Chapter 5. Alternative Measures to the Asian Marker Crude Oil
B. Review of New Marker Crude Oils
Although Dubai crude oil remains the marker crude in Asia, it has many problems that need to be solved, as discussed above. To secure a long-term alternative, it is necessary to look for a new marker crude. New marker candidates include Russia’s ESPO blend (East Siberia-Pacific Ocean Blend), Oman oil, China’s crude oil futures, and Dated Brent. The characteristics, strengths, and weakness of each variety are outlined below.
1) ESPO Blend
ESPO is a 4,857-kilometer-long oil pipeline built by Russia. The pipeline links East Siberia and the Maritime Province of Siberia and is a strategic project that was initiated to develop energy resources in the Eastern Siberia region as a means of freeing the country from the current Western Europe-centered energy supply system and build a supply chain for Asia and the Pacific region, where demand is growing rapidly.
Figure 5-1. ESPO Pipeline
56 Source: Newsbase (September 28, 2017), p.4.
The first stage of the Taishet-Skovorodino section was completed in December 2009, and the second stage of the Skovorodino-Kozmino section was completed in December 2012. The branch line from Skovorodino to Daqing, in China, was completed in September 2010 and is now supplying crude oil to China. The transport capacity of the pipeline was planned to be increased from the initial 600,000 b/d to 1 million b/d in 2016, with an additional increase to 1.6 million b/d planned by 2020. The transportation capacity of the Skovorodino-Daqing section is 300,000 b/d. In 2009, Russia’s state-owned Rosneft signed an agreement with China’s state-owned CNPC for the supply of 300,000 b/d over the next 20 years.79
The ESPO blend gets its name from the name of the oil pipeline through which it is transported. Produced mainly in three oilfields in Siberia (Vankorskoe, Talakanskoe, and Verkhnechonskoe), ESPO is a light crude oil with an API of 34.6 and sulfur content of 0.6 w%.80 ESPO is often mentioned as a new candidate for the Asian marker crude oil, owing to its rapid increase in production, easy transportation to China, and geographical advantage, in that the export port of Kozmino is located close to both Korea and Japan. Moreover, given that its quality is higher than that of Dubai and its end users are located in a variety of regions, including China, Japan, Korea, United States, Malaysia, Singapore, and Taiwan, ESPO is drawing the attention of market participants seeking a new marker crude oil.
As shown in Figure 5-2, ESPO is mostly exported to China, with the country accounting for 70% of total ESPO exports as of 2016. In terms of China’s total crude oil imports, Russian oil has surpassed Saudi Arabian oil.
However, ESPO’s lack of physical liquidity in Kozumino Port is hindering its growth. Initially, the inflow of crude oil to Kozumino was planned to be increased from 300,000 b/d in 2010 to 600,000 b/d in 2014, but the actual inflow reached only 498,000 b/d, failing to secure sufficient liquidity.81
Figure 5-2. ESPO Crude Oil Exports by Country (2016)
79 Requoted from Gorst (2014) and Weber (2015), p.5.
80 http://www.energyintel.com/pages/icoh_crudeoilproflanding.aspx (retrieved Apr. 16, 2015).
81 Weber (2015), pp.5-6.
57
Note: Prepared based on information from http://en.portnews.ru/news/232729 (January 17, 2017, retrieved June 28, 2017).
원문 번역문
중국 일본 한국 말레이시아 싱가포르 태국 미국 기타
China Japan Korea Malaysia Singapore Thailand United States Others
Furthermore, since term-contract volumes have been increasing gradually, there are concerns that the liquidity of the spot market is going to decrease even more. It has also been noted that Kozmino’s crude oil inflow may become unstable if Russia voluntarily acts as a swing producer for the European market as a means of expanding its influence in the international oil market. Nonetheless, it is encouraging that Kozmino’s crude oil exports showed year-on-year increases of 22% and 4.6%82 in 2015 and 2016, respectively. However, in order for ESPO to become an alternative marker crude to Dubai oil, a liquidity-rich spot market and accompanying price-discovery function first need to be firmly established.
