The physical basis of Dated Brent is not what it used to be, and BFOET production volumes have continued to fall.
In this episode of The Crude Report, vice president James Gooder and Argus Crude editor Michael Carolan revisit the Dated Brent discussion, and assess if the price can be resurrected with options like Johan Sverdrup or WTI.
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Take the poll: The Brent basket’s burdenTranscript
James: Hello, and welcome to the latest edition of "The Crude Report." This is a weekly podcast from Argus Media, in which we, hopefully, shine some light on some of the big issues of the day in the global crude markets. My name is James Gooder. I'm VP for crude in Europe and Africa. And I'm very pleased to welcome back to the pod our global crude editor Michael Carolan.Michael: Thank you. Glad to be here, James.
James: Good to have you back. So today, we're gonna come back to a theme we've covered a couple of times, but it's developing and changing, and that's the theme of the North Sea crude benchmark. Now, as we've discussed before, it's at a bit of a crossroads and there's been a lot of discussion, a lot of very animated and aggravated discussion over the past few months about this benchmark, Brent in common parlance.
And I think it's probably fair to say that there is a general acceptance that this benchmark needs updating, dusting off, and refreshing. It's running low on production. The grades that go into it from the North Sea are declining over time. And there is a question about the amount of trade liquidity in the benchmark. But the big question, and one that we're trying to find an answer to, is, should that extra liquidity and that extra volume, should it come from imported U.S. crude, like WTI?
Or should it come from additional North Sea supplies, like Johan Sverdrup? And these two options are not necessarily mutually exclusive. They are certainly dividing the market, I think it's fair to say. Now, we at Argus, you know, we're not a democracy, but we are running a poll. We'll put a link in the transcript of this podcast. You'll see the hyperlink there.
So if you want to click through and have your say, then we will take that into account and that will inform some of the thinking and discussions that we're having with the market. But let's have a look at production, first of all. What's the problem, Michael?
Michael: Well, on the surface, North Sea production appears to be pretty stable this year and, in the first half of this year, total North Sea production. Looks on course to average 2.7 million barrels a day, which is down from last year. But it's actually higher than the previous three years. Now, it perhaps doesn't fit our pattern of the North Sea's terminal long-term decline but, of course, the reason the [inaudible 00:02:39] of that decline is entirely down to the start-up of Norway's Johan Sverdrup field in 2019, which has been truly transformational for the region.
If you strip out Johan Sverdrup production, then North Sea production in the first half of the year would have been the lowest since 1979. So that long-term decline is still there.
James: Yeah, that's pretty clear that Johan Sverdrup is the, kind of, the thing that's bucking the trend here, right? And we at Argus as trying to bring some clarity to that grade so that people can work out whether it's really part of the solution to the problem or not with our new assessment that we launched back in IP Week this year. But thanks for that overview of what's happening with production.
How does this translate into trade information, though? Because, really, what matters in the benchmark, in what people call Dated Brent or North Sea Dated, what really matters is the amount of information that the market is generating, right?
Michael: Well, this is the problem. Johan Sverdrup, of course, is not included in the benchmark. So its production makes no difference to price discovery on North Sea Dated. Instead, we have Brent, Forties, Oseberg, Ekofisk, and Troll. Loadings of those five grades this month have slumped to just 600,000 barrels a day, which is lower than any month this century and much further back than that.
Six hundred thousand barrels is also the level which our competitors Platts described as critical for the functioning of the Dated Brent benchmark. As far as trade information is concerned, which is needed to price discovery on Dated, that is patchy at best. And the inclusion of delivered Rotterdam trade in the price discovery process has certainly helped improve the debility around the five grades.
But this information is really only available in a contango market, when buying a cargo on a foot basis, they need to sell it at a later date on a delivered basis, makes economic sense. In a flat or backwardated market, this trade is largely missing. Right now is a good example. There's been no [inaudible 00:04:38] activity on benchmark grades in the whole of May, and we have had no bids, offers, or deals on any of the five benchmark grades on a FOB basis for four consecutive sessions this week. So that means assessing the physical element of Dated has become extremely difficult.
James: Wow, that sounds like a fundamental flaw in the process, if you're only getting good price discovery under one set of market conditions and not the other.
Michael: Exactly.
James: Well, you know, to come back to our opening gambit, really, there is still a vocal contingent in the market that believes the best solution to this liquidity crisis is to add U.S. crude, that is West Texas Intermediates, WTI, delivered into Europe. Perhaps netted back across the North Sea to a virtual number. But that extra flow that we see into Europe, that could be part of the print basket, according to this contingent. What would you say are some of the pros and the cons of that idea?
Michael: Well, the theory is that Dated should represent the price of light, sweet crude in Northwest Europe. And WTI is already a light, sweet crude used by European refiners in large volumes. So why not just include that trade into the benchmark? And indeed, WTI is often the marginal barrel of light, sweet crude for European refiners, particularly when the arbitrage works, as it does at the moment.
So there is certainly a strong case for its inclusion. The problem is, how do we include it? There are no loading programs at WTI and there will always be an uncertain number of cargos available for European buyers because WTI could travel somewhere else or it could not travel at all if your economics aren't right. So how do you price an undetermined amount of supply? There's a large complex of futures and derivative contracts built on the assumption that the physical crude underpinning Dated is the North Sea FOB market.
There is no mechanism for adding delivered cargos into the forward contract, and no agreements over whether one could exist. So North Sea Dated or Dated Brent with WTI included would come to mean something different to Forward and Futures Brent. We need a way of linking spent with physical barrels of crude. And we ourselves have wrestled with this problem for the last couple of years.
