Why Dated Brent is no ‘Libor scandal in waiting’

The Oilholic was asked at a recent industry event whether he thought or had heard any anecdotal evidence about Brent being 'crooked' and susceptible to what we saw with financial benchmarks like Libor. Perhaps much to the annoyance of conspiracy theorists, the answer is no! A probe by the European Commission (EC), which included raids on the London offices of several oil companies and Platts last year, and an ongoing CFTC investigation into trading houses stateside, seems to have triggered the recent wave of questions.

Doubts in the minds of regulators and the public are understandable and very valid, but that an offence on an industry-wide scale can be proved beyond reasonable doubt is another matter. The UK's Office of Fair Trading has already investigated and cleared all parties raided by the EC. Furthermore, it stood by its findings as news of the EC raids surfaced.

As far as price assessment mechanisms go, only Platts' Market on Close (MoC) has faced allegations. It is cooperating with the EC and nothing has emerged so far. Competing methods, for instance ones used by Argus Media, another price reporting agency (PRA), were neither part of the investigation nor have been since.

Let's set all of this aside and start with the basics. A monthly cash-settled future is calculated on the difference between the daily assessment price for Dated Brent (the price assigned on a date when North Sea crude will be loaded onto a tanker) and the ICE daily settlement price for Brent 1st Line Future. Unless loaded as cargo, a North Sea oil barrel – or any barrel for that matter – retains the wider trading metaphor of a paper barrel.

Now as far as the Dated Brent component goes, agreed the PRAs are relying on market sources to give them information about bids, offers and supply-side deals. However, the diversity of sources should mitigate any attempt to manipulate prices by a group of individuals submitting false information. In the case of Libor, the BBA, a single body used to collate the information. In Brent's case, there is more than one PRA. None of these act as some sort of a centralised monopolistic data aggregation body. For what it's worth, anybody with even a minute knowledge of oil & gas markets would know the fierce competition between the two main PRAs.

Don't get the Oilholic wrong – collusion is possible in theory whereby traders gang-up and provide the PRAs with false pre-agreed information to skewer the objectivity of the assessment. However, the supply-side dynamic can wobble on the back of a variety of factors ranging from rig maintenance to an accident, a geopolitical event to actions of other market participants. So how many or how few would be required to fix prices and which PRA would be targeted, when and by how much and so on, and so on!

Then hypothetically let's assume all the price-fixers and factors align, given the size of the market – even if rigging did happen – it'd be localised and cannot be anything on the global scale of fixing that we have seen with the Libor revelations to date. Take it all in, and the allegations look silly at best because the 'collusion dynamic', should there be such a thing, cannot possibly be akin to what went on with Libor.

The EC wants to regulate PRAs via a proposed mandatory code and there is nothing wrong with the idea on the face of it. However, one flaw is that in a global market, buyers and sellers are under no obligation to reveal the price to the PRAs. Many already don't in an ultracompetitive crude world where cents per barrel make a difference depending on the size of the cargo.

If the EC compels traders to reveal information, trading would move elsewhere. Dubai for once would welcome them with open arms and other benchmarks would replace European ones. Anyway, enough said and the last bit is not farfetched! Finally, if fixing on the scale of the Libor scandal is discovered in oil markets and the Oilholic is proved wrong, this blogger would be the first to put his hand up!

Coming on to the current Brent forward month futures price, the last 5-day assessment provided plenty of food for thought. Supply disruptions in Libya (down by 100,000 bpd) and Angola (force majeure by BP potentially impacting 180,000 bpd) kept the contract steady either side of US$109 per barrel level, despite tepid US economic data. That said, stateside the WTI remained stubbornly in three figures on the back of supply side issues at Cushing, Oklahoma. The Oilholic reckons that's the fifth successive week of gains.

Meanwhile, the ICE's latest Commitment of Traders report for the week to February 11 notes that hedge funds and other money managers raised their net long position by 29.6% to 109,223; the highest level since the last week of 2013. The Brent price rose by around $4 a barrel over the stated period. By contrast, the previous week's net long position of 84,276 was the lowest since November 2012.