Another weakness of ESPO is that the state-owned Rosneft and Surgutneftegaz are the only suppliers. Some have raised concerns that ESPO could be used by Russia for political or strategic purposes, because both companies control all exports to China transported through pipeline and one-third of those transported through
82 http://en.portnews.ru/news/232877/ (retreived from June 28, 201)
58
Kozmino Port. In terms of demand, excessive concentration in China is also a problem. As mentioned above, China accounts for more than 50 percent of ESPO demand, so a likelihood of price manipulation by Chinese oil companies could arise in the ESPO market, as it did for Dubai crude.
Meanwhile, crude oil futures, with Urals as an underlying asset, started being traded on SPIMEX in Russia in November 2016. Urals crude oil futures trading uses global oil trade standards, which involve physical delivery settlement as the payment method, U.S. dollar as the transaction currency, and contract size of 1,000 barrels.83 Although the details of ESPO futures have yet to be announced, the ESPO futures market is likely to be launched to reflect the market need for standardized futures contracts if the Ural futures market successfully settles down.
Table 5-1. SWOT Analysis of ESPO
Strengths Weaknesses
- Strategically supported by Russia - Production increase
- Geographical proximity to Korea, China, and Japan
- Lack of liquidity in spot market - No futures market
- Monopolistic supply and demand concentrated in China
Opportunities Threats
- Diversification of supply structure, mitigating the concentration in the Middle East
- Strengthening relationship with Russia
- Supply likely to be controlled for political purposes
- Uncertainty of Russian-Chinese relationship
2) Oman Crude Oil Futures
Oman crude oil futures began trading in June 2007 on DME, the only futures exchange in the Middle East.84 Oman futures holds Oman crude oil, a medium sour oil, as an underlying asset, with U.S. dollars as the transaction currency. The size of one contract is 1,000 barrels, and contracts can be paid via physical delivery or also cash (Table 5-2). The basic structure of Oman crude oil futures is similar to that of WTI on NYMEX and Brent on ICE.
Table 5-2. Details of Oman Futures Contract
Item Detail
Trading unit 1,000 barrels Transaction
currency U.S. dollars Price quotation USD 0.01 per barrel
83 http://spimex.com/en/derivatives/urals-crude-futures/contract-description/ (retrieved, August 21, 2017)
84 DME was established in 2006 by the co-investment of the state-owned Dubai Holdings, Oman Investment Fund, and CME Group (http://www.dubaimerc.com/ (retrieved August 21, 2017)).
59 Trading hours
16:00 (Sunday) to 16:00 (Friday)
Closed from 16:00 to 16:45 (Monday to Thursday)
(Trading is open for 23 hours and 15 minutes per day (North American Central Standard Time).)
Trading months Maximum 72 serial months Settlement type Physical delivery
Last trading day Last trading day of the second month preceding the delivery month
Margin USD 4,750 (as of June 2017, for nearby-month contract, varies frequently)
Source: DME Oman Crude Oil Futures Contract Summary (http://www.dubaimerc.com/ (retrieved August 23, 2017)).
Oman crude oil has much more liquidity than Brent and Dubai, thus making it tradeable in the spot market, and no limits on its destinations of final consumption. Hence, it can be viewed as fulfilling the basic requirements of a marker crude oil. Since Oman futures are traded on DME, they are supervised and governed by the authorities of Dubai, rather than its producing country of Oman. Also, as all Oman futures transactions are guaranteed by the CME clearinghouse, they are regulated by the CFTC indirectly. The clearing guarantee of CME, the world’s largest futures exchange, is believed to help boost the credibility of DME and Oman futures, which are relatively new to the global oil market.
Oman crude oil futures were launched with the aim of having Oman crude serve as the marker crude oil for Middle Eastern crude oil exported to Asia. It was expected to provide risk management tools for market participants in the region and increase the transparency of the price-discovery function.85 Its geographical advantages were also highlighted, as it is capable of filling the time gap in trading between the European exchange and Singaporean exchange, which is the Asian trading hub. The Oman futures have also changed the way Oman crude oil spot is priced, because the official selling price (OSP) of Oman spot is determined based on the arithmetic average of the daily closing prices of Oman futures. As discussed in Chapter 2, the Oman oil spot prices are used in conjunction with Dubai oil prices in the pricing of term-contract oils sold by Middle Eastern oil-producing countries to Asia.
