The increasing divergence of WTI Pricing from World Markets

www.platts.com Market Issues The increasing divergence of WTI pricing from world markets Platts proposes launch of Americas Sour Marker to address problems with the primary US crude oil benchmark Introduction The Issue Proposed Solutions Platts Review Process of the WTI Market The Americas Sour Marker Field Information Assessment Determination Conclusion 2 2 2 4 4 5 5 6 LATEST UPDATE: March 2009 The McGraw Hill Companies MARKET ISSUES THE INCREASING DIVERGENCE OF WTI PRICING FROM WORLD MARKETS MARKET ISSUES The increasing divergence of WTI pricing from world markets Platts proposes launch of Americas Sour Marker to address problems with the primary US crude oil benchmark INTRODUCTION Platts has been monitoring the behavior of West Texas Intermediate (WTI) crude oil cash and futures markets and has become increasingly concerned over the unusual price volatility in these key US benchmarks, as evidenced in particular by recent extreme deviations in price relative to other global crude benchmarks. The disconnect of WTI from other world crude oil prices has drawn the worried attention of both refiners and producers dependent on its prices. More recently, it has been widely reported that major institutions such as the International Energy Agency have questioned the validity of the benchmark. In short, there has been a groundswell of commentary and reports questioning WTI’s continuing value as a broad benchmark for pricing crude oil in the Americas. As a result of its own observations and concerns expressed by market participants, Platts has launched a fast-track review process aimed at developing pricing alternatives for the Americas crude markets to address the disquiet of producers and consumers alike. Moreover, in light of the fact that various Platts assessment processes in the US incorporate to some extent WTI pricing, we believe it is necessary for Platts to mitigate the impact of WTI futures on the integrity of its own physical assessments of crude values in the Americas. Platts takes seriously its role as a supplier of information and it is making sure it both signals clearly its discomfort with WTI and offers clear alternatives. In a normal market, WTI should sell at a premium to Brent and always at a premium to heavier, sour grades that are more difficult to refine. Yet, on an increasingly frequent basis, WTI has sold at a steep discount, often $10 below Brent and even below sour crudes, including the OPEC basket and similar crudes from the Gulf of Mexico. The problem is tied to the difficult logistics in Cushing, Oklahoma, in particular the infrastructure ownership, the relative opacity of information on oil storage available in the area, and bottlenecks in pipelines from the Gulf Coast. The result is that WTI, usually viewed as a global reference price, is in fact functioning as a local, land-locked crude with an increasingly tenuous relationship to the overall US and international markets. In sum, WTI is neither a world benchmark nor a benchmark suited to price oil produced within or exported to the US. At best, WTI seems currently suited to pricing oil in Cushing, Oklahoma. Platts has been observing the pricing divergence of WTI for a number of years, taking note in numerous forums of the susceptibility to distortion of prices established in areas where there are supply, demand or transportation constraints. Platts has been a leader in identifying problem areas in pricing and offering solutions to the marketplace, as these challenges have not been limited to the US. Platts is very pleased to have designed and implemented robust solutions to earlier price formation problems in the North Sea and Dubai that are widely accepted by global oil market participants. THE ISSUE There has been ample industry comment and agreement on many of the factors affecting the stability of WTI pricing. WTI crude oil traded on the New York Mercantile Exchange has been the most commonly accepted benchmark for oil prices in the US, but the grade has increasingly diverged from global markets. Normally, WTI maintains predictable relationships with other global crudes, the most significant being Europe’s Dated Brent. These two benchmarks, practically equal in quality, should typically trade with WTI maintaining a $1.50 to $1.75 premium above Brent as a result of natural relationships in the physical oil markets and the cost of freight. PROPOSED SOLUTIONS Platts has been exploring several options in the US to improve crude oil price discovery and, as an example, focused