Away from pricing issues to its impact,  Fitch Ratings said in a recent report that production shortfalls and strategy changes to appease equity holders were a greater threat to the ratings of major Western European oil companies than a prolonged downturn in crude prices.

The ratings agency's stress test of the sector indicated that a Brent price of $55 per barrel would put pressure on credit quality, but compensating movements in cost bases and capex would give most companies a fighting chance at preserving rating levels.

Alex Griffiths, head of natural resources and commodities at Fitch, said, "With equity markets increasingly focussed on returns, bond yields near historical lows and oil prices forecast to soften, the chances of companies increasing leverage to benefit equity holders have risen. The European companies that have reported so far this year have generally resisted this pressure – but it may increase as the year goes on."

Separately, the agency also noted that a fall of the rouble would benefit Russian miners more than oil exporters. For both sectors, the currency's limited decline will strengthen earnings and support their credit profile, but ratings upgrades are unlikely without indications that the currency has settled at a new lower level.

To give the readers some context, the rouble has depreciated by 8% against the US dollar since the first trading day of the year and is down 17% from the end of 2012.

Depreciation of a local currency is generally good news for a country's exporters, but the effect on Russian oil exporters is less pronounced due to taxation and hence is less likely to result in positive rating actions in the future, Fitch said.

From Russia to the US, where there are widespread reports of a flood of public comments arriving at door of the State Department with public consultation on Keystone XL underway in full swing. See here's what yours truly does not get – you can have your comments included in the wider narrative, but are not obliged to give your details even under a confidentiality clause. This begs the question – how do you differentiate the genuine input, both for and against the project, from a bunch of spammers on either side?

Meanwhile, the Department of Energy has approved Sempra Energy's proposal to export LNG to the wider market including export destinations that do not have free trade agreement countries with the US. The company, which has already signed Mitsubishi and Mitsui of Japan and GDF Suez of France, could now spread its net further afield from its proposed export hub in Louisiana.

Elsewhere, Total says its capex budget is $26 billion for 2014, and $24 billion for 2015, down from $28 billion in 2013. No major surprises there, and to quote an analyst at SocGen, the French oil major "is sticking to its guns with more downstream restructuring being a dead certainty."

After accusations of not being too ambitious in its divestment programme, Shell said it could sell-off of its Anasuria, Nelson and Sean platforms in the British sector of the North Sea. The three platforms collectively account for 2% of UK production. Cairn Energy has had a fair few problems of late, but actress Sienna Miller and model Kate Moss weren't among them. That's until they took issue with one of the company's oil rigs blotting the sea off their party resort of Ibiza, Spain, according to this BBC report.

Finally, the pace of reforms and general positivity in the Mexican oil and gas sector is rubbing off on PEMEX. Last week, Moody's placed its Baa1 foreign currency and global local currency ratings on review for an upgrade.

In a note to clients, Tom Coleman, senior vice president at Moody's, wrote: "Mexico's energy reform holds out prospects for the most far ranging changes we have seen to date, benefiting both Mexico's and PEMEX's growth profiles in the medium-to-longer term."

And just before yours truly takes your leave, OPEC says world oil demand will increase by 1.09 million bpd, or 1.2%, to 90.98 million bpd from 89.89 million bpd in 2013. That's an upward revision of 1.05 million bpd in 2014. Non-OPEC supply should more than cover it methinks. That's all for the moment folks! Keep reading, keep it 'crude'!

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© Gaurav Sharma 2014. Photo 1: Oil tankers in English Bay, British Columbia, Canada © Gaurav Sharma, April 2012. Photo 2: Oil exploration site © Lukoil.

On a 'crude' UK raid, IEA & the 'Houston glut'

There was only story in London town last week, when late in the day on May 14, European Commission (EC) regulators swooped down on the offices of major oil companies having R&M operations in the UK, investigating fuel price fixing allegations. While the EC did not name names, BP, Shell and Statoil confirmed their offices had been among those ‘visited’ by the officials.

