS, or Upper Zakum, the bid for Dubai oil is excluded from Platts’ current guideline. If an offer for Dubai is higher than any offer for Murban, Oman, ALS, or Upper Zakum, the offer for Dubai is excluded. If an offer for Murban is lower than any offer for Dubai, Oman, ALS, or Upper Zakum, the offer for Murban is excluded first. If a bid for Murban is lower than any bid for Dubai, Oman, ALS, or Upper Zakum, the bid is excluded first. This principle basically reflects the differences in quality among the five varieties in the same basket.
3. Problems with Dubai Oil Price Assessment A. Opacity of PRAs’ Price-Assessment Process
A study by the Ministry of Strategy and Finance and the Korea Energy Economics Institute (2013) identified a
50 http://www.platts.com/IM.Platts.Content/MethodologyReferences/MethodologySpecs/Dubai-Crude-FAQ.pdf (retrieved April 6, 2017).
51 Dalseok Lee (2016), p.53.
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few cases where prices could become distorted in the PRAs’ assessment process.52 These cases are where: the PRA assesses price based on subjective judgment, the information provider provides distorted information, and market participants collude with the PRAs.
The PRAs’ pricing can become distorted if they make subjective judgments using only limited information from a few transactions in the market, which they would only do when the amount of available information is insufficient. The PRAs assess price using a variety of information besides that on bids, offers, and prices of concluded transactions, which are publicly available. In addition, in cases where they do not have sufficient data, they use information on similar transactions, similar products, or transactions of the same products conducted in other regions. In this process, the PRA assessor may apply subjective judgement. In particular, qualitative assessments based on the subjective judgements of assessors serve a greater role in the pricing of Dubai crude oil, as it has relatively less liquidity than Brent or WTI and only a small number of market participants. The lack of transparency in the qualitative assessments of PRAs is a critical aspect of the concerns over marker crude oil price distortions.
Price assessment can become distorted when the information provider selectively provides data or provides distorted data. Market participants are motivated to provide the PRAs with distorted information depending on the status of the derivatives they hold, and they are not required to provide all of the specific details of the transactions they have made. Of course, most PRAs have a system that monitors and evaluates the completeness and validity of the information provided. However, if these systems fail to function properly, the price assessment will be distorted. For example, the Commodity Futures Trading Commission (CFTC) discovered that Marathon provided false information to Platts in order to lower the WTI price in November 2003 and imposed a USD 1 million fine on it in August 2007.53 In addition, in May 2013, the Commission of the European Communities investigated international oil companies (IOC), including BP, Shell, and Norway’s Statoil, regarding charges of oil price manipulation.54 These companies were suspected of having manipulated oil prices by providing false transaction prices to PRAs, including Platts and Argus, over a period of 10 years, beginning in 2002. At the time, the oil companies all denied the allegations. This eventually led the European Union to authorize the European Securities and Markets Authority (ESMA) to directly control the manipulation of international oil prices in September 2013. ESMA is allowed to impose fines on price manipulators of up to 10% of their annual sales or EUR 1 million.55
Through collusion, PRA assessors can manipulate prices in favor of some market participants. In the PRAs’
price-assessment process, the cooperation of large market participants with relatively greater influence on market price determination is critical. Therefore, the PRAs come to assess prices in consideration of the interests of major market participants who provide information.
B. Doubt Regarding the Usefulness of Alternative Deliveries
In January 2016, in order to solve the liquidity shortage problem and price distortion in Dubai crude oil pricing on eWindow, Platts added Al-Shaheen and Murban to the Dubai benchmark basket, which had been composed of Dubai, Upper Zakum, and Oman.56
In this way, Platts has taken steps to improve eWindow’s Dubai crude-pricing function. However, the EI claims that this has created many complex problems for crude oil producers, traders, and refineries as well as for buyers.57
One of the problems is that large oil producers such as Saudi Arabia began to have difficulty determining their crude oil prices based on Dubai crude. Similarly, buyers found it difficult to assess the differentials of the formula
52 Ministry of Strategy and Finance and Korea Energy Economics Institute (2013) pp.75-76.
53 http://www.cftc.gov/PressRoom/PressReleases/pr5366-07 (retrieved April 11, 2017).
54 https://www.bloomberg.com/news/articles/2013-05-15/eu-oil-manipulation-probe-shines-light-on-platts-pricing-window (retrieved April 11, 2017).
55 https://regtechfs.com/eulibor-eu-unveils-benchmark-intervention-powers/ (retrieved April 11, 2017).
56 Platts (May 2016), p.30.
57 Energy Intelligence (December 28, 2015), pp.4-5.
46
prices provided by crude suppliers such as Saudi Arabia. Although the EI did not specifically explain the fundamental causes of the problem, it seemed to point out the price instability of the marker crude oil caused by the trading of crude oils with different properties, as shown in Table 4-1.
Table 4-1. Properties of eWindow Dubai Basket Crude Oils
Dubai Oman Upper
Zakum Al-Shaheen Murban API
(gravity) 30.4 30.5 33.9 28.0 40.5
Sulfur content
(w%)
2.13 1.38 1.84 2.37 0.74
Product yield (v%)
