We are living through a fascinating chapter in global crude markets. The shale revolution and lifted ban on U.S. exports alongside rising Chinese demand has shifted trade flows, while a flurry of sanctions and regulations reinforce the need for shrewd risk management.
Shorter term, International Maritime Organization (IMO) rules to cut sulphur dioxide in fuel oil from 2020 will require a drastic shift: exporters will have to change the cost of barrels they ship around the globe, refiners will need to balance their blend of bunker fuels and distillates, traders will need to merge bunker and distillate desks, and tanker companies must alter vessels to remove pollutants from high sulphur fuel.
To manage resulting price risk, the industry will turn to marine fuel derivatives and the benchmark for global crude: the Brent contract. Brent has strong logistical, pricing and price discovery links to the refined products it yields, and is used to determine the value of approximately 80% of oil on global markets.
This isn’t the first time the market has seen a significant shift. Ten years ago the oil market went through a similar transition, and just as Brent helped manage the rebalance in supply and demand dynamics then, it provides security to traders today.
A complex to manage shifts
The role of Brent crude is more critical than ever. As the international oil benchmark, Brent’s location straddling Asia and the U.S. in Europe’s export-import market, gives it unrivalled strategic importance. In this way, the Brent complex - comprised of more than 600 related oil products - facilitates trade between the world’s major players. U.S. sellers use Brent to determine the destination of local production, while buyers in Asia rely on Brent to help decide their mix of crude imports.
As one of the world’s most liquid crude grades, Brent is used to determine the value of hundreds of crude grades on global markets, from Australia’s Cossack to Russia’s Urals. Brent differential contracts are central to these connections. The liquid differentials markets of Brent versus Dubai, WTI, Russian Urals, Caspian Sea oil (CPC), Light Louisiana Sweet (LLS) and Gulf Coast Mars oil among others, allow financial traders to take positions on market events, and supports physical players looking to manage their exposure.
The Brent complex also enables players to manage risk across refined product markets in Europe, Asia and North America. Crack spreads represent the difference in value between a specific refined product such as gasoline or diesel, versus the price of a particular crude. This means traders can hedge the majority of a refined product’s outright price with crack spread derivative contracts. In turn, these crack spreads are one of the biggest demand signals impacting crude prices.
Physical traders dominate the Brent complex, with commitments by producers, processors, merchants or end users averaging 60% of total volumes. By contrast, physical players represent only 40% of commitments in other major oil markets. This dynamic enables Brent to be a true indicator of physical market demand, as with less impact from speculators and market makers, it matches movements in commercial markets.
Brent’s arbitrage capabilities are also important. As a waterborne contract, its accessibility means it is easy to price against other locations and grades. The Brent-WTI spread remains the most active on the export market, representing the difference between U.S. (WTI) pricing and the rest of the world. Similarly, the Brent-Dubai spread represents the price differential which regulates oil flows between the Atlantic basin and Asia - a signal for fundamental supply and demand conditions. And while most Asian sour crude is priced against Dubai, the Dubai benchmark itself is considered a derivative of Brent, with its crude prices influenced by Brent futures.
Amid growing demand for low sulphur fuel oil, market participants will look to Brent’s wide range of hedging tools to manage their price exposure - from suppliers and refiners to financial players. And just as it has throughout market cycles, the Brent complex offers a range of tools to manage whatever evolution comes next to global markets.