initially on US Gulf sour crude oil Mars. We believed the US market needed a strong sour benchmark, as most of the crude consumed, produced, refined and imported is sour. The frequent threat of hurricane activity and the vulnerability of operations and platforms to outage in the US Gulf, however, has shown the exposure created when price is centered on a single stream of crude oil. Platts has extensive experience in creating alternative delivery processes that, in effect, incorporate related grades of crude to 2 MARKET ISSUES THE INCREASING DIVERGENCE OF WTI PRICING FROM WORLD MARKETS broaden the availability of crude volumes to form a price benchmark, lessen the possibility of logistical constraints and open price formation to a representative community of buyers and sellers. This approach of alternative delivery has been extremely successful in the North Sea and also in the Middle East. Platts is now ready to apply lessons learned from applying such a mechanism to price formation in the Americas crude market. Platts published on March 2, 2009, the following subscriber note detailing its proposal to launch a benchmark that will reflect tradable sour crude oil in the US Gulf Coast: Platts is considering the launch of a new sour crude assessment in the US to capture the value of sour crude oil in the US Gulf of Mexico, the main hub for refining, production, importing and handling of crude oil in the United States. The assessment is spurred by the apparent ongoing inability of the West Texas Intermediate reference, particularly at Cushing, Oklahoma, to fully represent US Gulf Coast crude economics. The launch of this new assessment would come as early as March 16, 2009. The US Gulf Coast, comprising of Alabama, Louisiana, Mississippi and Texas, together have a total refining capacity of 6.3 million b/d (barrels/day) or about 42% of the country's total refining capacity. The new assessment, which would be named Americas Sour Marker (ASM), would reflect four US Gulf Coast sour pipeline crudes: Mars, Poseidon, Southern Green Canyon, and Thunder Horse. The underlying methodology for ASM would follow the Platts Brent-Forties-Oseberg-Ekofisk (BFOE) assessment model in the North Sea, with the ASM assessment reflecting the most competitively priced grade of the four sour crudes. Platts would publish ASM assessments for the first three months. The rollover for ASM would coincide with the rollover of the existing sour crude pipeline assessments and would take place on the first business day after the 25th of each calendar month. On March 16, Platts would publish ASM assessments for April, May and June. On March 26, ASM assessments would reflect May, June and July. ASM would be published on Platts Global Alert page 171, in Platts Crude Oil Marketwire, in Platts North American Crude Wire, in Platts Oilgram Price Report, and in Platts Dispatch. Platts is seeking industry comment on this proposal through March 9. Please direct your comments, questions and inquiries to Jorge Montepeque, +44 207-176-6136, Jorge_montepeque@platts.com, Esa Ramasamy, +1 713-6583292, Esa_Ramasamy@platts.com and Sheela Tobben, +1 212904-4105, sheela_tobben@platts.com, with a cc to pricegroup@platts.com Platts believes that price formation should occur where there is a marketplace—in short where there is a confluence of buyers, sellers, physical facilities geared to supply, and proximity to consuming centers. This is evidenced in the US Gulf, where there are sellers to supply oil relatively free of logistical concerns, and where there are buyers willing and able to acquire it. These two simple but important conditions are not present in Cushing, Oklahoma. The following graph shows the pronounced volatility experienced by WTI, as on one hand, supply is tightened and/or demand overwhelms the physical infrastructure for a short period of time, or on the other hand, supply goes begging or rolls between the front and the second month to create wide gaps in pricing for the same commodity. WTI Inter-Month Spread (front month minus second month) 15 10 5 0 -5 -10 Dec-07 Feb-08 ($/bbl) Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 The excesses in volatility have led to truly remarkable spikes and troughs. Spikes and troughs are not in themselves nonrepresentative of market conditions, but in this particular case those aberrations represent very local issues at Cushing, Oklahoma. Due to the influence of WTI and its wide usage as a benchmark, refiners and producers, among others, are buffeted and potentially harmed as price signals are distorted by local events