OiL FUTURES: Whose Oil Is the Benchmark?

It was announced last week that world oil prices had set another record. They were talking about the oil types that are traditionally considered the main ones – the American WTI ($119 per barrel) and North Sea Brent ($116). Lately Arab and Russian producers have entered the fray over whose oil is the benchmark, however.

Whose Oil Is the Benchmark?

Russian citizens are used to rejoicing at the news of rising oil prices. The authorities have already forgotten about the theory of Dutch disease, according to which the growth of raw materials exports ruins the economy. On the contrary, they point out that Russia has shown only high GDP and personal income growth with the rising oil prices, as well as a budget surplus, in which money for increased social spending has been found. The public observes the influx of petrodollars into Russia with satisfaction and assumes that it will have the opportunity to use that money. Indeed, they have that opportunity now. The stores are full of imported goods and they enjoy a vigorous demand. The authorities, though, are hinting that the public's petrodollar opportunities will be even greater, if only in connection with the reform of the stabilization fund and the theoretical possibility of using the accumulated funds for pensions. In any case, they tell the public about the fantastic of growth of the Central Bank's gold and currency reserves and create the impression that, with such reserves, the ruble will not collapse. Not only that, the plentiful reserves and good shape the budget is in convince them that Russian banks, with the state's help, will withstand the world credit crisis. Meanwhile, the public gives little thought to what the world oil prices are. Some know from newspapers and the television news that the main types of oil are the America WTI and North Sea Brent. They are the ones setting records. But along with WTI and Brent Russian Urals and Siberian Light are rising to, and Russia is becoming richer.

It is not really so simple. West Texas Intermediate and North Sea Brent are so far the main crude oils in the world. That is mainly because they are in the “sweet” category, that is, the are distinguished by their low level of sulfur, less than 3 percent, and their lightness, that is, they are not thick. Therefore, it is easier to make gasoline form them. The fact that the London ICE exchange trades in future on the deliver of Brent plays a big role too. London's role as the world's main financial center and the high liquidity of Brent futures has made that oil type world financial benchmark for decades. In recent years, however, WTI has been considered the benchmark and it futures sold on the New York NYMEX. It has somewhat higher quality than Brent and is sold in the United States of America, the world's main oil consumer. The quality of WTI and the strategic location of its sales has caused WTI to sell for $1-2 more per barrel than Brent. Obviously, when records have been set in recent years, it is WTI that has drawn attention – the most expensive type of oil was the first to pass the $90, $100 and $110 levels.

Whose Oil Is the Benchmark?

ICE Futures exchange and NYMEX compete fiercely. (The situation is complicated by the fact that the London ICE Futures exchange belongs to American investors.) ICE Futures exchange started trading in light American oil as well as Brent to undermine the position of WTI. In response, NYMEX began trade in contracts on Brent.

In February of last year, due to a fire at an oil facility in Oklahoma that served as a distribution point for WTI from Texas, local reservoirs received an excess of oil, and it fell sharply in price, confusing everything forever. WTI was then $6 cheaper than Brent. The fact that WTI is sold exclusively on the American market began to be seen not as an advantage, but as a fault. Leo Drollas, chief economist at the Center for Global Energy Studies, commented that everyone has seen now that WTI is a “local crude,” incapable of being the world's benchmark. Ed Morse, energy economist at the Lehman Brothers investment bank, called WTI a “broken benchmark” and said it was caught in the American trap, cut off from the world market, which is based on waterborne crudes.

Arab exporters of oil to the U.S. especially Saudi Arabia, expressed their discontent at the beginning of last year that the fall in price of WTI brought down the price of their oil as well.

The continually falling production of that type of oil also causes exporters to doubt that WTI can remain the benchmark. The same can be said for Brent, which now is delivered to be world market in only a few tankers a week. Experts doubt its place as well. At present, the production and export are increasing for thicker sour crude oil, with a higher level of sulfur, such as is produced in the Persian Gulf, Russia and Venezuela. That type of oil already accounts for 80 percent of world production. Last year, the question arose of what should be the price benchmark for the most widely distributed oil in the world. ICE Futures exchange and NYMEX undertook it to answer that question. The New York exchange organized the Dubai Mercantile Exchange, which opened on June 1, 2007, with the support of the United Arab Emirates and Oman, since Oman oil was chosen as its benchmark for sour crude. ICE Futures exchange tried to surpass its competitor and announced in April 2007 that it would begin electronic trading using its own benchmark for sour crude, called Middle East Sour Crude. David Peniket, president of ICE Futures exchange, stated that “We have designed this contract in response to customer demand for a better tool to serve their risk-management needs within the dynamic global crude market.”