However, from 2007, when the transaction of Oman futures began, to April 2017, the accumulated trading volume reached 11.78 million contracts,86 which is less than half of one month’s trading volume of WTI futures, with its liquidity falling far short. It is rated that DME has not fully achieved the original purpose it sought through Oman futures. In addition, the high volatility in the trading volumes of Oman futures has also been pointed to as a problem.
Figure 5-3. Daily Volume of Traded Oman Crude Oil Futures Contracts
85 Dubai Mercantile Exchange (http://www.dubaimerc.com (retrieved August 23, 2017)).
86 Dubai Mercantile Exchange (http://www.dubaimerc.com (retrieved August 23, 2017)).
60
Note: Prepared based on information retrieved from Bloomberg (https://www.bloomberg.com/ (retrieved August 25, 2017)).
Table 5-3. SWOT Analysis of Oman Crude Oil Futures
Strengths Weaknesses
- Larger production volume than other varieties
- Adopting global standards for contract details
- Spot tradeable and re-exportable
- No participation of state-owned oil companies in the region
- Major lack of transaction volume - Disinterest of global financial investors
Opportunities Threats
- As the only futures in the Middle East, they can serve as a reference for the region’s medium sour oil.
- -Exposure to geopolitical risks of the Middle East
In order for Oman oil futures to establish itself as an Asian marker, both in name and reality, it first needs a liquidity expansion plan. Lack of liquidity leads to increased risk management costs and poor performance of the price-discovery function, making it difficult to attract the attention of market participants. This contributes to the formation of a vicious cycle by further decreasing liquidity. Considering the fact that the state-owned oil companies in the region do not participate in the market, it is necessary to attract international financial investors.
Although financial investors and their speculative trading are frequently pointed to as the main cause of price volatility, they are a necessary evil if Oman futures are to be developed to the level of their competitors, such as WTI.
3) Chinese Crude Oil Futures
The launch of Chinese crude oil futures has been delayed, but Chinese crude oil is frequently mentioned as a candidate for the next Asian marker crude oil. Chinese oil demand grew rapidly in line with the country’s dramatic economic development, raising the country to the position of the second-largest oil consumer in the world, after
61 the United States, in the 2000s.
Figure 5-4. China’s Dependence on Imported Crude Oil
Note: Prepared based on information from BP (2004 and 2016).
원문 번역문
수요 대비 수입 비중 Import-to-demand ratio
China became a net oil-importing country in the mid-1990s and recently surpassed the United States in terms of crude oil imports. Now the world’s largest crude oil importer, China has strong purchasing power. However, as its dependence on imported oil has increased, the country has become increasingly vulnerable to risks in the international crude oil market, such as supply disruptions and price volatility. Especially, since the global oil supply shortage in the mid- to late-2000s drove the price of oil to USD 140 per barrel, there is now an urgent need for better risk management.