having no connectivity to market conditions in the wider US or elsewhere in the world. As an illustration, if someone wants to use a thermometer to obtain a representative temperature in a location, say the kitchen, it is clear the thermometer should not be placed in between the refrigerator and the stove, or otherwise the temperature reading is going to be subject to wild variations which have nothing to do with the representative temperature for the room. The following graph shows the backwardation and contango in the Brent market over the exact same period as above and on the same scale. The difference in performance could not be more stark, with the behavior in the US market pointing to a stressed Brent Inter-Month Spread 15 10 5 0 -5 -10 Dec-07 Feb-08 ($/bbl) Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 3 MARKET ISSUES THE INCREASING DIVERGENCE OF WTI PRICING FROM WORLD MARKETS Dubai Inter-Month Spread 15 10 5 0 -5 -10 Dec-07 Feb-08 Apr-08 ($/bbl) In sum, WTI is neither functioning as a world benchmark nor a benchmark suited to price oil into the US. At best, WTI is increasingly suited to price oil in Cushing, Oklahoma only. The graph (bottom left) shows the actual comparison of the three benchmarks, where it becomes apparent that WTI clearly unhinged from global oil economics from September 2008. This disconnected behavior has continued for six months and the clamor for solutions has steadily grown. Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 PLATTS REVIEW PROCESS OF THE WTI MARKET Platts routinely reviews markets and methodologies in its role as an impartial and independent publisher. Platts enjoys access to numerous market perspectives, ample data and is in a position to engage both suppliers and consumers, longs and shorts with a view to develop market solutions. Due to the fact that many participants have positions in the market, it sometimes becomes difficult for some of them to provide non-partisan views, but during the process of market consultation Platts is able to reconcile conflicting viewpoints, gain a better understanding of critical market processes, and offer impartial solutions. Platts has observed and reported on surges or falls in the price of WTI associated with inventories, refining or pipeline issues in Cushing for years, and three years ago started a communication process with exporters and importers about the need to have a market price discovery solution that relied more on sour crude and less on sweet due to the preponderant fact that roughly twothirds of the crude production, imports and refining capacity in the US market is sour. Platts also believed that price discovery in Cushing, Oklahoma was itself anomalous as the oil there faces significant logistical difficulties in reaching what should be its main market, the US Gulf Coast refining center. The focus at the time was Mars crude, but the impact of Hurricane Katrina and other major storms quickly put to rest the notion that a market solution reliant on one single grade was a sound idea. Besides the fact that facilities can be impaired by hurricanes or other unforeseen events, some crude streams are characterized by dominant ownership, leading to issues of ownership control and availability of freely tradable crude in the marketplace. situation with bouts of heavy selling and heavy buying in Cushing, Oklahoma, which are not replicated elsewhere. Furthermore, it should be noted that the US is heavily dependent on foreign crude, which increasingly is Brent linked. While the economics in the US are and should be distinct from other areas of the world, the US is not isolated from world oil economics and indeed attracts oil from the North Sea and also from the Middle East, among many other areas, to feed its refining system. But even when compared with Dubai, the key benchmark for Asian economics, the same pattern of relative stability in other areas is evident as compared with the US. The following graph shows the contango and backwardation of Dubai over the same period and price scale. A comparison of the three world benchmarks shows a behavioral disconnect in the US highlighted by a combination of factors that have lead to the market distortions. Difficult logistics in Cushing, Oklahoma related to infrastructure ownership, relative opacity of the actual tankage available in the area, difficult access to the oil in the area via pipeline to other oil-thirsty locations in the US, and technical situations that develop between longs and shorts result in spikes or troughs that bear no relation to the actual tightness