LPG 2.20 Naphtha
17.50 Kerosene
14.00 Light oil
26.90 Fuel oil
39.70
LPG 1.35 Naphtha
17.04 Kerosene
11.31 Light oil
19.59 Fuel oil
50.71
LPG 3.69 Naphtha
22.52 Kerosene
13.93 Light oil
15.93 Fuel oil
43.93
LPG 2.00 Naphtha
19.66 Kerosene
8.23 Light oil
30.80 Fuel oil
39.31
LPG 1.54 Naphtha
24.06 Kerosene
19.10 Light oil
26.71 Fuel oil
28.57 Note: Excerpted from Energy Intelligence (2015).
The EI also predicted that ALS oil could have a major impact on Dubai oil pricing. The unusual nature of ALS may excessively curb the rise of the price of Dubai crude oil and even set a price cap.58 ALS oil (API of 28.0 and sulfur content of 2.37 w%) is the heaviest oil with the highest sulfur content among the five varieties that are deliverable as a Dubai crude basket. This can hinder the active purchasing of buyers because of the concerns over the low quality of ALS. Most Asian refineries do not like ALS, which provides relatively high yields in fuel oil and lubricating oil production. Even Chinese refineries that are well equipped with upgrading facilities tend to avoid ALS.59 This means that if traders buy ALS through aggressive purchases on eWindow, they will have to resell the ALS on eWindow as well. Another problem with ALS that could cause the price of Dubai crude to decrease is its inflexibly in terms of shipping dates. ALS buyers must agree to fixed shipping dates, which can lead to difficulties such as additional shipping costs for loading another Middle Eastern crude oil cargo on the same tanker.
In July 2016, Platts introduced a quality premium for Murban, which is a high-quality oil (API of 40.5 and sulfur content of 0.74 w%). Used in the existing Dated Brent price assessment of Platts,60 this new mechanism aimed to prevent extremely high bid calls by ensuring that market participants consider the premiums they may have to pay. Most buyers do not need premium-charged Murban crude, so the quality premium is a kind of preventive measure against aggressive bids that could cause price distortions.
58 Energy Intelligence (December 28, 2015), p.5.
59 Energy Intelligence (December 28, 2015), p.5.
60 In the price valuation of Dated Brent or BFOE (Brent-Forties-Oseberg-Ekofisk) of Platts, Oseberg crude oil is of relatively high quality, meaning that sellers delivering Oseberg receive a quality premium from buyers.
47
However, the quality premium is unlikely to induce the sale of Murban oil on eWindow. The reason for this is that Murban’s quality premium is only 60% of the price differential between the previous month’s spot prices of Murban and Oman oils, meaning that the seller must give up 40% of the value. In fact, no physical deliveries of Murban had been made until April 2017. It is therefore quite doubtful that Murban can help secure liquidity in physical transactions and curb aggressive bidding, as initially expected by Platts.
C. Problems with the MOC Methodology
Platt’s Dubai crude eWindow uses MOC as its price-assessment methodology. However, along with the liquidity issues of Dubai crude oil, the MOC methodology is likely to distort prices in the case of abnormal transactions done immediately before market closing.61
There have been several suspicious transactions on Dubai eWindow. For example, China Oil, a trading company under the state-owned China National Petroleum Corporation (CNPC), made bids for most of the tradeable crude oils on Dubai eWindow, which led to a sudden price surge. At the time, the seller was Unipec, a trading company of Sinopec, another Chinese state-owned oil company. Though it is unknown how the two companies gained any advantage by engaging in such activities in the Dubai oil market, two similar cases have occurred, first in 2014 and again in 2015. China Oil purchased 47 cargoes (23.5 million barrels) in December 2014 and 55 cargoes (27.5 million barrels) in June 2015 on Dubai eWindow. In August 2015, the price of Dubai oil rose when the company purchased the largest ever volume of 65 cargoes (32.5 million barrels).62
Market observers had various opinions on the case. Some interpreted the bulk buying of China Oil as merely a measure to meet China’s domestic demand and secure a strategic petroleum reserve or as the speculative trading activities of Chinese rivals seeking to make money in the paper market. Others viewed it as a “rehearsal” for China to take control of and wield influence over the Asian oil market.
According to the EI, the latest suspected case of Dubai oil price distortion was when China Oil purchased 85 partial cargoes of the 89 March shipment of Dubai oil cargoes from January 3 to 10, 2017, and the resulting surge in the Dubai oil price.63 At the time, China Oil secured only three physical cargoes, and the sellers were China’s Unipec and Shell, which offered 46 partial cargoes and 27 partial cargoes, respectively. The EI argued that the sharp decline in Brent-Dubai oil swap prices that occurred on January 10, falling to USD 0.48 per barrel from USD 1.82 per barrel in the previous month, was caused by the aggressive purchase made by China Oil and was thus not wholly attributable to the production cuts made by OPEC’s oil-producing countries.64
As such, Dubai eWindow has frequently experienced suspected case of price manipulation, which is fundamentally because only a small number of companies are involved in the market. There are only about 10 companies participating in Platts eWindow, most of which are production or trading companies. State-owned oil companies in the Middle East and end users do not participate. Even before Chinese oil companies started participating in the market in earnest, the trade volume of large oil companies such as Shell and Vitol and trading companies accounted for the majority of transactions. Inevitably, such limited market participation and small trade
61 Argus, one of the PRAs, uses the volume weighted-average (VWA) methodology, which weighted-averages the volumes of transactions made at a certain point in time (usually minutes before the close of the market). Since the VWA methodology uses a weighted average of transaction volume, price distortions due to abnormal transactions are less likely to occur, unlike the MOC methodology. However, this is also a short period of time where, if the price at a certain point, which is used for price assessments, is highly volatile, it does not accurately reflect the value of the commodity at the time when the price is calculated (market closing on that day (Ministry of Strategy and Finance and Korea Energy Economics Institute (2013), p.71).
62 Energy Intelligence (August 31, 2015), p.8; and Dalseok Lee (2016), pp.53-54.
63 Energy Intelligence (January 16, 2017), p.8.
64 OPEC started decreasing crude oil production by about 1.2 million b/d from January 1, 2017, in accordance with the decision made by the General Assembly on November 30, 2016. Production cuts in Middle Eastern oil-producing countries, most of which are OPEC members, are likely to cause the price of Dubai oil to increase compared to the prices of other marker crude oils.