In response to this, China introduced crude oil futures contracts as a means of hedging against the risk of oil price volatility (see Table 5-4). In 2013, the Shanghai International Energy Exchange (INE), a subsidiary of the Shanghai Futures Exchange, began preparing for the establishment of a crude oil futures exchange in earnest. The crude oil futures contract that the INE has been preparing to launch is based on medium sour oil (API of 32 and sulfur content of 1.5 w%) as the underlying asset, physical delivery as the final settlement method, and the Chinese yuan as the transaction currency, instead of the U.S. dollar. The contract size is set at 100 barrels, which is one- tenth that of WTI and Brent futures.87
Trading of INE crude oil futures contracts was planned to commence on November 5, 2015, but it was postponed to the end of 2016 due to the instability of the financial market in China at the time. Later, it was postponed again, and no specific timetable was given as more time was needed to make legal modifications, among other changes. With these delays, there was a growing expectation that the opening of the Chinese crude oil futures exchange would be canceled. However, with the INE’s announcement of its intention to launch crude oil futures in the second half of 2017, China is expected to begin crude oil futures trading in the near future.88
If the launch of China’s crude oil futures exchange goes smoothly, it would be highly likely for China crude oil to emerge as the Asian marker crude oil, replacing Dubai crude. This is because Chinese crude oil futures will be the first crude oil futures traded in China, which has become the world’s largest oil consumer, as well as because they hold medium oil, which is preferred by Asian countries, as an underlying asset. In terms of attracting financial investors, Shanghai is in a more advantageous position to secure liquidity in the initial stage than Dubai, which is
87 http://www.ine.cn/en/regulation/regulation/911319603.html (retrieved June 28, 2017).
88 Oilprice.com (April 18, 2017).
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located in an Islamic region. In addition, the Chinese authorities are more strongly committed to nurturing the development of the country’s own benchmark oil.89
Table 5-4. Details of INE Crude Oil Futures
Item Detail
Underlying asset Medium sour oil Contract size 1,000 barrels per contract
Transaction
currency RMB (yuan per barrel) Minimum price
fluctuation RMB 0.1 per barrel
Daily price limits ±4% from the settlement price of the previous trading day
Listed contracts Monthly contracts of recent 12 consecutive months followed by quarterly contracts for the following 24 months
Settlement type Physical delivery
Trading hours 9:00-11:30 and 13:30-15:00 (Beijing time)
Deliverables
Seven varieties: Basrah Light, Dubai, Masila, Oman, Qatar Marine, Shengli, and Upper Zakum (Other medium sour oils from Russia, South America, and West Africa are currently being evaluated.)
Delivery period Five consecutive trading days after the last trading day Source: INE Rules (http://www.ine.cn/ (retrieved June 28, 2017)).
However, there are some problems with INE crude futures that must be solved before INE crude oil can become a marker. Weber (2015) noted three major problems: short transaction time, nonconformity with the global standard for one contract unit, and use of the Chinese yuan as the transaction currency.90 First, INE trading hours span only 3 hours and 50 minutes, from 9:00 to 11:20 and from 13:30 to 15:00 (Beijing time). This is far shorter than the trading hours of the WTI and Brent futures, which are 22 to 23 hours. In addition, the hours do not overlap with 16:30 in Singapore time, which is when the Platts Dubai oil price is determined. The short trading time would thus undermine the competitiveness of INE crude as a reference and serve as an invisible entry barrier to market participants. In order for INE crude to be established as the Asian marker crude, the trading hours should be extended.
In addition, the unit of contracts should be in conformity with the global standard. WTI and other global futures set one contract unit at 1,000 barrels, because physical transactions of crude oil are generally carried out in units of 1,000 barrels. If the unit size of one contract is reduced to 100 barrels, more small oil companies and individual
89 Dalseok Lee (June 2016), p.55.
90 Weber F. (2015), pp.7-8, Dalseok Lee (June 2016), pp.55-56.
63
investors would be able to participate, invigorating the market. However, the resulting increase in transaction costs would hinder the participation of foreign companies, thus having a negative effect on liquidity overall.
Table 5-5. SWOT Analysis of Chinese Crude Oil Futures
Strengths Weaknesses
- World’s largest crude oil importer - No global-scale crude oil futures in the region
- Connection point between Southeast and Northeast Asia
- Chinese yuan used as transaction currency
- Limitedly open financial market - Strong competitors
- Frequent financial market turmoil
Opportunities Threats
- Arbitrage trade opportunities between U.S., European, and Asian markets - Means of hedging against risks of medium sour oil
- Excessive market dominance of Chinese government and large state-owned oil companies
- Containment from Japan and Western countries
Source: Modified and complemented information from Dalseok Lee (2016.6), p.38.
The use of the Chinese yuan, rather than the U.S. dollar, as the transaction currency will act as an entry barrier.