 

More details emerged overnight, as pricing information provider Platts admitted it was also paid a visit. The EC said the investigation relates to the pricing of oil, refined products and biofuels. As part of its probe, it will be examining whether the companies may have prevented others from participating in the pricing process in order to "distort" published prices.

 

That process, according to sources, is none other than Platts’ Market On Close (MOC) price assessment mechanism. "Any such behaviour, if established, may amount to violations of European antitrust rules that prohibit cartels and restrictive business practices and abuses of a dominant market position," the EC said, but clarified in the same breath that the raids itself did not imply any guilt on part of the companies.

 

The probe extends to alleged trading malpractices dating back almost over 10 years. All oil companies concerned, at least the ones who admitted to have been visited by EC regulators, said they were cooperating with the authorities. Platts issued a similar statement reiterating its cooperation.

 

So what does it mean? For starters, the line of inquiry is nothing new. Following a very vocal campaign led by British parliamentarian Robert Halfon, the UK's Office of Fair Trading (OFT) investigated the issue of price fixing and exonerated the oil companies in January. Not satisfied, Halfon kept up the pressure and here we are.

 

"I have been raising the issue of alleged fuel price fixing time and again in the House of Commons. With the EC raids, I'd say the OFT has been caught cold and simply needs to look at this again. The issue has cross-party support in the UK," he said.

 

In wake of the raids, the OFT merely said that it stood by its original investigation and was assisting the EC in its investigations. Question is, if, and it’s a big if, any wrongdoing is established, then what would the penalties be like and how would they be enforced? Parallels could be drawn between the Libor rate rigging scandal and the fines that followed imposed by US, UK and European authorities. The largest fine (to date) has been CHF1.4 billion (US$1.44 billion) awarded against UBS.

 

So assuming that wrongdoing is established, and fines are of a similar nature, Fitch Ratings reckons the companies involved could cope. "These producers typically have between US$10 billion and US$20 billion of cash on their balance sheets. Significantly bigger fines would still be manageable, as shown by BP's ability to cope with the cost of the Macondo oil spill, but would be more likely to have an impact on ratings," said Jeffrey Woodruff, Senior Director (Corporates) at Fitch Ratings.

 

Other than fines, if an oil company is found to have distorted prices, it could face longer-term risks from damage to its reputation. While these risks are less easy to predict and would depend on the extent of any wrongdoing, scope does exist for commercial damage, even for sectors with polarising positions in the public mind, according to Fitch. Given we are in the 'early days' phase, let's see what happens or rather doesn't.

 

While the EC was busy raiding oil companies, the IEA was telling the world how the US shale bonanza was sending ripples through the oil industry. In its Medium-Term Oil Market Report (MTOMR), it noted: "the effects of continued growth in North American supply – led by US light, tight oil (LTO) and Canadian oil sands – will cascade through the global oil market."

 

While geopolitical risks persist, according to the IEA, market fundamentals were indicative of a more comfortable global oil supply/demand scenario over the next five years at the very least. The MTOMR projected North American supply to grow by 3.9 million barrels per day (mbpd) from 2012 to 2018, or nearly two-thirds of total forecast non-OPEC supply growth of 6 mbpd.

 

World liquid production capacity is expected to grow by 8.4 mbpd – significantly faster than demand – which is projected to expand by 6.9 mbpd. Global refining capacity will post even steeper growth, surging by 9.5 mbpd, led by China and the Middle East. According to the IEA, having helped offset record supply disruptions in 2012, North American supply is expected to continue to compensate for declines and delays elsewhere, but only if necessary infrastructure is put in place. Failing that, bottlenecks could pressure prices lower and slow development.

 

Meanwhile, OPEC oil will remain a key part of the oil mix but its production capacity growth will be adversely affected by "growing insecurity in North and Sub-Saharan Africa", the agency said. OPEC capacity is expected to gain 1.75 mbpd to 36.75 mbpd, about 750,000 bpd less than forecast in the 2012 MTOMR. Iraq, Saudi Arabia and the UAE will lead the growth, but OPEC's lower-than-expected aggregate additions to global capacity will boost the relative share of North America, the agency said.

