In order to continue to ensure the smooth functioning of
the benchmark, Platts fine tuned the mechanism further
in the wake of volatility in the spread between sweet and
sour crudes that emerged in late 2004 and 2005. This
volatility was seen simultaneously in all major markets,
not only in the Middle East and Asia, but also in Europe
and the US.
As flat prices rose to record highs above $70/bbl in
2005, owing to the demand for light sweet crude, the
premium of low sulfur against high sulfur streams
widened. The wide price gap between low and high sulfur
oils has resulted in part from underinvestment in hydro
capacity in refineries at a time when sulfur levels in oil
products such as diesel and gasoline were being
tightened drastically to meet environmental regulations.
This phenomenon of widening spreads is called the
'rubber band" effect. Two lines drawn in a rubber band
widen relative to one another as the rubber band is
stretched. As prices are 'stretched", the sulfur
differentials tend to periodically widen before snapping
back when systems become less overstretched.
The behavior of the Oman/Dubai differential suggests
this factor has been at play in the Persian Gulf as the
Oman/Dubai markets have diverged since September
2004. The difference in price between Oman and Dubai
had been mostly less than 60 cts/bbl, with occasional
spikes seen in 2003 being limited to a 70-75 cts
premium for Oman above Dubai. However, in 2004, the
situation quantifiably changed. In late October, the
spread between the two grades blew out to a massive
$2.80/bbl, which was far beyond the differential dictated
by yield and netbacks for the individual grades.
The widening of sulfur spreads was replicated in other
benchmark markets; for instance, the differential
between Russian Urals crude and Brent crude oil
widened to as much as $8.00/bbl at roughly the same
time that the Oman/Dubai spread widened. WTI versus
Mars demonstrated a similar pattern.
Because of these structural changes in the market, the
lower sulfur in Oman effectively led to an option value for
the grade that was sufficient to allow the opportunity of a
squeeze on Dubai in which the price cap was too far apart
from the Dubai value to be effective. While there have
been no squeezes to date, Platts considered it judicious
to put in another cap that was nearer in value to Dubai.
As part of its goal of formulating long-term solutions Platts
incorporated Abu Dhabi"s Upper Zakum crude into the
Dubai assessment process as from February 1, 2006.
In selecting an additional crude for alternative delivery,
Platts sought to identify a grade that most closely met
the benchmark requirements spelt out earlier. Despite
the high production of sour crude, however, few Middle
Eastern crude grades meet the overall requirements
and most of the physical streams available are not
fully comparable with Dubai"s quality. Issues to
consider include geographical differences to Dubai's Al
Fateh loading location, which would result in adverse
freight influences, quality differences including gravity
and sulfur, the ability to be traded in the spot market
and the breadth of equity ownership.
While no single "perfect" solution is obvious, certain
alternatives appeared more workable than others.
Upper Zakum has a daily production of about 500,000
b/d and rising, with 750,000 b/d targeted in the
medium term. Equity ownership is being widened with
US oil giant ExxonMobil set to take a 28% stake, in
addition to the existing non-government stake held by
Japan"s JODCO. Loading facilities are in close proximity
to Dubai"s Al Fateh and very critically, the implied price
of Upper Zakum is similar to Dubai as the Abu Dhabi
crude is just marginally lower in sulfur and gravity.
Platts standards call for the inclusion of the grade
provided Upper Zakum is free of destination restrictions.
While anyone with pricing exposure to Dubai would
welcome a wholesale lifting of the destination
restrictions on Upper Zakum, change takes time.
The most important issue moving forward is the steady
and ongoing decline in physical Dubai production. While
pricing is so far robust and no distortions have occurred
in recent years, Platts believes that action needs to be
taken well in advance of any issue caused by the decline
in production. It is inevitable that Dubai production will
eventually disappear entirely.
In order to continue to reflect Middle East crude
fundamentals in its daily assessments, Platts is creating
a crude class -Middle East Crude, or MEC -the
parameters of which should be identical with those of
Oman/Dubai/Upper Zakum, but which can be adapted in
the coming years to reflect the evolving market
characteristics in the Gulf region.
As the Gulf producers are blessed with the world"s
largest oil reserves, the need for reliable benchmarks in
this region is pressing and one in which Platts has been
proactively involved in delivering solutions. Because of
its crucial role in global oil supplies, the issue of pricing
in this region is of global significance. But it is also
crucial for the development of Gulf economies, as
financial markets across the region blossom.
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