NOCs look to price formation and hedging

Among Middle East producers, the business culture has historically focussed on strong customer relations and security of demand, says Paul Young

Paul Young is the head of Energy Products at the Dubai Mercantile Exchange.
Paul Young is the head of Energy Products at the Dubai Mercantile Exchange.

Oil pricing is usually never far behind the headlines when it comes to the world of hydro-carbons, but in the three-and-a-half-year period between the start of 2011 and mid-2014 when prices consistently above $100 per barrel were considered the new normal, pricing was largely relegated to a mere footnote in the financial bulletins.

Now oil markets are back at levels not seen since the early part of the century prices are once making headlines, impacting everything from the economic survival of shale producers in the US to the national budgets and geopolitics of the Middle East, price formation and transparency are coming under close scrutiny, particularly as producers look at hedging opportunities to mitigate losses as a result of potential price swings in the coming months and years.

Benchmark crude grades with an attached futures contract offer the greatest hedging opportunities for oil producers and of around 200 types of crude oil that can be classified as significant streams or blends, only three of those make the criteria – Brent in Europe, WTI in the Americas and the newest addition to that very select group, Oman, serving the Asian and the Middle East markets. The flagship Oman futures contract on the Dubai Mercantile Exchange (DME) was launched in 2007, joining the more-established Brent and WTI. The DME was conceived to offer a viable Middle East/Asia contract for trading and risk management opportunities and leverage on the terrific economic growth throughout the region. While a futures contract is not a guide or forecast to what will happen in future, it will allow buyers or sellers to lock in prices at a future date, or fix a buy/sell price through the options mechanism.

For example, a canny shale producer that locked in five years’ worth of production in 2014 against WTI at an average futures price of $80 a barrel would be in a much better position to ride out the storm until the oil markets rebalance and begin a steady price recovery, which can be anticipated due to the cyclical nature of the business.

Oman’s Ministry of Oil and Gas took the landmark decision in 2007 to migrate all of its oil pricing to the DME — the first government anywhere in the world to fully price its oil revenues against an index derived from a futures Exchange.

This switch by the MoG cemented Oman crude as the most important benchmark grade for the Middle East and Asia, while also helping to make Oman one of the most popular crude grades among customers.

Among the Middle East producers the business culture has historically focused around strong customer relations and security of demand, leaving price formation to others and selling on an Official Selling Price (OSP) which is calculated against underlying physical prices generated by media companies that specialise in commodities reporting.

National Oil Companies (NOCs) in the region had made little contribution to underlying prices in the past but a number are now taking a far greater role in the pricing mechanics of the industry. Oman has been the leader in that respect with the formation of Oman Trading International which takes hedging activity and trading positions across the barrel, ranging from crude oil, refined products and petrochemicals.

More recently, Saudi Arabia is making headwinds in the refined products markets with the formation of Saudi Aramco Products Trading Company, while Qatar’s Tasweeq is taking a much more market-focused view of its trading activities. In fact Qatar was the first Middle East producer in 2012 to use oil futures options to hedge against price volatility.

Since its launch the Oman futures contract has enjoyed an average yearly growth of 25% in average daily volume terms (ADV) and last year reached the nine billion barrel mark in terms of barrels of Oman crude traded on the Exchange during the last eight and half years, and offers enormous potential as the oil benchmark of choice in the coming years.

A significant ingredient for Oman’s success as the most prominent benchmark grade in Asia has been the sharp increase in production and exports over recent years, which has enabled the DME contract to deliver between 15 and 22mn barrels of Oman crude every month via the DME’s delivery mechanism. Over 30 customers typically lift physical Oman crude via the Exchange delivery mechanism every month, shipping the oil to refineries across Asia. Oman crude production recently hit one million barrels per day, making it by far the largest benchmark crude grade anywhere in the world.

While DME Oman is for now the little brother of the more established Brent and WTI contracts, Oman will continue its rise and establish a place as one of the world’s top commodity benchmarks. NOCs will be a significant part of that success story.


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Oil & Gas Middle East - September 2020

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