In the crude oil trading world, having ownership of physical barrels is prized for the information it gives about the market.
Investors, swaps traders, and hedge funds scrabble for published information about what national oil companies, majors, and refiners are doing with their oil, who themselves already know, of course, because they are the ones that own it.
This aspect of the oil market is little remarked upon in news stories about acquisitions, because it is little understood.
In Shell’s recent purchase of BG Group, for instance, coverage naturally focused on BG Group’s substantial reserves offshore Brazil. But from the point of view of market information, there was little coverage of what the deal means in the North Sea.
BG Group holds a 21.73% in the UK’s Buzzard field, the largest single contributor to Forties blend, and is also an equity holder in the J-Block fields that feed into Ekofisk blend.
Forties and Ekofisk are two of the four North Sea grades which at the margin determine the price of Dated Brent, the world’s most widely used physical crude oil benchmark. Along with Brent/Ninian blend and Oseberg, they are the only grades which can be used to make physical delivery for cash BFOE contracts, against which ICE Brent futures get their settlement value.
In the May Forties loading program currently trading, for instance, Shell has three 600,000-barrel equity cargoes, while BG Group also has three. Shell owning BG Group’s production in this month would have doubled their initial share of the overall Forties program from 15.25% to 30.50%, for example, although the acquisition is expected to be finalized closer to the end of this year.
In the Ekofisk May program, BG Group has one equity cargo, Shell none.
As such, the BG Group acquisition ‘gives them [Shell] a relatively stronger position,’ said one trader at the time. ‘But fair play. If you’re willing to spend that amount of money, that’s some of the goodies you get along with it.’
Owning a flow of oil, either through an equity stake in fields or a long-term off-take agreement, is not limited to majors or independent producers of course. It is one way oil trading houses have tried to deepen their insight into the markets in which they compete.
While buying fixed logistical assets can be a way to access information, it is also partly a response to other market participants having more information. Most trading houses own mid-stream assets like terminals and storage tanks — these have always been crucial in their business of exploiting fleeting, time-sensitive arbitrage opportunities, instead of waiting in a queue to use someone else’s facilities while the opportunity passes.
But some analysts say that increasing levels of transparency in the oil market are actually driving trading firms towards ownership of fixed assets, as information that isn’t in the public domain becomes more valuable.
Physical assets and end-to-end supply chains give traders access to exclusive and non-public information about the market. So as a result of the ever-increasing transparency brought to oil markets by price reporting agencies like Platts, ‘the informational value of physical-asset ownership is increasing,’ according to a McKinsey consultancy paper.
The point was made in a different way in a recent paper sponsored by Trafigura and authored by University of Houston Professor Craig Pirrong.
All major commodity houses own assets like storage and terminals, he says, partly just to avoid the risk of a third party creating a bottleneck in the right market conditions.
As specific oil markets get more liquid, arbitrage opportunities become rarer and more brief. Pirrong sees price reporting agencies as having allowed more market participants to perceive arbitrage opportunities, and thus for such opportunities to be eroded faster as the market becomes more efficient. This places greater importance on owning the physical assets to take advantage of such arbitrage opportunities quicker.
The extent of transparency does seem to have an impact on the type of trading that takes place in each part of the oil value chain, and vice versa. More illiquid markets tend to have less transparency, and less incentive for the fewer participants to become more transparent.
Alternatively, more developed, liquid parts of the oil complex like Dubai, WTI futures, and North Sea crude, the oil market already has arguably more transparency than any other commodity in the world.
Any subscriber to a news service has access to information to compete with firms who have invested millions — if not billions — of dollars in physical assets. These are the places where trading companies that don’t own any physical oil cargoes or infrastructure continue to exist, and in some cases thrive. This suggests that whatever the advantages of owning physical assets in oil trading, it is possible to compete without them, but it does make it easier.
By Ned Molloy