Saudis Drop WTI Oil Contract - But Why?

This comes via the FT:

Saudi Arabia on Wednesday decided to drop the widely used West Texas Intermediate oil contract as the benchmark for pricing its oil, dealing a serious blow to the New York Mercantile Exchange.

The decision by the world’s biggest oil exporter could encourage other producers to abandon the benchmark and threatens the dominance of the world’s most heavily traded oil futures contract. It is the main contract traded on Nymex.

Before anyone tries to spin this as an anti-dollar move, you should read what else the FT article says:

In January, WTI, which usually trades at a premium of $1-$2 a barrel to Brent, fell sharply, leaving it at a discount of almost $12 – a record gap. This dislocation in the market continued well into the summer.

From January, Saudi Arabia will base the price of oil for its US customers on a new index developed by Argus, the London-based oil pricing company.

The Argus Sour Crude Index will track the price in the physical market of a basket of US Gulf Coast crudes, including Mars, Poseidon and Southern Green Canyon.

The point of this move is not to undermine the dollar but to get away from the WTI contract where prices have been artificially inflated due to storage shortages at Cushing.

A friend familiar with this market also indicated that big bank punters active in this market will like this move as well as it helps them evade the position limits and regulation of the CFTC. He says,

In fact, the lack of transparency and regulation on the Dubai Merc was one of the reasons why you had such successful speculation in the oil market during the spring of 2008.

I see a spike in oil prices as a risk to any sustained recovery. Anyone with more insight into why the Saudis made this move, do comment.

Comments

[Clive Corcoran:]

The NYMEX have also announced that they will begin trading futures against this new ASCI immediately. So there will be no opportunity to evade the CFTC's regulations at least for the contracts traded in New York. However with a universal benchmark index which can presumably trade in Dubai, Singapore etc - this move does allow for jurisdictional arbitrage and ways to avoid oversight.

Nov 01 05:53 AM

[Tom Armistead:]

The index selected covers sour crude. Sweet/sour spreads have been closer together lately, squeezing sour refiners such as Valero. Maybe the index selection has something to do with that phenomenon.

Nov 01 06:06 AM

[rob134:]

"A friend familiar with this market also indicated that big bank punters active in this market will like this move as well as it helps them evade the position limits and regulation of the CFTC."

"However with a universal benchmark index which can presumably trade in Dubai, Singapore etc - this move does allow for jurisdictional arbitrage and ways to avoid oversight. "

If these two comments are correct then it appears the purpose of the move is to allow more price volatility, and higher prices for the producing countries.

Nov 01 08:11 AM

[Brynjo:]

Given the recent rumblings from oil players OTHER THAN the Saudi's about pricing oil in something other than dollars, this reaffirmation of a US based benchmark, I would suggest, is the Saudi's way of saying they are committed to dollar denomination of oil prices.

Nov 01 09:11 AM

[Ferdinand E...:]

I wonder if our Saudi friends are genuinely interested in a sustained recovery of the international macroeconomy. Aside from some possible short run gains, I don't see the logic in this move.

Nov 01 09:33 AM

[Steven Ward:]

This move permitsthe Saudis to participate in the Singapore and Dubai markets willy nilly without scrutiny.

The Saudis want to make money on oil speculation as well as physical product.

Nov 01 09:44 AM

[Chris Cook:]

I think that the problem is ongoing systemic manipulation via the Brent/BFOE Complex in particular.

In essence funds are loaning money to producers, who in return are loaning (selling forward) oil they have in the ground. The investment banks intermediate this process, and the result is, as we see, that oil prices track money prices (ie the yield curve) very closely in these circumstances.

See

av.r.ftdata.co.uk/lib/...

I think that the BP/Goldman nexus is key to the financial/physical arbitrage, but other producers - possibly the Saudis - are also caught up in it because they have the most to gain from higher prices....but it's a fine and dangerous path they tread.

The effect is not dissimilar to the way that tin producers were able to keep the tin price artificially inflated for years until they ran out of money to support the growing tin stockpile. The problems in this macro oil manipulation are that firstly it has no reverse gear - stopping it for anything more than a short period leads to collapse. Secondly, eventually downstream losses from reduced product demand become insupportable, and the bubble in crude oil collapses - like the tin market did.

The physical/OTC dog is wagging the derivatives tail. That's why the GLG hedge fund is getting into the physical market; why Oxy bought Phibro from Citigroup; Vitol are buying Petroplus assets etc etc

I suspect that the Saudi approach to the US benchmark is not a million miles away from their use of the BWAVE Brent pricing method rather than Platts. It is an attempt to minimise market friction losses.

The oil price currently - as in the spike last year, and the long inflation that preceded it - has nothing whatever to do with the fundamentals of oil supply and demand.

I'm not sure how this ends (well I do, it's just a matter of when), but it seems to me it's only QE - by pushing investors into asset classes like commodities - keeping the oil price pumped up - IMHO by investment banks in tandem with a couple of producers.

I think we have been seeing in the oil market - for maybe as long as ten years - what Mike Riess calls modern market manipulation

www.materialsmanagemen...

on a macro scale.

As Riess pointed out, Hamanaka and Sumitomo manipulated the copper market for ten years, and for five years this was AFTER David Threlkeld blew the whistle......

Nov 01 09:50 AM

[koolsool:]

Most of the oil produced in the middle east is sour crude now. Easy to refine light sweet crude has peaked, it has become a minor part of production. Should'nt the benchmark be based on what is actually traded on the market??

Nov 01 09:59 AM

[Dave Wrixon:]

I think what this clearly shows is that the Saudis and others are going to be be quite flexible in their approach to ensuring the best outcomes. If the Dollar fits with the strategy then fine, if not it is toast.