And our experience with the North Sea benchmark including WTI is that it would almost certainly result in a lower price for Dated, which is unacceptable to at least half of the market.
James: Yeah, exactly. So apart from the technical challenges, we are talking about a kind of step change in the value or the price of the benchmark. And, of course, that calls into question all of that forward exposure on Brent. So, yeah, looking closer to home, if your home is in Europe, then the North Sea basket is clearly under pressure. But there are other grades, as you say, produced in the North Sea that could be used to bolster the benchmark, right? So what's holding those back?
Michael: Well, this brings us back to the North Sea's largest crude, Johan Sverdrup. So while half the market has been tying itself in knots trying to include U.S. crude into a European benchmark, others have been pointing out the answer to the problem of declining volumes is on our doorstep. Like the existing benchmark grades, Johan Sverdrup also has a loading program. It loads in the North Sea on mostly Aframax tankers and it already trades on a FOB basis.
So it already ticks lots of boxes. And there are obviously plentiful volumes of the crudes. And Johan Sverdrup alone accounted for 20% of the North Sea's output this month, compared with a combined 30% for the five benchmark grades. And unlike the other five grades, volumes of Johan Sverdrup are gonna grow in the next few years and not fall. One objection is that Johan Sverdrup is largely used by Asian refiners rather than European ones, but probably no more than Forties.
And in its short life, Johan Sverdrup has found plenty of buyers in Europe as well. But the main objection is one of quality. It's a heavier crude with a gravity of 28 degrees API. And it's more sour, with a sulfur content of 0.8%. But it's only sour by North Sea standards. This is not Urals. Its sulfur content is actually not dissimilar to the 0.62% of Forties. And Forties used to regularly be around 0.8% sulfur when the giant Buzzard field was producing there.
It wasn't seen as a problem then. The gravity is maybe more of an issue. But we must remember that the five existing benchmark grades differ from each other pretty markedly. There's five degrees of gravity between Forties and Troll, for example. We currently use quality premiums to adjust for such a difference. So it's not beyond the realms of possibility that we find similar ways of adjusting the price of Johan Sverdrup for that benchmarking purposes and include into Dated.
James: Yeah. It's interesting. I mean, one of the objections to Forties, setting the price, has been that it's a global crude. But then, some people say that that is precisely the point, you know, with Brent being used all the way from, you know, the U.S. Gulf, and Brazil, to China. Then perhaps a grade that does reflect that global arbitrage is exactly the kind of thing that should be setting the benchmark.
So, I mean, as we've seen, WTI has its supporters. There's an equally vocal camp that favors adding Johan Sverdrup into the basket. Is it possible that different parts of the market could gravitate to different benchmarks? I mean, it seems unlikely, perhaps, but, you know, in the U.S., WTI futures we have in Cushing, which is up in Oklahoma, of course. But then, there's also, you know, an active WTI benchmark in Midland, in Texas, and then, again, down in Houston. And now we have prices at the coast.
Could it be possible that the underlying index for crude outside of North America could become the futures? And then, Johan Sverdrup and the FOET grades could represent the physical FOB North Sea prices. And WTI delivered into Rotterdam could become the basis of a SIF index representing light, sweet crude in Europe, if you'd like. Is it possible that the market could bifurcate like that?
Michael: Well, I think it's an interesting idea and, perhaps, a workable one. But I think we have this situation because everyone is looking for the perfect benchmark for their particular needs, which, unfortunately, doesn't tally with anyone else's needs. I expect what we will end up with is a compromise that suits nobody perfectly, and the market needs to accept that. If you're going to invent a crude benchmark from scratch, the last thing you would ever come up with is Dated Brent.
And either solution we've talked about is only gonna make it more cumbersome and more complicated. But the complex that has built up around Brent means that a solution has to be found for the short and medium-term at least. For the long-term, I suspect the market will look elsewhere. For a global benchmark to be situated in a region with plummeting supply and, presumably, soon to be plummeting demand makes little sense to me.
James: Yes, perhaps it's all symptomatic of the decline of Europe. But as you say, in the short to medium-term, something needs to be done to keep this very important benchmark representative. You know, we are the challenger in this market. Argus is providing an alternative. But what are we doing to help this process along?
Michael: So, as you know, James, we are actively involved in the discussion. And that means canvassing the wider market, not just a small club of North Sea players, because this benchmark matters to players globally. We're trying to bring transparency to the market for Johan Sverdrup, both in Europe and in Asia so its fitness as a market can be judged. So we currently have a FOB Mongstad price for the crude as well as a price for Johan Sverdrup delivered into China.
We also, of course, have a delivered Rotterdam WTI price. And then, our new North Sea Dated price, which has been running for a couple years, is available for anyone who wants to see how a Dated including WTI can differ from the existing Dated price. And, spoiler alert, it's a lot cheaper. But our job, ultimately, is to find an alternative to the incumbent. We're in the process of making some largely cosmetic changes to our North Sea Dated methodology, and we're gonna be thinking very hard about future changes in the months to come.
James: Excellent. Well, thanks every so much for that, Michael. Obviously, a very thorny and complex issue, but it does seem to be falling down into a binary set of choices. So that simplifies things somewhat. As I say, anyone listening to this is welcome to have their say. Do feedback to us through any channel you like, but there is this poll that we have, and you can make a suggestion about how the benchmark ought to develop right there.
It's not just the two choices. There is a third option and we're willing to hear those, too. So thanks very much, Michael. And thanks for listening to the August "Crude Report." We'll be back again with you soon.
