Why the ‘Two-Thirds’ Myth for Oil Price Referencing Doesn’t Add Up

There is the curious case of the recently reported claim that two-thirds of the world’s oil production was priced according to a specific reference.  Two-thirds?  That seems a lot; two-thirds means twice as much as all the others combined.  Is that credible?  We were curious and, perhaps, at least a little skeptical as well, so we embarked on trying to calculate how much of the world’s oil production is priced according to different references.  I share the result of this below.

As our source material to make our calculations, we relied on publicly available information from the Energy Information Administration (EIA), BP’sStatistical Review of World Energy,” analysis of world oil production pricing formulas from widely used subscription services and other industry sources.  Our basic methodology was to start with consumption (which equals production in EIA’s account balances) for each region of the world because much of the world oil-pricing referencing is determined by consumption region: North America, predominantly WTI; Europe, Brent; Asia mostly Oman-Dubai with a significant portion Tapis-Minas.  Where substitutes for the dominant are appropriate (i.e. ASCI, Urals and some others for North American) then they are subtracted from the base consumption and accounted for separately.

Other regions need to take some additional factors into account.  For many oil-producing countries outside Canada, the U.S. and Western Europe, internal consumption is frequently based on their own production and either not subject to market pricing or priced via internal fiats or non-transparent formulas .  Many producing countries, for instance, control prices for consumption.  Accordingly, in many of these instances we accounted for barrels as not subject to any price reference.  This is a significant amount of overall oil production.  Though it weighed heavily in some regions (i.e. the Middle East) it was also a factor in North America (Mexico), Eurasia, Africa, and, even part of Asia.

For Central and South America, we also removed consumption from the price reference category but added back in imports from Africa.  Central and South America produce more oil than they consume. Because they both export and import oil, it’s  difficult to separate the influence of market prices for export, market prices for import, and internal influence over consumed prices.  Nonetheless, we believe we captured most of the imports and exports accurately.

The reason we were able to capture imports to Central and South America was because, for Africa, we did include net exports—all treated as price referenced to Dated Brent.  So, we treated internal African consumption as not referenced but its 7.5 mmbd (million barrels per day) of net exports as Dated Brent referenced.  As a note, we backed out from consumption any African imports to other regions to avoid double counting, but we still ended up with 1.3 mmbd of African net exports that we did not back out.  For this region, this may result in over counting Dated Brent as a reference by 1.3 mmbd, but we made no additional adjustment for that.

We included all Middle East oil consumption and Indian production (used for internal consumption) as not price-referenced.  As for Eurasia, we estimate that 80-90 percent of the more than 5 mmbd that is produced and refined internally is priced via non-transparent internal transfer pricing mechanisms.  Conservatively, we assigned 2 mmbd of this to the “not referenced” category, which we then subtracted from total consumption to avoid double counting since some of the refined products are exported outside the region.  The rest was allocated as Dated Brent, which means that here as well we may have over-allocated to Dated Brent, in this case 2-2.5 mmbd.

We used 2009 annual data as the base because it was the latest full year available.  However, the refining data we used for Eurasia were actually based on 2007 because they were the most recent available.  The reference categories we considered were: WTI, Dated Brent (Platts), ICE Brent (BWAVE), ASCI (Argus), Oman-Dubai (Platts), DME Oman, Tapis-Minas and Not Referenced.

The Results

Reference Consumption  (Millions of Barrels per Day) Percentage
WTI 17.4 mmbd 20.6%
Dated Brent 22.82 mmbd 27.0%
Ice Brent 1.5 mmbd 1.8%
ASCI 1.6 mmbd 1.9%
Tapis-Minas 7.64 mmbd 9.0%
Dubai-Oman 12.87 mmbd 15.2%
DME Oman .75 mmbd 0.9%
Not Referenced 19.82 mmbd 23.5%
Total 99.9%

 

Now, we do not represent this analysis as iron clad; it is intended to apply reasonable approximate calculations.  But, to the extent there is any bias, it’s towards overstating Dated Brent. Despite that bias, Dated Brent does not come close to two-thirds, nor does any other single reference.

There may be some who suggest either combining the two Brents as one or treating Dubai-Oman as a sub-category of Brent, but neither of those actions would be legitimate.  The structures of the two Brents are fundamentally different and they are distinct from each other, as well as from Dubai-Oman.  In fact, if we examine the correlations of daily price changes between each of these, it makes this point very clear – the correlation between both Brents and Dubai-Oman are well below 50 percent.  The highest correlation we could find between the two Brents was 80 percent. But if you compare that to the correlation between ASCI and WTI at 95 percent – they are treated as distinct in spite of ASCI being defined as a simple differential to WTI – clearly, there is no basis for combining the Brents.

Our intent with this post is simply to improve the quality of the public record relative to estimates regarding the use of the references.  Our finding is that it is difficult to support any one source as the price reference for two-thirds of the world’s production.  However, we do not actually think that endeavors such as this are properly focused.  There are a number of different references used, but the choice of any one reference for pricing physical sales does not appear to be very influential on how the world trades.

Clearly, the references that are most used are the futures and options contracts which have experienced strong growth in use almost every year since petroleum futures were introduced by NYMEX in 1978. These tools are used predominantly for hedging, investing, and trading, and the growth in use they have experienced testifies to their overall effectiveness with respect to all of the price references listed above.  We think that is the most important conclusion of all.

Bob Levin is managing director of energy research & product development at CME Group.

Bob Levin is managing director of energy/ commodity research and product development at CME Group.

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