Nov 01 11:38 AM

[Tony Daltorio:]

What absolute nonsense - you're exactly 180 degress wrong!

The Saudis are steaming mad at the blatant manipulation that was occuring in the WTI contract, which was selling well below the true global market price of oil.

The Saudis were mad that they were getting shafted on the price of oil they received while the Wall Street banksters were making millions from their heavy short positions in WTI contracts.

Do NOT forget that Wall Street as a whole HATES commodities and 90% of the time they are shorting commodities while they are juicing the stock market contracts to the up side. Their MAIN business is the stock market, they don't want people investing in commodities for the long term.


On Nov 01 09:50 AM Chris Cook wrote:

> I think that the problem is ongoing systemic manipulation via the
> Brent/BFOE Complex in particular.
>
> In essence funds are loaning money to producers, who in return are
> loaning (selling forward) oil they have in the ground. The investment
> banks intermediate this process, and the result is, as we see, that
> oil prices track money prices (ie the yield curve) very closely in
> these circumstances.
>
> See
>
> av.r.ftdata.co.uk/lib/...
>
> I think that the BP/Goldman nexus is key to the financial/physical
> arbitrage, but other producers - possibly the Saudis - are also caught
> up in it because they have the most to gain from higher prices....but
> it's a fine and dangerous path they tread.
>
> The effect is not dissimilar to the way that tin producers were able
> to keep the tin price artificially inflated for years until they
> ran out of money to support the growing tin stockpile. The problems
> in this macro oil manipulation are that firstly it has no reverse
> gear - stopping it for anything more than a short period leads to
> collapse. Secondly, eventually downstream losses from reduced product
> demand become insupportable, and the bubble in crude oil collapses
> - like the tin market did.
>
> The physical/OTC dog is wagging the derivatives tail. That's why
> the GLG hedge fund is getting into the physical market; why Oxy bought
> Phibro from Citigroup; Vitol are buying Petroplus assets etc etc
>
>
> I suspect that the Saudi approach to the US benchmark is not a million
> miles away from their use of the BWAVE Brent pricing method rather
> than Platts. It is an attempt to minimise market friction losses.
>
>
> The oil price currently - as in the spike last year, and the long
> inflation that preceded it - has nothing whatever to do with the
> fundamentals of oil supply and demand.
>
> I'm not sure how this ends (well I do, it's just a matter of when),
> but it seems to me it's only QE - by pushing investors into asset
> classes like commodities - keeping the oil price pumped up - IMHO
> by investment banks in tandem with a couple of producers.
>
> I think we have been seeing in the oil market - for maybe as long
> as ten years - what Mike Riess calls modern market manipulation<br/>
>
> www.materialsmanagemen...;br/>
>
> on a macro scale.
>
> As Riess pointed out, Hamanaka and Sumitomo manipulated the copper
> market for ten years, and for five years this was AFTER David Threlkeld
> blew the whistle......

Nov 01 11:52 AM

[Bull Run:]

The middle east region is soon to have it's regional currency, with the Central bank located In Saudi's capital, maybe switching from US futures, into European pricing, there's a larger plan?

Nov 01 12:49 PM

[Chris Cook:]

@Tony Daltorio

As I said, the Saudis probably wished to minimise friction losses in the use of the WTI benchmark. I don't see that as inconsistent with your view.

I can't speak for Wall Street, but I do know that the energy markets have in the last 10 to 15 years been probably one of the biggest source of profits for Goldman Sachs, Morgan Stanley, and all of the lesser piranha in the Wall Street pool.

It is true that the interests of these Wall Street Refiners is diametrically opposed to the interests of the long term investors through ETFs and the like, who bring much needed liquidity to the energy markets. Which is what you appear to me to be saying.

In that respect, I think that you may well agree with the views I expressed in my interview in Hard Assets Investor here

www.hardassetsinvestor...

Nov 01 02:36 PM

[Long Silver...:]

What would happen if OPEC priced oil in grams of gold?

Nov 01 03:48 PM

[ryanclarke:]

Because light sweet crude ... which is what WTI is suppose to reflect ... is on the decline and can no longer be labeled a "commodity" ... and heavy sour crude will be mostly what the Saudis and nearly all other oil producers ... WILL PRODUCE going forward in the future. I will go a step further and predict in ten years oil futures will be eliminated entirely but NOT the oil product futures ... namely gasoline futures and diesel futures ... and their will be a seperate bioethanel future index as well.

Nov 01 09:51 PM

[Advill:]

Our "saudis friends" are exactly as "american friends" were before.... their interest is first so you can not expect any "kindness" in the commercial field (geostrategic could be different).

There is a serious effort in OPEC countries to move away of the "american scenario" in relation with oil.
In the long term is clear that oil will travel less than today, Arabia, Russia, Iran, Irak etc will supply Europe and China , Japan, India etc.

America will have to supply from Canada, Gulf of Mexico, Mexico ( if mexicans conciliates themselves with their oil) and South America fields every where there.

Additionally OPEC is moving away of the dollar and the first step is moving reference price, why Arabia?...because they are the OPEC leaders they have to move before anyone could try...specially having Chavez of Venezuela and Iran around.

I think that we can expect other movements coming from S/Arabia in the future, just for the same reason.
rgds

On Nov 01 09:33 AM Ferdinand E. Banks wrote:

> I wonder if our Saudi friends are genuinely interested in a sustained
> recovery of the international macroeconomy. Aside from some possible
> short run gains, I don't see the logic in this move.

Nov 02 08:04 PM