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South Korean arbitrage redraws landscape of Dated Brent market

By Olivier Lejeune in London

November 22, 2012 - The unanticipated and rapid emergence of a major arbitrage route to export crude from Europe to South Korea has transformed the North Sea market over the last year, boosting the value of the key Dated Brent benchmark and increasing market volatility at times, traders said November 21 (see chart: Dated Brent (mean $/barrel): Sep 15, 2011 - Nov 20, 2012).

BP started the trend in November 2011 when it decided to export a VLCC containing Forties blend crude to South Korean refiner GS Caltex, and the arbitrage shipments have continued unabated ever since, despite initial skepticism from the trading community.

Shipping crude on a VLCC from the North Sea to South Korea typically costs between $4 and $6 million and takes two months, making it far more lengthy and expensive than for cargo imports from the Middle East, the main source of South Korea's oil supply.

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But despite the cost, around 44 million barrels of North Sea crude have been exported to South Korea since November last year and understanding the so-called South Korean arbitrage has become key to making money as a North Sea physical and paper trader.

A little under one-third of all Forties production of the past year has been consumed by South Korean refiners, according to Platts data.

This makes South Korea one of the largest single users of the crude blend, along with European countries such as the UK and the Netherlands.

The export volumes have also redefined the regional supply/demand balance in Europe for North Sea crude, leading to a rise in North Sea physical premiums, with repercussions for financial instruments such as Brent futures and Brent contracts-for-difference (CFDs). (see table: Volumes of Forties and other North Sea crudes).

Birth of an arbitrage

Forties and other North Sea crudes had been exported to South Korea and Japan in the past, but never on the scale witnessed over the last year, according to traders.

The catalyst for the surge in volumes was a free trade agreement between the EU and South Korea that was passed in July 2011, and which canceled all duties for crude exported from the EU to the Asian country.

The saving is equivalent to around $3/barrel when oil prices have remained above $100 for most of the year, or about $6 million for a VLCC, more than enough to pay for the long voyage to South Korea, say traders.

Another key factor has been the relative tightness in the market for sour crudes from the Middle East due to the rising political tensions between the West and Iran this year, and the accompanying drop in Iranian crude exports.

The Dubai crude price, used as the pricing benchmark for the bulk of crude exported from the Persian Gulf, has traded at a lower discount to Brent than in 2011, making North Sea crude exports to Asia more economical as a result.

Traders say both the duty cut and the high Dubai price are behind the large movements of North Sea cargoes to South Korea seen this year.

The arbitrage appears to have first been spotted by South Korean refiners on the lookout for cheaper alternatives than their usual crudes.

"Someone had some stored Forties blend barrels in the region...we tested it and we liked it," one trader at a South Korean refiner told Platts last month.

North Sea barrels are replacing sour crudes from the Middle East such as the UAE's Murban or Iraq's Kirkuk, as well as Asian sweet grades, the trader said.

Of the 44 million barrels sent to Korea since November last year, 29 million barrels were Forties blend from the UK sector of the North Sea, the crude used to set the Dated Brent oil benchmark most days. (see chart: Forties differential to Dated Brent ($/barrel): Sep 15, 2011 - Nov 20, 2012).

While the volume is not thought to be significant by the standards of the oil industry -- much larger volumes of crude travel from the Middle East to Asia -- it has had a large impact on North Sea physical prices, which are used as a benchmark for many of the world's physical transactions.

The rest of the exports, about 15 million barrels, was mainly made up of sweet crudes from the North Sea such as Norway's Troll and Alvheim blends, which are not part of the Dated Brent benchmark.

Norway is not part of the EU but it ratified the same free trade agreement with South Korea as part of the European Free Trade Association.

The maximum volume of Forties crude that South Korean refiners can use in a month is 5 million barrels -- 2 million for GS Caltex, 2 million for SK Energy and 1 million for Hyundai, said traders. This is because South Korean refineries are not capable of processing more Forties each month.

SK Energy also regularly imports barrels of Norwegian crude from Statoil.

Next page: Impact on crude prices

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