Jon O'Neill of Hess Energy Trading Co. called the opening of the Dubai market a decisive step in depriving WTI of its benchmark status. Ed Morse said that an exchange like Dubai's could replace those in New York and London and create a benchmark that has real meaning.

Russian authorities, who long ago stated their intentions of setting the price on Russian oil without reference to benchmarks such as Brent, have developed the Rebco brand (which NYMEX even tried trading). Now they too are engulfed in the struggle to advance new price setters for sour crude (and thus create a world benchmark). A week ago, Russia remembered its ambition. It was decided at a meeting with Russian Prime Minister Viktor Zubkov to open the International Commodities and Raw Materials Exchange in St. Petersburg. It will be opened without NYMEX's cooperation and will operate independently. It will begin with trading in petroleum products.

As the struggle for a benchmark heats up, it is becoming less and less clear what currency to set oil price in. Last week, Iranian President Mahmoud Ahmadinejad announced that Iran will trade oil in any currency, except the dollar, since the dollar is now worth nothing. It can be recalled that, when Iran organized its own oil exchange in February of this year, Iranian authorities said they were ready to trade even in rubles, just so long as they do not trade in dollars. The rest of the OPEC countries are not refusing to trade in dollars. They mention the continually falling dollar as justification for the continually rising oil prices. Maybe prices are not rising, the oil exporters say. Rather, they are compensating themselves for their losses in exchanging the dollar into other currencies, mainly the euro, as they must to finance consumer imports from Europe.

It can only be concluded that oil is trading in the world not only in dollars, but in another, mysterious currency called the “continually falling dollar.” Pricing in the latter is completely arbitrary.

Thus, a strange picture is emerging. Price records are being set by oil brands whose value is dubious, and in a currency that is no less questionable. The records themselves look suspicious. As oil price rose, the world lost any unity. Every oil producer not only wants to place oil production under the control of it authorities to the greatest extent possible, it also wants advance its oil as the benchmark for the whole world. The situation could eventually lead to full oil independence. Prices could go in opposite directions with no benchmark acknowledged. Oil will become cheaper in one country and more expensive in the next.

A Short Course in Oil Refining
Since oil production began in the 19th century, industrialists have been identifying the differences among the contents of oil from different fields (including sulfur content) and developing the technology for its refining. In a technical encyclopedia published in Russia in 1904, it states “The valuable characteristics of oil and its various distillates first became known in 1860, when the first large fountain of liquid petroleum was opened from a well drilled near Titusville, Pennsylvania. In the course of that year, up to 600,000 tons of oil were extracted… Refining of crude oil involves the fractional distillation at an ever growing temperature and the condensation of products of distillation in special refrigerators. The distillation apparatus consists of vats resembling those of steam boilers lined up in sequence… In the latest equipment, 10-12 vats make up a battery. Crude oil enters one vat and passes from one vat to the next to the end of the battery. The vats are heated with steam… and the temperature continually rises from the first vat to the last. The products of distillation from the first two vats of the battery are collected together and are sold under the name “gasoline.” The products of distillation from the second two vats constitute benzine. The products of distillation from all the remaining vats are collected together and that mixture is called “kerosene.” It consists of all products whose boiling point is higher than that of benzene but lower than 230 degrees Celsius (the temperature in the mixture in the last vat). Gasoline is used for lighting and as a solvent in the rubber industry for diluting tar. Benzine has the same uses and is uses for dry cleaning linens… The residues from the distillation of petroleum is sold as a good fuel for steamships and locomotives… These residues are called fuel oil, and they comprise up to 65 percent of the raw product of Baku petroleum.”

Whose Oil Is the Benchmark?
Consequently, it became known that benzine was good not only for removing stains from clothing, but as a fuel for internal combustion engines, and kerosene ceased being the most valuable petroleum product with the introduction of electric light. Cracking technology was introduced in the 1930s. It uses high temperatures, pressure and catalyzers to produce benzine and hydrocarbons used for petrochemicals. In the United States in 1920, refining one 42-gallon barrel of oil (1 gallon = 3.78 liters) produced 11 gallons of benzine. Now a barrel of oil produces 21 gallons of benzine.

Source: Kommersant| by Sergey Minaev

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