or surplus of oil in the US markets and in general. WTI, Brent and Dubai Inter-Month Spreads. It shows WTI (the red line) disconnecting from other benchmarks ($/bbl) 15 10 5 0 -5 THE AMERICAS SOUR MARKER Platts has reviewed the pipeline systems, production and ownership of a number of crude streams and concluded that the Americas Sour Marker (ASM) assessments should be composed of Mars, Southern Green Canyon, Poseidon and Thunder Horse. The combined production of these streams is roughly 835,000 b/d. Thunder Horse crude oil is of lower sulfur content than the other grades, but Platts believes that it should be part of the basket and would only play a significant role in times of severe supply distress. This grade acts in a similar manner to the potential check that Ekofisk plays as a component of the BrentForties-Oseberg-Ekofisk mechanism (BFOE). WTI Brent Apr-08 Dubai Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 -10 Dec-07 Feb-08 4 MARKET ISSUES THE INCREASING DIVERGENCE OF WTI PRICING FROM WORLD MARKETS Alternative delivery systems operate on the basis that as one of the crude oil streams comprising the basket becomes dear for whatever reason, the seller can supply a better grade and the buyer would end up even better off. In an assessment process reliant on the most competitive grade — as used in the price determination of the key world benchmark Dated Brent — if the most competitively priced crude oil were to disconnect, then the benchmark price would be set by the next best competitively priced crude oil. The following slide shows the production of crude oil forming the marker. ASM daily production totals close to 835,000 b/d. FIELD INFORMATION Thunder Horse: BP is operator of the project with 75% equity interest. The remaining 25% is owned by ExxonMobil. The Thunder Horse platform is located about 150 miles southeast of New Orleans, Louisiana, in Mississippi Canyon at a water depth of 6,050 feet. Mars Blend: Shell's production originates from Ursa, Mensa and Mars platforms and is commingled with Amberjack pipeline volumes to create Mars Blend. Shell Pipeline Company LP serves as operator of both the Mars and Amberjack pipelines. These two lines also gather production from Green Canyon, Ewing Bank, Ship Shoal, South Timbalier and Grand Isle. Here is the link on the structure of the Mars system: http://www.shellpipeline.com/cd_maps/SPL403_D_marsmap_f.pdf Poseidon: The Poseidon pipeline gathers supplies from Garden Banks, Vermillion, South Marsh Island, Eugene Island Ship Shoal, Green Canyon, South Timbalier and Ewing Bank. Here is the link on the structure of the Poseidon system: http://www.shellpipeline.com/cd_maps/SPL403_D_posmap_f. pdf Southern Green Canyon: The Cameron Highway Oil Pipeline System (CHOPS) gathers from fields located in Green Canyon: The fields include K2, Ticonderoga, Constitution, Atlantis, Mad Dog, and Holstein. A link to CHOPS system follows: http://www.cameronhighwayoil.com/Schematics_And_Capabiliti es/Schematic_DelPnts.PDF Volume composition of Americas Sour Marker 200,000 b/d 24% 365,891 b/d 44% Mars Poseidon 149,413 b/d 18% SGC Thunder Horse 119,258 b/d 14% Mars production reflects average for December 2008. Poseidon and Southern Green Canyon (SGC) production reflects average for January 2009. Thunder Horse production reflects estimate announced by BP in December 2008. ASSESSMENT DETERMINATION Platts is proposing for the ASM benchmark to be determined by activity in the marketplace in its normal Market-on-Close assessment processes in the US. The assessment would be set by the most competitive stream in the basket. This process is currently widely used in the daily assessment processes for Brent, Forties, Oseberg and Ekofisk (BFOE) in the North Sea and by the Dubai Asian benchmark which is composed of Dubai, Upper Zakum and Oman. The approach is time tested and flexible to incorporate further streams over time should it prove necessary to maintain the health of the benchmark. Platts has reviewed the suitability of supplying crude from segment 17 in LOOP (the Louisiana crude discharge and storage facility) in the event that waterborne crude could be considered in the assessment process at a later stage. The ASM basket of crude trades in an area where the US has 6.3 million b/d of refining capacity, which equates to roughly 42% of the total US market. In Platts’ view, the confluence of the refining capacity and production should result in a market price that is unlikely to suffer distortions. The only issue remaining is that US Gulf Coast crude is not exportable. But since