NEW YORK: Physical traders in the North Sea oil market are bracing for two more months of gyrating volume and quality of Forties Blend crude, a situation that some say leaves Brent exceptionally vulnerable to squeezes.
Forties typically sets the value of “Dated” Brent, which underlies the price of much of the oil traded worldwide.
The Dated Brent market also underlies Brent futures, which react rapidly to shifts in the supply-and-demand disposition in the North Sea.
However, oil field maintenance will not only slash Forties production in September and early October but will also significantly alter the quality of the grade, according to preliminary estimates by Forties pipeline operator BP.
North Sea traders expect Forties volumes in September to be 20 to 25 percent below the already limited 290,000 barrels per day being produced in August.
Not only will Forties volumes be exceptionally low in September, but the quality of the grade, the main factor behind its price, is set to change significantly.
Forties’ API gravity, a measure of its density, will swing from 37 degrees at the start of September, before spiking to nearly 44 degrees around mid-month and falling back to just under 39 degrees in mid-October.
Sulfur content, which is expected to be around 0.9 percent in August, will tumble to as low as 0.3 percent for part of September before rebounding to 0.8 percent in mid-October.
Both changes mark an improvement, albeit temporary, in the quality of Forties which should, theoretically, boost its price relative to other grades.
A higher API number means the blend will yield upon distillation more high-value light hydrocarbons such as gasoline and fewer low-value heavy products.
Similarly, a lower sulfur content means refiners need to treat the oil less severely to remove impurities in refined products.
Some traders argue the temporary improvement in Forties quality might help Brent by offseting some of the impact of lower liquidity in the market.
Forties typically sets the Dated Brent price because it is the cheapest by far of the four grades that are deliverable in the so-called BFOE market that sets Dated Brent.
An improvement in Forties quality will perhaps make the alternative grades in the BFOE market — Brent blend, Oseberg and Ekofisk — more competitive, which may mitigate some of the loss of liquidity due to the anticipated plunge in Forties output in September. But the problem here is that oil refiners typically refuse to pay top dollar for crude grades that fluctuate in quality.
It also means that two Forties cargoes loading at different times of the month will be essentially two different grades of oil, making comparisons of their prices almost impossible.
This is of huge importance, particularly in the coming weeks when the market will be trading cargoes loading in early September, as it greatly complicates the “true” value of Dated Brent.
Fragmenting liquidity in the BFOE market has already left it open to temporary “squeezes,” when traders caught short are forced to pay up for limited supplies.
These squeezes make Brent vulnerable to decoupling from global oil flows.
Brent futures may well reflect more accurately fluctuations in Forties volumes and quality over the next few weeks than the state of world oil supply and demand.
But “fixing” this situation is difficult. There are no easy ways to add liquidity to the BFOE market. Given that the current situation with Forties blend is temporary, the market is expected just to muddle through.
The problem is that these issues will continue to crop up, and probably with increasing frequency. The natural decline of North Sea production means volumes in the BFOE market will continue to dwindle. Fluctuations in the quality of individual crude grades are also likely to become more common.
Tackling this problem is a serious challenge for Platts, the McGraw Hill unit that assesses and publishes the authoritative Dated Brent price. Platts acknowledges the problems arising from falling North Sea production and the impact this has on market liquidity. The company is actively looking at ways to change the BFOE market to put it back on a sustainable footing.
Restoring liquidity in the BFOE market probably means abandoning the current structure that lets one grade set the price, but it is far from clear that an acceptable alternative will be found quickly.
The huge vested interests in the current BFOE market are reluctant to see change imposed on them. And each party will seek to steer the discussion to preserve as much as possible its own advantages.
Yet in the wake of the still-unfolding Libor scandal in commercial banking, it is obvious that the overhaul of the most important market in the global oil trade ought not be done behind closed doors.
— Robert Campbell is a Reuters market analyst. The views expressed are his own.
Erratic oil quality to play havoc with Brent in September
