Do You Believe in Brent After WTI? - Implications of Adding WTI to the Dated Brent Price Assessment
Like an aging pop star, price benchmarks have to re-invent themselves from time to time to maintain their status. The Dated Brent marker –– as much a survivor as Cher, still going strong at 76 –– has had successes and setbacks in the past and will undergo yet another transformation by June 2023, courtesy of price reporting agency Platts. You definitely need to pay attention to this change, because Dated Brent is used as a pricing reference not only for several crude oil streams sold around the world, but also for other commodities such as LNG, fuel oil and other refined products and petrochemicals — oh, and financial derivatives too. Also, the latest version of the price marker will include an adjusted price for the U.S.’s prolific West Texas Intermediate (WTI). In today’s RBN blog, we discuss the details and implications of Dated Brent’s latest makeover for traders, refiners and other market participants.
According to Wikipedia, Cher’s career has gone through 13 phases (so far!), beginning with her initial solo breakthrough (with Sonny Bono as her producer) in the early 1960s through her more recent success with Dancing Queen, a hit album in which she covers a slew of ABBA songs. Dated Brent doesn’t have Cher’s longevity (it was created in the 1980s) or as many #1 hits (for Cher, at least one every decade from the ’60s through the 2010s), but it has undergone a significant number of re-dos to help ensure its center-stage role in global energy markets. And don’t question its star status — according to some estimates, Dated Brent is used as a reference for as much as 60% of the world’s crude oil spot or contract transactions.
Ironically, over the last 20 years or so, calculating the Dated Brent price has been one of the most challenging endeavors of the energy industry. That’s because, as the years have worn on, the markets evolved and the older fields producing crude included in the Brent basket have declined, the assessment has also evolved to ensure it’s an accurate representation of the Brent market. We’ve previously published two comprehensive blogs on the subject. The first, titled Wake Up!, fleshed out how the lack of liquidity due to declining Brent production forced price reporting agencies to lengthen the time-frame for price reporting and to include production from other areas. In 2002, after years of declining production in the Brent field in the North Sea between Scotland and Norway, crude oil grades representing nearby Forties and Oseberg production were added, as were Ekofisk and Troll grades in 2007 and 2017, respectively. The second blog, titled Lift Me Up!, explained the elements of the entire “Brent Complex,” which is an intricate pricing system that includes not only spot transactions, but also Forward Brent and Brent Futures, all of them woven together via Contracts for Differences, Dated to Frontlines and Exchange for Physicals. All of the changes to Dated Brent were made after consulting with the market at large and the same has been happening in the latest go-round.
The announcement regarding the inclusion of WTI volumes in the Dated Brent price assessment is the latest attempt to add liquidity to a benchmark that continues to remind both physical traders and the financial community that certain commodities have life cycles, and in the case of crude, decline rates that accelerate over time, leading to the practical inability to support credible and representative market prices. Facing the reality of smaller physical volumes of crude oil in the North Sea, the formula for setting Dated Brent is again being jiggered to make sure it will remain valid and relevant in the future. After a public consultation initiated in mid-2021 and a formal proposal issued in February 2022, Platts in June announced its upcoming June 2023 changes to the Dated Brent price assessment, which — not surprisingly — will include an adjusted WTI price.
The new 2023 North Sea basket would include WTI transactions (bids and offers), complementing the Brent, Forties, Ekofisk, Oseberg and Troll (BFEOT) volumes already being factored in. So, why add WTI now? Well, future production of all North Sea crude streams added to the Brent basket so far will dwindle significantly and the option of a basket that considers only native grades as BFEOT is no longer a long-term solution for this important price marker.
WTI cargoes, on the other hand, have been arriving in significant numbers in the European market for over six years now, which helps ensure the physical liquidity necessary to consider WTI as an option, even given its geographic disconnect from the North Sea. And given the production prospects in the U.S. as well as the export infrastructure investments that have been completed along the U.S. Gulf Coast, the plan to add WTI to the basket seems to be a positive one for liquidity. U.S. crude exporters found a fertile market in Europe when the U.S. ban on most crude oil exports was lifted more than six years ago, and, with Russia's war on Ukraine and its repercussions, U.S. exports are even more welcomed in Europe now.
In order to frame the addition of WTI into the context of the Dated Brent basket, let’s start by reviewing the role of U.S. crude exports in this region. For decades, the U.S. market was short crude and imported North Sea grades; therefore, Dated Brent crude prices served as a mechanism upon which those transactions relied. Following the lifting of the U.S. crude export ban in December 2015 and the build-out of pipeline and export infrastructure, U.S. crude exports (excluding exports to Canada) have gone from virtually zero to about 3 MMb/d.
Figure 1 - U.S. Crude Export Destinations. Source: EIA
Today, about 43% of U.S. crude exports go to Europe (blue line in Figure 1) — 1.2 MMb/d so far in 2022 — with about 51% of the total sent to Asian refiners (red line). The balance of U.S. exports (green line) is sent to other destinations, such as occasional trade to Latin America or Africa.
Now that we know a little bit more about the magnitude and destination of WTI exports, let’s review the specific addition to be implemented to the Dated Brent price assessment, and its implications. Platts announced June 8 that it will incorporate WTI Midland into its Dated Brent price assessment, with the changes to be implemented by June 2023. Here are some key elements of this move:
- Currently, the Dated Brent assessment published by Platts considers cargoes of five different North Sea crude grades (Brent-Ninian Blend, Forties, Oseberg, Ekofisk, and Troll) on both a Free on Board (FOB) basis and Cost Insurance and Freight (CIF) basis. FOB, representing the point of sale where producers gather their barrels and buyers take possession, is the most common publishing method as it captures the value of waterborne vessels leaving the North Sea. CIF, however, represents crude delivered into the port of Rotterdam and so must account for the difference in location that arises.
