Summary
The recent volatility in the crude oil market over the last several months resulted in the NYMEX Light Sweet Crude contract trading at a significant discount to Brent Futures. This phenomenon, coupled with a contango market structure led to the perception that the NYMEx crude oil contract had become disconnected or even irrelevant from the rest of the world oil market. The major oil markers in the Atlantic Basin, NYMEX Light Sweet Crude, ICE Brent and Dated Brent all have their limitations.
Analysis
The last 18 months have seen its share of volatility in the crude oil markets. From just over $50 per barrel two years ago, to nearly $150 last July and back to $50 today, the oil market makes the Coney Island Rollercoaster look boring.
There are not enough fingers in the room to point at the blame: Was it hedge funds, exchange traded funds? Speculation? Supply and demand? Some other sinister mechanism lurking in the shadows? Could it have been the NYMEX Light Sweet Crude contract, perhaps the Intercontinental Exchange (ICE) Brent contract or even Dated Brent? Is this volatility killing the crude oil contracts? Again?
There are hundreds of different types of crude oil around the world and they all have different qualities. Consequently they are priced to reflect these differences. Think of your house. My three bedroom house is priced similar to other three bedroom homes in the neighborhood, but it might have more square footage than some and less than others. I wish it could price like a million dollar mansion but it won’t. No marble bathrooms here.
Choose Your Poison
Crudes are priced against market crudes. The NYMEX light sweet crude contract is one such contract. The Dated Brent price is another. Depending on the location and quality, crude oils price at premiums or discounts to these markers. What’s the difference?
Prices on the NYMEX Light Sweet Crude futures contract are widely disseminated every day but the contract itself is misunderstood. Commonly referred to as WTI or West Texas Intermediate, this is only one of many crude oils that are deliverable. On average, over 600 million barrels per day of light sweet crude are traded on the NYMEX. For about $6,000, I can buy a futures contract of 1000 barrels of crude worth $500,000 at delivery. Talk about leverage. While it is true that WTI production has declined to 300,000 to 400,000 barrels per day, one can deliver many other domestic crude oils into the contract. In addition, five foreign crudes are permissible. These crudes can come from the UK, Norway, Nigeria and Colombia. This means that well over 2 million barrels per day of crude oil is deliverable to the NYMEX contract. NYMEX crude futures: Transparent, liquid, marker crude, plenty of oil to make or take physical delivery.
When prices rise, we expect to see inventory declines, not only at Cushing but around the world. The EIA/DOE issues weekly inventories not only for the entire USA but specifically at Cushing OK, the NYMEX delivery point. The USA imports over two thirds of its crude oil requirement. When Cushing gets full and prices get really cheap, crude oil is on sale, and eventually imports into the USA decline and the inventory at Cushing is drawn down. It just can’t happen overnight. It takes months. And if crude oil is on sale enough, it indeed can be exported, one only needs a license. In fact in 2008, according to the EIA/DOE, over 10 million barrels of crude oil were exported from the USA.
Prices on the Intercontinental Exchanges Brent Futures contract are also widely published. During the first two months of 2009, an average of just over 200 million barrels per day of Brent has been traded. For $10,000 or less I can buy a 1000 barrel futures contract of Brent. Once again, that’s very good leverage. According to the ICE rulebook, only Brent Blend Crude oil is deliverable at Sullom Voe, UK on this contract. With production of less than 200,000 barrels per day, this is far less than the volume permitted to be delivered on the NYMEX contract. Unfortunately there is no entity in Europe that publishes weekly Brent inventory figures. Brent Futures: Transparent, liquid, marker crude, but a bit more difficult to make or take physical delivery.
The Dated Brent market, against which crude oil from the North Sea, Russia, West Africa and the Caspian price, has its drawbacks. The Dated Brent price reflects the least expensive price for a 600,000 barrel cargo of Brent, Forties, Oseberg, or Ekofisk loading in the next 10 to 21 days. I wish the local real estate tax man would assess my taxes compared to the cheapest three bedroom house around. Platts assesses these prices with initial bids and offers due by 1610 PM, ending at 1625 PM London time and issues a price at 1630 PM. The parcel sizes that Platts considers range from 50,000 barrels up to 600,000 barrels. At $50 per barrel, for a mere $2.5 million dollars, one can participate in this market and buy something. Have you ever bought one tenth of a house? I’ll take the kitchen, leave the dining room behind. On March 18, not a single cargo traded in this 10 to 21 day window, yet Platts still issued a Dated Brent price. Dated Brent: Transparent? Liquid? Marker Crude? Hardly. Nonetheless widely used. This is how the market has developed in order to buy and sell crude oil around the world. It goes up, it goes down. There are winners and losers.
My chosen poison is beer. Think I will go and remodel the house.