 

Away from supply-demand scenarios and on to pricing, Morgan Stanley forecasts Brent's premium to the WTI narrow further while progress continues to be made in clearing a supply glut at the US benchamark’s delivery point of Cushing, Oklahoma, over the coming months. It was above the US$8 mark when the Oilholic last checked, well down on the $20 it averaged for much of 2012.However, analysts at the investment bank do attach a caveat.

Have you heard of the Houston glut? There is no disguising the fact that Houston has been the recipient of the vast majority of the "new" inland crude oil supplies in the Gulf Coast [no prizes for guessing where that is coming from]. The state's extraction processes have become ever more efficient accompanied by its own oil boom to complement the existing E&P activity.

 

Lest we forget, North Dakota has overtaken every other US oil producing state in terms of its oil output, but not the great state of Texas. Yet, infrastructural limitations persist when it comes to dispatching the crude eastwards from Texas to the refineries in Louisiana.

 

So Morgan Stanley analysts note: "A growing glut of crude in Houston suggests WTI-Brent is near a trough and should widen again [at least marginally] later this year. Houston lacks a benchmark, but physical traders indicate that Houston is already pricing about $4 per barrel under Brent, given physical limitations in moving crude out of the area."

 

The Oilholic can confirm that anecdotal evidence does seem to indicate this is the case. So it would be fair to say that Morgan Staley is bang-on in its assessment that the "Houston regional pricing" would only erode further as more crude reaches the area, adding that any move in Brent-WTI towards $6-7 a barrel [from the current $8-plus] should prove unsustainable.

 

Capacity to bring incremental crude to St. James refineries in Louisiana is limited, so the Louisiana Light Sweet (LLS) will continue to trade well above Houston pricing; a trend that is likely to continue even after the reversal of the Houston-Houma pipeline – the main crude artery between the Houston physical market and St. James.

 

On a closing note, it seems the 'Bloomberg Snoopgate' affair escalated last week with the Bank of England joining the chorus of indignation. It all began earlier this month when news emerged of Bloomberg's practice of giving its reporters "limited" access to some data considered proprietary, including when a customer looked into broad categories such as equities or bonds.

 

The scoop – first reported by the FT – led to a full apology by Matthew Winkler, Editor-in-chief of Bloomberg News, for allowing journalists "limited" access to sensitive data about how clients used its terminals, saying it was "inexcusable". However, Winkler insisted that important and confidential customer data had been protected. Problem is, they aren't just any customers – they include the leading central banks in the OECD.

 

The US Federal Reserve, the European Central Bank and the Bank of Japan have all said they were examining the use of data by Bloomberg. However, the language used by the Bank of England is the sternest so far. The British central bank described the events at Bloomberg as "reprehensible."

 

A spokesperson said, "The protection of confidential information is vital here at the bank. What seems to have happened at Bloomberg is reprehensible. Bank officials are in close contact with Bloomberg…We will also be liaising with other central banks on this matter."

 

In these past few days there have been signs that 'Bloomberg Snoopgate' is growing bigger as Brazil’s central bank and the Hong Kong Monetary Authority (the Chinese territory's de facto central bank) have also expressed their indignation. Having been a Bank of England and UK Office for National Statistics (ONS) correspondent, yours truly can personally testify how seriously central banks take issue with such things and so they should.

 

Yet, in describing Bloomberg's practice as "reprehensible", the Bank of England has indicated how serious it thinks the breach of confidence was and how miffed it is. The UK central bank has since received assurances from Bloomberg that there would be no repeat of the issue! You bet! That's all for the moment folks! Keep reading, keep it 'crude'!

 

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To email: gaurav.sharma@oilholicssynonymous.com
 

© Gaurav Sharma 2013. Photo: Abandoned gas station © Todd Gipstein / National Geographic