- This is done through a Freight-Adjustment Factor (FAF), in this case 80% of the average freight cost from the five North Sea ports into Rotterdam. This factor is added on to the price of CIF Rotterdam-delivered crude to virtually transport it to one of the North Sea locations — making it comparable to FOB basis cargoes loading at those locations. To be included in the Dated Brent pricing basket, WTI cargoes will be assessed as if available for sale alongside other North Sea locations, rather than being delivered to Northwest Europe (NWE).
- Under this consideration, the pricing agency is basically acknowledging the fact that WTI cargoes are already arriving in Europe (via Rotterdam) and that by adding a hypothetical freight rate from there to the North Sea it will be possible to mimic the arrival of such WTI barrels as if they came from Sullom Voe or other North Sea terminals. (It’s worth noting that U.S. crude arrives in significant volumes at NWE destinations other than Rotterdam, like Spain, France and the U.K, but only Rotterdam-delivered barrels are included in this assessment.)
For practical purposes, the price assessment will continue to rely on Platts’ Market on Close (MOC) methodology, which will include all corresponding transactions, as well as bids and offers for WTI CIF Rotterdam as well. The MOC is a way that Platts approaches price assessments that basically focuses on capturing the price of transactions (as well as bids or offers) completed by the end of the day, rather than during the full day.
How much liquidity will be added with this proposed change? In its July 2021 white paper on the subject, the pricing agency included the graph shown in Figure 2. As you can see, the gray-shaded “Forecast” area not only shows the addition of WTI volumes delivered to Northwest Europe (dark pink layer) but the possible addition of volumes from the Johan Sverdrup field in the North Sea off Norway (light pink layer) — more on that in a moment.
Figure 2 - Dated Brent Production Volumes. Source: S&P Global Platts
The data in Figure 2 is consistent with today’s crude flows — as of June 2022, the total U.S. crude arriving in Europe was hovering around 1.2 million MMb/d, in contrast with the approximate 800 Mb/d that the Brent basket (BFOET; various blue layers) currently represents. So, the addition of WTI to this North Sea basket is a valid argument toward additional liquidity — that is, Dated Brent transactions will no longer be dominated by a few European producers and offtakers, but it will include additional cargoes arriving from the U.S. as well. More cargoes to be assessed means more transactions, which in summary means more liquidity.
As for the Johan Sverdrup reference in Figure 2, that was tied to an option that Platts had discussed about adding volumes from that North Sea field as well. However, given the quality difference between Johan Sverdrup crude (28 API; 0.8% sulfur) versus the rest of the light sweet basket (hovering in the 37-39 API range; 0.20% to 0.40% sulfur) it makes sense to leave the idea of adding Johan Sverdrup crude to the Dated Brent basket on the back burner for now.
The extent to which the addition of WTI increases liquidity will hinge upon how many WTI trades are effectively completed within the Platts MOC window. It will also be important to understand with more granularity the actual freight costs to be factored into the revamped Dated Brent assessment next year, but the sheer potential of delivered WTI cargoes into Rotterdam will likely define most of the Dated Brent assessments after June 2023.
There are several other elements that could potentially add noise to the North Sea marker due to this implementation, two of which are worth monitoring closely. One is that limited ship availability in the Atlantic Basin (or an excessive surplus of tankers) could result in artificially high or low WTI prices when compared to the rest of its European basket peers. The other is that U.S.-specific events could unilaterally modify the WTI price, which when exported into Europe would impact the region’s refiners and consumers.
So, is adding WTI to the Dated Brent assessment good news? “Good” is always in the eye of the beholder. It certainly seems to be a reasonable decision that adds more liquidity to the Dated Brent basket and strengthens the utility of this global benchmark. However, change can be difficult, and adding a geographically distant grade to the Brent mix might not be viewed favorably by all market participants. Plus, as with any change, there is always the chance that certain unintended consequences may arise.
By following a consultative process, however, Platts is acting as the pricing agency equivalent of Roger Davies, Cher’s longtime manager, who has successfully reshaped the singer’s image over the decades to keep her relevant as she prepares for yet another tour.
Note: The article was authored by Jaime Brito of Baker & O’Brien and published on RBN Energy’s Daily Energy Post on August 11, 2022.
“Believe” was written by Brian Higgins, Stuart McLennen, Paul Barry, Steven Torch, Matthew Gray, Timothy Powell, and Cher. It appears as the first song on Cher’s 22nd studio album of the same name. Released as a single in October 1998, the song went to #1 on the Billboard Hot 100 Singles chart and has been certified Platinum by the Recording Industry Association of America (RIAA). The song features the use of Auto-Tune, a voice pitch-correcting software invented by Andy Hildebrand; it was the first song released utilizing the effect. Auto-Tune has been heavily used in dance-pop and hip-hop since “Believe” was released and is often referred to as the “Cher effect.” With its repeating chorus of “Do you believe in life after love” and its infectious electro-pop beat, the song became popular in dance clubs and on the radio worldwide. Personnel on the record were: Cher (vocals), Mark Taylor (programming, keyboards, Auto-Tune), Brian Rawling (sampling, programming), and Gypsyland and Adam Phillips (guitar).
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