International Crude Oil Pricing

Argus Information Papers on Crude Oil Pricing

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Below are links to four Argus information papers on crude oil pricing in the Asian market.

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Australian Crude Oil Requirements

Australia has two major operating oil refineries. While Australia has substantial crude oil production, Australian refineries only source a minority of their crude oil requirements from Australian fields.

This is partly because Australia crude oil is generally light and getting lighter. Some heavier crude oils are required to produce heavier products such as lubricating oils and bitumen, and as this occurs Australian refineries (which are in general not designed to process large quantities of the very light crudes), must resort to heavier crude imports.

The other significant reason is that overseas crude oils can be purchased at lower prices. This is a function of the value that all oil refineries place on each possible crude they can purchase. Every refinery has a different configuration of plant and equipment and depending upon the product demand in their particular market, particular refinery limitations, and the different product yields (petrol, diesel, kerosene) that are produced from each crude oil, they will each see slightly different value for every crude oil at a particular point in time. Australian refineries are no different and with the highly competitive Australian market under considerable financial pressure, refiners are always seeking ways of reducing costs, and finding cheaper crudes (or better value crudes) is one of these.

See the latest version of 'Downstream Petroleum' for further information on Australian refineries, crude oil imports and sources, and on the Asian regional refining market more generally.

Crude Oil Pricing

Exchanges, price reporting agencies (PRAs) and national oil companies (NOCs) contribute to a complex pricing network for crude oil around the world. Hundreds of different qualities or grades of crude are priced at differentials to actively-traded benchmarks or marker prices that serve as a yardstick to compare value, depending on characteristics such as the share of different oil products that can be produced from each grade, their availability at a specific point in time and the proximity of their production site to demand centres.

The world’s two leading crude benchmarks are WTI (West Texas Intermediate) crude futures listed on the Chicago Mercantile Exchange (CME-Nymex) and Brent crude futures listed on the Intercontinental Exchange (ICE). In the Middle East, the Dubai Mercantile Exchange (DME) trades Oman crude futures that also serve as an important regional marker together with Dubai crude, which is not traded on exchange but has ample liquidity in what are known as over-the-counter (OTC) transactions that are cleared through exchanges. The combination of these financial derivatives allow participants in the oil market to effectively manage risk, hedging the price of their sales and purchases.

The majority of the world’s crude grades trade at differentials to these futures contracts, and those differentials are published by price reporting agencies, which specialize in the collection of transactional data under the PRA principles outlined by IOSCO. Both the exchanges and the PRAs increasingly rely on electronic platforms that streamline the information to generate accurate and widely used indices. Supplementing this pricing network for spot markets and longer-term supply agreements, are the official selling prices that national oil companies (NOCs) of oil producing countries like Saudi Aramco or the Abu Dhabi National Oil Company publish on a monthly basis, which generally reflect the same trends that drive the underlying benchmarks.

The following are requirements for the success of crude price benchmarks:

• Significant and stable supplies
• Homogeneous quality
• Favourable geographic location relative to demand centres
• Dynamic infrastructure and logistics
• Stable government and regulation
• Broad range of participants
• Consistent liquidity: physical and derivatives trading volumes
• Transparency

Brent in the North Sea rose as a benchmark for light sweet crude in northwest Europe in the 1980s, while in North America WTI prevailed as the main pricing mechanism for the domestic US market and for imports from virtually every region, as the US relied on shipments from abroad to meet more than half of demand. With the expansion of production in west and north Africa, Brent gained relevance as a marker for the wider Atlantic basin and the Mediterranean, while WTI continued to anchor pricing across the Americas.

Crude oil grades like Tapis and Minas from Malaysia and Indonesia respectively became regional benchmarks across southeast Asia in the 1990s, but dwindling output has eroded the liquidity of trade that contributed to price formation of these markers, leading to the adoption of North Sea dated (Brent) as the marker for most of the crude produced in Asia-Pacific, including Australian grades.

Declining crude production in the North Sea over the past decade has raised questions about the continued viability of Brent as a widely used benchmark. And the dramatic increase in US output over since 2010, including soaring exports beyond North America to Europe and Asia, are now re-asserting the influence of WTI as a global pricing reference. Increasing pipeline capacity has allowed inland US shale oil supplies to be shipped to refining centres around the world. The flows of North American crude to Europe, for example, are inserting WTI pricing right into the heart of the Brent pricing complex in northwest Europe, as US supplies compensate for the output decline of indigenous North Sea grades.

Please refer to the International Energy Agency Oil Market Report for the latest information and data on crude oil prices and on the international oil market - including key data on supply, demand, stocks, prices and refinery activity. See iea.org/.

Pricing of Physical Crude Oil Trades

Generally this is based on a formula approach where a marker crude is used as the base and then a quality differential (premium/discount) as well as a demand/supply (premium/discount) is added depending on the crude being purchased.

Thus in times of tight supply this premium will rise and gradually drag up the Marker crude price, whilst in times of surplus supply, a reduced premium or even a discount will drag down the Marker crude price. Of course big changes, announcement or events that can significantly influence crude supply levels will sometimes result a large step change in the prices of crude oil (eg. OPEC announcements, civil unrest or wars, hurricane activity, major refinery shutdowns or outages etc).

That is, crude oils being purchased do not always slavishly follow marker crudes. Marker crudes are indicators of what is happening in regional markets.

Crude Oil as an Input Cost to Refiners

It is true to say that the cost of crude oil is the major input cost for refiners. However, the relationship between such a cost and the final price for a petroleum product produced from that crude, such as petrol or diesel, is not as direct as one would think.

There are, for instance, additional petroleum product markers which give a guide to prices. That is, prices are not just a function of cost-push, but are also strongly influenced by demand-pull.

For example, USA environmental requirements for gasoline (petrol) have at times pushed up the prices in the USA by significantly more than the movements in crude prices. This is the market working as refiners who see these prices work hard to increase production to capture some of these high prices before they dissipate under competitive pressure - both from within the USA and from the resulting massive influx of product cargoes from other producing centres in the world.

There are also a number of other variables which affect the price of products such as petrol. In addition the perception of the purchasers and sellers in the market as to the price risk over time can also add or subtract premiums to the product marker price.

For information on price markers for the Australian market, see:

• Facts - About Prices & the Australian Fuel Market

Conclusions

Prices of crude oil markers and petroleum product markers are affected by a myriad of factors including:

• overall supply/demand for crude
• supply/demand for petroleum products
• freight rates
• competition in the crude markets
• competition in the regional and domestic markets for petroleum products.

They all have a role in determining the final price charged to consumers and the role that each of these elements plays can change over time. It is this very complexity in markets which makes it very difficult to determine a theoretical price as part of regulation in markets because there may be a perception that because the theoretical price is different from the market price that the market price is 'not fair' for some reason.