the US market is a net importer of crude, and by a large margin, the issue is not worrisome. The ASM streams can be delivered readily into an area in Texas/Louisiana with a refining capacity of 6.3 million b/d. The US is currently operating at a rate of about 15 million b/d, implying that the basket of crude could access roughly 42% of the US actual operating capacity. The actual users of these grades comprise much of the major refining community in the US. The latest production detail, gravity and sulfur content are provided below: Production, gravity and sulfur content Latest data: Volume (b/d) Mars 365,891 Thunder Horse 200,000 Southern Green Canyon 149,413 Poseidon 119,258 Sulfur (%) 2.23 0.65 2.48 1.41 Gravity (API) 29.18 33.7 28.4 33.17 For technical information regarding the field and pipeline structure, Platts recommends following the links in the attached field information. 5 MARKET ISSUES THE INCREASING DIVERGENCE OF WTI PRICING FROM WORLD MARKETS All of the crudes in the ASM basket share similar characteristics and track general and broader market trends as they all compete with many other similar crudes for outlets in the US Gulf Coast marketplace, while buyers vie for the same crude oils to feed their units. Conceptually, the possibility of supply squeezes would be substantially reduced as the basket contains daily production of roughly 835,000 b/d and it is flexible enough to accommodate future expansion with other US domestic streams or foreign oils. Conversely, refiners would react quickly to buy oils if prices were overly attractive, as the streams have access to a broad and ready market via several pipelines reaching 6.3million b/d of potential consumption. To illustrate the components of the basket, the following graphs shows the four grades envisioned: not because sour grades are at a premium to the WTI but because WTI has fallen below its own economic value, were it to be in a place other than Cushing, Oklahoma. This price independence is more marked since December 2008 as seen in the following graph. The following graph shows the WTI price differential to ASM, which in normal times should be positive (i.e. above zero). However, as WTI disconnects it has now fallen below the market. This fall is symptomatic of the troubles faced by WTI and anyone using WTI as a marker. WTI Spread Versus ASM 15 ($/bbl) The Price Behavior of Americas Sour Marker Components 150 130 110 90 70 50 30 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 ($/bbl) Poseidon SGC Thunderhorse Mars 10 5 0 -5 -10 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 CONCLUSION Following an extensive analysis of crude oil pricing in the US, Platts has concluded that WTI pricing is exhibiting a significant disconnect from global oil economics as well as from US Gulf Coast economics, a condition that is likely to persist. Market signals emanating from WTI create a distorted perception, as prices could be falling in Cushing, Oklahoma, while rising elsewhere or rising in Cushing while falling or stable elsewhere as seen in September when the US prices rose intraday by $25.00/barrel. Platts believes that alternative pricing models can serve to provide better representation of the value of crude oil in the broader Americas markets. It is proposing to offer an alternative formed by the most competitive of four crude oil streams, Mars, Poseidon, Southern Green Canyon and Thunder Horse. These four crudes would form the Americas Sour Marker. Platts continues to analyze the situation and believes, in addition, a light crude benchmark free of the deviations faced by WTI may be appropriate. Platts is evaluating the further launch of a sweet light marker and/or setting a bracket around WTI to ensure Platts assessments are not distorted when WTI is diverging from broader market norms. The Americas Sour Marker would be determined by the most competitive assessment of the four grades. The following graph shows the flat price behavior of the Americas Sour Marker. It should be noted that the marker follows general market trends and that it was formerly influenced largely by the behavior in WTI. However, in recent months the components of the basket as well as other US crudes are showing a behavior more consistent with broader market conditions and have been trading at a premium to WTI. This is The Price Behavior of Americas Sour Marker 150 130 110 90 70 50 30 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 ($/bbl) For comments or questions please contact Jorge_montepeque@platts.com, Esa_ramasamy@platts.com, Suzanne_evans@platts.com. 6