Crude Oil Benchmarks & their Pricing

CRUDE OIL BENCHMARKS & THEIR PRICINGWHAT IS CRUDE OIL?Crude oil is a naturally-occurring substance found in certain rock formations in the earth. It is a dark, sticky liquid classified as a hydrocarbon. It is a compound containing mainly carbon and hydrogen. Crude oil is highly flammable and can be burned to create energy.

WHAT IS BENCHMARK?Benchmark oils are used as references while pricing oils. There are approximately 161 different benchmark oils, of which the main three West Texas Intermediate, Brent Crude, and Dubai Crude. Other well-known blends include the Opec basket used byOPEC, Tapis Crude which is traded in Singapore,Bonny Light used in Nigeria,etc. Crude oil is the most actively traded commodity and is bought and sold in contracts. A contract trades in units of 1,000 barrels of oil and benchmarks help to determine the price of a barrel of oil in a contract.WEST TEXAS INTERMEDIATEWTI is probably the most famous of the bench mark oils. It is a light, sweet crude with an API gravity of 39.6 degrees. That gives it a specific gravity of 0.827, which means that at 60 degrees Fahrenheit, WTI is only 8/10 as heavy as water. It contains 0.24% sulfur and is refined in the Midwest. It comes from the Southwestern United States.BRENT CRUDEBrent Crude, named after a goose, comes from the North Sea. It is a light, sweet crude with an API gravity of 38.06 and a specific gravity of 0.835, making it slightly heavier than West Texas Intermediate. The sulfur content is 0.37%. The price of Brent Crude is used to set prices for roughly 2/3 of the worlds oil. It is mostly refined in Northwest Europe and is also called Brent Blend, London Brent, and Brent petroleum. The Brent field is located in the East Shetland Basin, halfway between Scotland and Norway.DUBAI CRUDEDubai Crude is light and sour, with an API gravity of 31 degrees and a specific gravity of 0.871. Its sulfur content is 2%, making it 6 times more sour than Brent Crude and 8 times more sour than West Texas Intermediate. It is generally used for pricing oil that comes from the Persian Gulf. Dubai Crude is also known as Fateh. Its importance comes not only from its quality, but also from the fact that it was the only freely traded oil from the Middle East until recently.CRUDE OIL PRICINGGenerally, Crude Oil is sold through a variety of contract arrangements and in spot transactions. Oil is also traded on futures markets but not generally to supply physical volumes of oil, more as a mechanism to distribute risk. These mechanisms play an important role in providing pricing information to markets.

Pricing of crude oils has become increasingly transparent from the 1990s onwards through the use of above marker crudes i.e. :West Texas Intermediate (WTI USA)Brent (Europe, Africa and Asia)Dubai and Oman (Middle East)The main criteria for a marker crude is for it to be sold in sufficient volumes to provide liquidity (many buyers and sellers) in the physical market as well as having similar physical qualities of alternative crudes.

The marker crude should provide pricing information. WTI does this through the New York Metals Exchange (NYMEX) as the basis of a futures contract where trade is equivalent to many hundreds of millions of barrels per day, even though physical WTI production is less than 1 million barrels per day. A futures contract for crude oil is, a promise to deliver a given quantity of crude oil but this rarely occurs as participants are more interested in taking a position on the price of the crude oil. Futures markets are a financial instrument to distribute risk among participants with the side effect of providing transparency on the pricing of crude oil.

Brent offers pricing information based more on the physical trading of oil through spot trading, and forward trading but also offers futures trading but not to the same extent as WTI.In Asia there is no futures exchange where crude oil is traded and which would provide pricing information to the same extent as WTI and Brent. In Asia the pricing mechanism for say Tapis, a marker for light sweet crudes in the region, is based on an independent panel approach where producers, refiners and traders are asked for information on Tapis crude trades.

CONCLUSIONPrices of crude oil markers and petroleum product markers are affected by a myriad of factors including:overall supply/demand for crudesupply/demand for petroleum productsfreight ratescompetition in the crude marketscompetition 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 as 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.

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