The way we price it. The places we trade it. The companies that stand to profit most.
It's all about to change.
This was confirmed at a meeting I just attended in The City, London's financial district. I arrived from Moscow's Domodedovo Airport for an unusual Saturday morning gathering of bankers, traders and analysts called only days before.
The subject? A new oil-pricing index.
This is huge.
More oil-project funding is raised within a three-mile radius of The City's Liverpool Street train station than anywhere else on Earth. And now they're preparing to control the oil trade, as well.
This will create all kinds of new ways to make money in oil. Not just with fancy financial instruments designed for the "big boys," but with retail investments, too. So there's money in this for you.
Traditional Benchmarks Tell a Fraction of the StoryThere are more than 200 benchmark rates for crude oil. But only two of them, essentially, determine most of worldwide pricing: West Texas Intermediate (WTI), the benchmark used in New York Mercantile Exchange (NYMEX) trading; and Dated Brent, the equivalent in London.
Despite accounting for less than 15% of the daily volume actually traded, these two have controlled the market.
They hardly reflect the real world of oil. Both are sweet (low sulfur) grades. Yet most of the world deals with sour (higher sulfur) crude.
That's why Argus Media in London recently began issuing its new Argus Sour Crude Index (ASCI) benchmark. A decision by Saudi Aramco to leave WTI and price its exports on ASCI, beginning with January deliveries, has emboldened the new approach. And now there are strong indications that Kuwait and Venezuela may soon follow suit.
This is a very big deal.
As a sour crude rate becomes more the benchmark of choice, "wet-barrel" trading (buying and selling the actual oil) will rely less on prices set by future contracts, or "paper barrels," in New York.Â
This has a number of people showing interest.
In fact, our meeting took place at Argus Media's head office on St. John Street. And while the proceedings were informal, there is a general consensus on what is coming.
Two things stand out:
- The differential between the paper barrels and the crude oil sales - the actual asset upon which they are based - will become more volatile.
- As this takes place, trading liquidity will begin to follow the crude pricing to futures contracts based on ASCI - rather than WTI.
This is really all about liquidity.
The greater the liquidity in a market, the easier it is to determine a realistic price for the commodity.
Illiquid markets are forced to peg contract prices to markets that are liquid. This has allowed WTI and Brent to dominate because of the aggregate value of active contracts priced on them. Most other consignments using alternative benchmarks cannot provide sufficient liquidity for a genuinely separate trading mechanism. So they end up pegging prices at a premium or discount to either WTI or Brent.
ASCI is about to change that...
A More Accurate Price for OilFor some time, global trade as a whole has overlooked the imbalance. But with WTI reflecting neither the true value of global oil or, for that matter, even the grades of oil increasingly used in the United States, pressure's been building to revise the trading system.
ASCI provides a volume-weighted average of all physical deals (cash-settled contracts) in the three primary U.S. Gulf Coast sour grades taken together - Mars, Poseidon and Southern Green Canyon. That contrasts with Platts, Argus Media's primary competitor, which uses a "window," a period of time during which bids and offers are entered, to determine a daily closing price for WTI.
Some have suggested the Platts method allows for a certain amount of "gaming the market." If a window is used to report the bids and offers, but one still uses a market-closing to determine the price, it allows possible trades merely to influence the final quote.
That does give ASCI a certain transparency advantage.
"We are positioning ASCI to serve as a more reliable barometer of the actual price," Argus Chief Executive Officer Adrian Binks told me during a coffee break. Peering over his spectacles, he added: "Liquidity will follow the benchmark most openly set and reflecting the widest number of actual trades."
No date has been set yet for electronic trading in the contracts. That awaits firm liquidity in cash contracts. But ICE certainly believes that is coming - and fast.
David Peniket, president and COO of London-based ICE Futures Europe, told us that the exchange is moving quickly to set up the structure for a full range of derivatives and options trading on them once ASCI-priced contracts are set.
Its competitors are moving quickly, too.
On Dec. 7, CME Group Inc. (Nasdaq: CME), the world's largest futures exchange (combining the Chicago Board of Trade, the Chicago Mercantile Exchange, and the parent company of the NYMEX), began trading in its own Gulf Coast sour crude oil futures contract - available via the Globex electronic trading platform and the NYMEX trading floor. This new contract will deal with Mars grade sour crude only, with delivery at the Louisiana Offshore Oil Port LLC (LOOP) facilities.
Unlike Argus and ICE, CME officials do not think a new benchmark is arriving anytime soon. They have tried to launch sour crude rates before, without success.
ASCI competition and a market-wide recognition that new pricing mechanisms are warranted, however, make this an entirely different ballgame.
What happens next will provide investors with several new opportunities to profit, regardless of where this "battle of the exchanges" takes crude oil rates.
Overall Prices Will Start to IncreaseThe overall prices of these contracts will be moving up for the simple reason that increasing liquidity in sour crude trading contracts will finally provide for direct pricing, not estimated pricing off of WTI or Brent levels.
I expect the volume of sour crude contracts trading elsewhere - Dubai, Singapore, St. Petersburg and even the fledgling benchmark established by the new Iranian Kish Island exchange - to increase, too, and to show widening justification for genuine derivative instruments.
Everyone at this meeting expected the same thing. Several noted that the emerging arbitrage environment will allow a wide variety of swaps, secondary paper trading, option opportunities, creation of investment funds, hedge moves, and a multitude of exotics.
Given the widening number of liquid contracts likely to emerge pegged to a wide variety of benchmarks, the days of reserving oil trading primarily to a few well-financed players may end. As another attendee, a veteran Cyprus-based oil trader with whom I have worked for years, succinctly put it: "ASCI is the first of many."
That means that you can expect to see new vehicles for retail investment in a very active oil commodity and futures market. I'll show you how to profit from them as soon as they surface. And I'll also shake out the companies best-positioned in the new trading environment.
News and Related Story Links:
Official Web Site.
Official Web Site.
The City of London.
Official Web Site.
- Â Wikipedia:
West Texas Intermediate.
United for Peace:
NEWS: Western corporate media willfully silent as Iran opens oil exchange on Kish Island.
Saudi Aramco Switches to Argus Sour Crude Index for U.S. Deliveries.
Dated Brent Crude.
IntercontinentalExchange Inc. Press Release:
ICE Announces Launch of Argus Sour Crude Index (ASCI) Futures Contracts.