Traders Look To Brent, But Oil Benchmark Has Own Problems

By SARAH KENT

LONDON—Brent crude has recently emerged as the best indicator of world oil prices, but it is a difficult sell as the permanent global yardstick.

Brent has gained prominence at the expense of West Texas Intermediate, the U.S. benchmark, which has broken from the global market as logistical issues have led to rising supplies at its land-locked delivery point in Cushing, Okla., keeping prices down. To many oil producers, traders and consumers, soaring Brent prices, not cheaper WTI, better reflected the violent upheavals in Libya and other key oil-producing countries in the Middle East and North Africa.

April futures for light, sweet crude oil, a category that encompasses WTI, settled 60 cents, or 0.6%, higher at $97.88 a barrel Friday on the New York Mercantile Exchange, while April Brent finished up 78 cents, or 0.7%, at $112.14 a barrel, a 2½-year high.

“These events will intensify the debate about the future of WTI as a benchmark, and more people will switch to Brent and [other benchmark crudes],” said Eugen Weinberg, head of commodities research at Commerzbank.re

At stake are oil-futures trading volumes, a source of revenue for both CME Group Inc., which owns the New York Mercantile Exchange, and IntercontinentalExchange Inc., which runs the primary platform for trading Brent futures. If oil producers and consumers who use Nymex futures to manage price volatility find that the contract fails to fully reflect the market’s perceptions of global supply and demand, they could migrate to ICE Brent.

There is no indication of a widespread shift, as the share of the market split between the two benchmarks is holding steady in terms of number of contracts outstanding. Trading volumes in ICE Brent and Nymex WTI hit records last week, although Brent is still below typical levels for Nymex crude.

Brent has some local supply issues of its own. While WTI prices are being held down by a glut, the European benchmark will require delicate adjustments by its minders to avoid a future where declining North Sea production could send prices soaring.

Declining output from fields that supply benchmark crudes is an ongoing issue. WTI was chosen to underpin crude-oil futures when Nymex launched them in 1983 because it was of the high quality preferred by many U.S. refineries geared toward producing gasoline. Since then, output of WTI has dwindled, and Nymex has allowed other, similar types of crude oil to be delivered in place of it to meet the contract requirements.

Production from the fields that feed into the Brent mix fell 13% from 2008 to 2010. The less oil output there is, the easier it becomes for a single trader to exert a heavy influence on prices by buying up a large amount of North Sea crude. In January, Hetco, the trading arm of Hess Corp., provoked fears of a Brent squeeze when the company bought one-third of the February supply of Forties, the largest component of the benchmark blend. Hetco sold its cargoes without triggering any major price moves. Hess didn’t respond to a request for comment.

The threat of a company manipulating the benchmark was big enough in 2002 for other fields to be grouped with Brent when gauging the benchmark’s price by Platts, a pricing and information service that designed the physical Brent benchmark. By assessing physical Brent prices that are used for the cash settlement of the futures, Platts effectively manages the Brent benchmark. The service provides similar assessments for other physical benchmarks, including WTI.

Today, “Brent” actually includes four types of North Sea oil. Platts may add two additional fields in the next few years, said Jorge Montepeque, the company’s global director of markets and pricing. Oil from as far away as Azerbaijan may have to be included by the end of the decade if the North Sea’s decline isn’t reversed, he said.

The North Sea’s production troubles have given ammunition to Brent’s critics, chief among them CME.

“There’s a production issue, Brent production is decreasing rapidly. These problems won’t go away,” said Joseph Raia, head of energy products at CME.

Including more fields in the Brent benchmark also makes it difficult to maintain a consistent quality, particularly as lower-quality fields are added to the typically high-end Brent mix. Platts adjusts for these shifts in the benchmark’s makeup with its daily assessments.

ICE said Brent volumes are more than adequate for the crude blend to serve as a global benchmark.

“Production and development levels in the North Sea are healthy, but ICE will work with the appropriate industry parties to broaden the range of crude-oil streams…if and when appropriate,” said ICE spokesman Lee Underwood.

Ultimately, the oil market may end up relying on many regional benchmarks, instead of one global one. Argus Media, a Platts rival, introduced a U.S. Gulf Coast benchmark adopted by Saudi Arabia and Kuwait for U.S. oil sales in early 2010.

Fast-growing Asian economies may someday want a benchmark closer to home, said Simon Wardell, an energy analyst with IHS Global Insight, a consultancy.

“Some form of alternative benchmark will have to develop as people are seriously shaken by what is happening with WTI,” Mr. Wardell said. “But there currently really aren’t that many viable alternatives.”

—Jerry DiColo contributed to this article.

Write to Sarah Kent at sarah.kent@dowjones.com

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