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Aug 10, 2012 ||
Justin Bozzino ||
It has become almost an article of faith in some quarters that ‘waterborne’ crude oil benchmarks are somehow more connected with global markets than pipeline delivered ‘landlocked’ benchmarks. Simply by virtue of being transported in oil tankers, some benchmarks are confidently declared to be more ‘responsive’ to global fundamentals. Like the earth extending only as far as the eye can see, the notion that a crude benchmark ends at the water’s edge is comfortingly simplistic, but also badly mistaken.
Pipeline delivery is undoubtedly more flexible than tanker delivery. West Texas Intermediate crude (WTI) delivered at Cushing, Okla. can be delivered in parcels as little as one lot (1,000 barrels). This flexibility in delivery ensures a strong connection with the underlying physical market. With pipeline delivery there is no need for a ‘partials’ market, as there is with Brent and Dubai benchmarks, where tanker cargoes are artificially divided up into synthetic partial cargoes of 25,000 barrels.
This was a necessary and timely innovation given the rapidly declining supply in both these markets. However, it lacks the clear physical convergence of the WTI delivery mechanism. Also, with ample storage at Cushing, the convergence between the WTI futures and physical markets occurs with minimal outside disruption. Conversely, the need to charter an appropriate tanker for specified delivery times – even in a well-supplied and efficient freight market – introduces an alien element into the price discovery process for tanker delivered benchmarks.
That’s certainly not to say that pipeline delivered benchmarks are inherently ‘better’ than other benchmarks – indeed, how a benchmark is delivered and transported is something of a red herring. By focusing on this aspect, commentators miss the real point of what makes a robust benchmark: responsiveness to global fundamentals, transparency in settlement, adequate and stable production, and convergence with the physical market.
That is why the recent infrastructure projects in the U.S., including the Seaway pipeline reversal, are a sign of confidence in the future of the WTI benchmark. Now that the vibrant physical market at Cushing is connected with the refineries in the Gulf Coast and by extension the global oil markets, WTI continues to remain connected to global markets and anchored to global fundamentals.
On the other hand, the recent anomalies of Brent prices – accentuated by local production outages and tax distortions – are not helped at all by the fact that it is ‘waterborne’. Rather, they are mitigated by a robust and transparent settlement process, with a clear connection to the physical market. That is why, late last year, we launched the Platts related 25 day Brent contract, which brings a far better convergence between futures and the underlying physical Brent market than currently exists, and adequately reflects the recent changes in assessment that Platts have introduced to deal with rapidly declining North Sea production.
One contract worth mentioning in this context is the DME Oman futures contract, the up-and-coming Asian benchmark at the Dubai Mercantile Exchange, one of our partner exchanges. With a robust and transparent delivery mechanism, steady production, and reflection of the underlying physical market, it is well placed as a benchmark for the East of Suez markets. And, given the contract is tanker delivered, maybe even the flat earthers will learn to love it.
Justin Bozzino is executive director of energy products at CME Group.
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