JEDDAH, 9 May — Features of the NYMEX futures contract have been termed as important not only for Saudi Arabia but for all oil producers.
“Two major features of the NYMEX futures contract — risk reduction and increased price transparency are important goals for the Kingdom and, I dare say, for all oil producers,” Minister of Petroleum & Mineral Resources Ali Al-Naimi said in his address on the occasion of NYMEX’s award for global vision in energy in New York on Monday.
“All of us in the oil industry seek to reduce our risk. As producers, we can best reduce risks for the oil industry by promoting price stability. Consumers also benefit, and want price stability. While each person may have his or her own view of the ‘right’ price for oil, we all benefit from price stability.
In a free market, many factors and players influence the price of oil and volatility is the norm, not the exception. Nevertheless, we should work to narrow the band of fluctuations,” he said.
Thanking the NYMEX chairman and board of directors for inviting him and the hosts for the prestigious award, Al-Naimi said stable oil prices that offered a fair return were crucial to the economy of the Kingdom and the world economy. “Oil market developments of the past two years have provided invaluable lessons. The oil price collapse in 1998 in the wake of the Asian economic crisis not only highlighted the strong link between world oil demand and economic growth, but also affirmed the necessity of a stable oil market where supply and demand are in equilibrium. This experience reaffirmed what we’ve known all along — to maintain a healthy global economy we must work hard to ensure the availability of adequate oil supplies to balance growing demand.” he added.
These goals, according to Al-Naimi, “have directed our efforts in OPEC since its inception. For example, over the past three years, we successfully, in concert with other producers, reduced production in 1998 and increased output in 2000, to balance the market. The production decreases adopted early this year fall within this market-balancing endeavor in an ever-changing world economic environment.”
He expressed his belief that the less favorable the US and world economic outlook for this year and the changing inventory behavior of the industry warrant caution and continued vigilance to keep the market stable for the sustained growth of the world’s economies and the health of the industry.
“Our aim, as always, is to keep the market well supplied and prices at the desired average of $25 a barrel for the OPEC basket, which equates to about $28 for West Texas Intermediate. As an aside, would like to clear a common misconception that the NYMEX WTI price represents the price the Kingdom receives for its crude oil sales or what oil refiners pay. It’s not. The DoE’s Energy Information Administration’s latest figures show that, in general, US refiners’ per barrel crude costs in January this year were about $4 less than the WTI price. The composite amount the Kingdom received for its crude oil sales to the US in January was substantially lower; about $7 below the WTI price, due to differences in both quality and transportation. What this means is that when WTI sells for $28 on the NYMEX, our crude sells in the US for only $19-$22 a barrel, depending on the grade of crude,” Al-Naimi clarified. Expanding further on the importance of price transparency for oil producers like the Kingdom and its efforts to balance world oil markets and reduce risks by maintaining price stability, Al-Naimi said: “For any producer supplying goods to a market, balancing supply with demand is not an easy task that can be executed precisely. This task can be made all the more difficult by lack of price transparency. The inaccurate and untimely data on economic activity as well as on oil demand, supply and stocks aggravate the situation. These shortcomings mean that decisions taken by market participants may be based on information that does not accurately reflect underlying economic conditions, or the relationship between oil demand and supply. The important determinants of price are often flawed, and this is a reality in which we must operate in the oil industry.”
Mentioning that the NYMEX and the IPE crude contracts while increasing market transparency and providing a tool for managing risks were not perfect, Al-Naimi said, firstly, while they were the most liquid and most visible crude markets in the world, movements in the NYMEX and IPE futures prices were often influenced by factors other than the underlying global supply and demand fundamentals. “The NYMEX and IPE crude contracts are both based on regional markets — the West Texas Intermediate market in the case of the NYMEX, and the Brent market in the case of the IPE — heavily influenced by ‘local’ economic conditions and industry fundamentals. At any time, regional factors in the US Mid-continent or Northwest Europe may be more influential in setting prices than global demand, supply and inventory.”
Secondly, he said, futures prices could be unduly influenced by attempts to ‘squeeze’ or manipulate the underlying physical WTI and Brent markets.
Since most of the world’s crudes were priced relative to these two benchmarks, such attempts could distort price relationships in world markets. Thirdly, crude futures prices were influenced by large funds that switched between oil and non-oil trading. To these funds, oil was just another asset in a diversified portfolio of assets. Decisions to buy or sell depended on the relative prices of other non-oil assets, not on underlying oil market conditions of demand, supply and inventories. In addition oil was bought and sold by technical traders who analyzed charts and chart patterns and not barrels of oil produced, he added.
Al-Naimi said: “crude prices are subject to ‘mass psychology’ that is moved more by the latest news story than by fundamentals. This characteristic diminishes the usefulness to producers of price signals generated in these markets as they attempt to assess underlying fundamentals and the need to make supply adjustments.”
Fourthly, according to him, “We’re watching with great interest attempts to expand the use of the Internet for oil trading. While we’re intrigued by the potential of the Internet to bring buyers and sellers to gather in an efficient manner, we need to carefully watch its development. Three questions come to mind: What risks are posed by these developing ‘electronic markets,’ how will they affect price volatility, and what safeguards will protect buyers and sellers who may have no prior relationship.”
Any pricing system, he said, had its limitations, given the nature of world oil markets. Nevertheless, the NYMEX crude contract was a major step forward, providing oil markets with much needed price transparency to the benefit of both producers and consumers.
“The Kingdom is proud of its record as a reliable supplier of crude oil to meet the world’s growing energy needs. We’ll continue to work for a balanced and price stable oil market. The Kingdom continues to maintain excess capacity for moderating price spikes whenever disruption to supplies occur, as we did after the invasion of Kuwait,” Al-Naimi said, adding that for the foreseeable future, crude oil would continue as the principal fuel for economic development and “we all have a vested interest in its price stability. We believe that a continuing dialogue between producers and consumers is crucial to achieving the goal of price stability. To this end, Crown Prince Abdullah, deputy premier and commander of the National Guard, has proposed establishing a permanent secretariat for the International Energy Forum to foster discussion and cooperation among energy producers and consumers on issues of common concern, including economic growth, energy and the environment.”