Since the U.S. dollar is used as the settlement currency in the global crude oil market, market participants will not be willing bear the risk of yuan exchange rate fluctuations in order to engage in INE trading, especially considering the existing risk of oil price fluctuations.91 Since the petrodollar system is not expected to collapse any time soon, it is necessary to consider replacing the transaction currency with the U.S. dollar or using the U.S. dollar and Chinese yuan in parallel.
4) Dated Brent
Dated Brent is the spot price of Brent blend crude for which a loading date has been set, as mentioned in Chapter 2. Dated Brent is a spot price; however, given the time it takes from the contract signing date to the shipment date, it is essentially a forward price. Dated Brent has long been noted as a candidate for Asia’s new marker crude.92
In the past, Asian refiners have used several varieties of oil with different qualities as pricing references. For example, they determined the price of medium sour oil based on Dubai oil; the prices of light sweet oil and condensate oil based on Malaysia’s Tapis; the price of medium sweet oil based on Indonesia’s Minas; and the price of heavy sweet oil based on Indonesia’s Duri. However, the crude oils mentioned above dropped out of the ranks of marker crudes as their production volumes decreased. So, with no other alternative, Asian refiners and trading companies have increased the share of Dated Brent as a reference for transaction pricing.93 Since Asia
91 Dalseok Lee (June 2016), p.56.
92 Platts proposed the use of Dated Brent as the new Asian marker crude oil in 2008 (Platts, 2008).
93 Malaysia abandoned its existing Asia Petroleum Price Index (APPI) in 2011 and adopted Dated Brent. Indonesia, Australia, Papua New Guinea, and Vietnam also partially used Dated Brent as a benchmark.
64
has been expanding its oil imports from the Middle East and West and North Africa due to the supply shortage, its choice of Dated Brent is viewed as reasonable, according to its own estimation.
It seems that Asian refiners and trading companies considered the fact that about 70% of global crude oil transactions are directly or indirectly affected by the price of Brent.
Table 5-6. SWOT Analysis of Dated Brent
Strengths Weaknesses
- World’s No 1. marker crude oil - Benchmark for crude oil from Africa,
whose imports to Asia are increasing
- Production base geographically distant from Asia
- Does not include varieties preferred by Asia
- Production decrease
Opportunities Threats
- Various derivatives of Brent can be used as a means of hedging against risk.
- Its relative overvaluation is disadvantageous to end users.
However, Dated Brent does not meet all the requirements of a marker crude. Especially, as its production volume has been declining, questions have been raised about its effectiveness as a marker crude oil. Moreover, the production site of Brent is geographically distant from Asia, so it has difficulties in accurately reflecting changes in the oil supply and demand in the region. In addition, it would be questionable to use light sweet oil produced in the North Sea area when Asian refiners prefer Middle Eastern medium sour oil.
As such, the varieties mentioned above have not been fully qualified to function as marker oils for 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.94 Ultimately, it is expected that the pricing methodology of Asia, which uses Dubai oil as its benchmark, will be kept in place for the foreseeable future. In the long term, discussions on a new marker crude oil for Asia would do well to exclude varieties that are likely to be excessively influenced by particular countries. Oil varieties whose pricing is likely to be subject to significant influence from particular oil- producing countries, as well as those that may be under the 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 acceptable alternatives.
3. Strategy for Policy Implementation through International Cooperation
Ultimately, market participants are free to choose which pricing method to use for their crude oil transactions.
Therefore, when many market participants use a particular pricing method, it is difficult to replace it with another one, and the relevant costs can become quite high. Although several problems have been identified with the Platts- assessed Dubai oil price, Dubai oil still serves not only as the benchmark for term-contract crude oils in Asia but
94 Iraq’s state-owned oil sales company (SOMO) asked its Asian customers on August 20, 2017, to comment on its plan to adopt the Oman oil futures price on DME as the reference for its domestically produced Basrah crude oil from January 2018.
However, in a letter sent to its customers on September 10, 2017, SOMO said that it was going to take more time to review the plan (Thomson Reuters, September 12, 2017).