Murban: a Benchmark for the Middle East?
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October 2019 Murban: A benchmark for the Middle East? OXFORD ENERGY COMMENT Ahmed Mehdi, Eesha Muneeb, Adi Imsirovic, Bassam Fattouh 1. Introduction The Gulf producers are the world’s largest crude oil exporters, with most of their crude – sold via long- term contracts – flowing eastward. But oil market dynamics are shifting, reinforcing certain existing trends and creating new ones: East of Suez crude balances over the next decade highlight Asia’s growing crude import requirement; light crude exports (particularly US grades) to Asia keep increasing (see Figure 1); crude slates are getting lighter, reflecting the shift in product demand patterns, especially due to the International Maritime Organization 2020 low-sulphur bunker fuel requirements; and Asian trading participants are becoming more active ‘price makers’ rather than ‘price takers’.1 Figure 1: US crude flows to Asia, kb/d 1600 1400 1200 1000 800 600 400 200 0 Korea India Vietnam Thailand Indonesia Japan China Taiwan Note: kb/d = thousand barrels per day. Source: US EIA. As the region’s cushioned position unravels in the face of rising oil production from other corners of the world, Gulf national oil companies (NOCs) face a fresh challenge: how to remain competitive in their largest and most profitable market. The response and strategies necessary to confront these challenges are more layered than simply keeping prices low. As Asia’s refiners buy increasing volumes of crude oil from previously inaccessible origins, they are also exposed to dynamic pricing and hedging options. The crude oil pricing system is key to these dynamics. Historically, the region’s Asia-bound sales have been priced against two sour markers: Platts Dubai and Oman. But recently the traditional benchmarks have been challenged: key producers such as Oman and Saudi Arabia have amended the benchmarks used in their pricing formulae, while China has developed its own crude oil futures contract.2 Against this background, Abu Dhabi is seeking to develop a light crude reference marker of its own. This would be to price both its own exports and to develop a regional benchmark to reflect shifting Asian fundamentals and shifts in global crude oil flows.3 Underpinning this ambition is the role of Murban – a light high-sulphur crude oil (40° API gravity and 0.7% sulphur) produced onshore in Abu Dhabi. Several factors are driving the proposed move: 1 Adi Imsirovic, ‘Oil markets in transition and the dubai crude oil benchmark’, Oxford Energy Comment, October 2014. 2 Bassam Fattouh, ‘What next for Asian benchmarks?’, Oxford Energy Comment, July 2018. 2 Bassam Fattouh, ‘What next for Asian benchmarks?’, Oxford Energy Comment, July 2018. 3 Argus, ‘Crude oil: The Murban makeover’, 9 August 2019; S&P Global Platts, ‘ADNOC, ICE, to launch Murban crude futures on Abu Dhabi exchange in H1 2020’, 13 September 2019. The contents of this paper are the authors’ sole responsibility. They do not necessarily represent the views 2 of the Oxford Institute for Energy Studies or any of its Members. ▪ Given increasing light crude flows within and into Asia, the market will naturally gravitate toward an informal price reference marker, with or without a Middle East benchmark for light crude. One such crude appears to be West Texas Intermediate (WTI) Midland.4 Refiners in Asia have added Midland, Eagle Ford, Domestic Sweet (DSW), Bakken, and Louisiana Light Sweet (LLS) into their linear programming (LP) models as of 2018. The adoption of US crude into Asian refining models is now far easier due to the lack of Official Selling Price (OSP) setting methods, destination restrictions, and the existence of well-established paper markets. With growing WTI flows, the grade could ultimately become a new Asian benchmark.5 ▪ With almost 50 million barrels of production per month and accounting for over 50% of the UAE’s total oil production, Murban is one of the largest crude grades originating from the Middle East. By comparison, Forties – the largest crude stream in the UK and part of the Brent pricing basket – has a monthly production of 13.5 million barrels and has been declining over the years. ▪ A new $3.1 billion Crude Flexibility Project (CFP) at the 417,000 b/d Ruwais 2 refinery complex – expected to be completed in 2022 – will allow Abu Dhabi National Oil Company (ADNOC) to run heavier grades (33.9° API Upper Zakum) at Ruwais, freeing up the lighter Murban grade for export. ▪ Murban is one of the most voluminous Middle East crude grades available to be traded openly on the spot market – a key prerequisite for benchmark status. ▪ ADNOC is currently in a growth phase, with plans to raise production to 5 million barrels per day (mb/d) by 2030; the company has signed agreements with ENI and OMV to develop a new trading venture (ADNOC Global Trading) focused on product sales and securing third-party crude feedstock for ADNOC’s expanding downstream portfolio. ADNOC is also expanding storage capacity at Fujairah and overseas (via a stake in global storage business VTTI)6. ADNOC Global Trading can potentially support the development of new benchmark and provide liquidity. ▪ More than 90% of Murban is exported to Asia-Pacific. Exports are shared in the rough proportion of one-third ADNOC, one-third BP and Total, and one-third Asian firms. This is a well-diversified seller base, which is essential for the success of a benchmark. The diversified equity ownership of Abu Dhabi’s crude production and the emirate’s political stability reduce the risk of manipulation, although there are concerns that ADNOC Global Trading may possess a potential information advantage if it starts trading the Murban contract itself. ▪ ADNOC is seeking to change the way it prices Murban, moving away from a retroactive system to a forward pricing basis.7 Being primed for success does not, however, guarantee it. Many key questions remain: how will ADNOC exclude Murban from potential OPEC cuts? Will ADNOC lift destination restrictions on its crude? Liquidity is already split in the Middle East pricing complex between Platts Dubai and DME Oman: what impact will the introduction of a Murban benchmark have on formula pricing in the region, and will such a move impair liquidity, price discovery and risk management options? To explore these issues, this paper is split into several sections: Section 2 examines a number of key trends in global crude trade flows; Section 3 provides a snapshot of the evolution of Middle East crude pricing; Section 4 assesses the crude quality spreads; Section 5 assesses the viability of Murban as a regional benchmark, and identifies the challenges and next steps required for ADNOC to promote the grade to benchmark status. 4 Bloomberg, ‘U.S. oil challenges Mideast sellers with Asian trading debut’, 19 August 2019. 5 Assuming an eventual end to the current US–China trade war. Argus currently publishes WTI FOB Houston delivered China quotation, while we are told that Platts will be launching WTI Midland DES Asia assessment in October 2019. 6 Shareholder structure will be: Vitol (45%), IFM Global Infrastructure Fund (45%), and ADNOC (10%). 7 S&P Global Platts, ‘ADNOC crude pricing formula change “inevitable, much needed”: refiners’, 26 July 2019. The contents of this paper are the authors’ sole responsibility. They do not necessarily represent the views of the Oxford Institute for Energy Studies or any of its Members. 3 2. Shifting crude flows and rising competition in Asia Significant shifts in global crude flows are expected over the next decade. In particular, oil flows are expected to continue their onward shift eastward (see Figure 2). Figure 2: Crude surplus/deficit by area, kb/d 2000 2005 2010 2015 2016 2017 2018 30,000 20,000 10,000 0 -10,000 -20,000 -30,000 Europe Russia and Central Asia Middle East Africa Asia-Pacific North America (inc. Canada) Central South America Source: ENI. Despite risks to the prospects for oil demand growth - such as climate change and air pollution policies and technological changes - economic and demographic shifts in Asia (a rising middle class, population growth, and the shift to consumer-led economies) continue to drive demand growth. According to the International Energy Agency (IEA), oil demand is expected to grow to 106.4 mb/d by 2024 (see Figure 3), with China and India expected to account for over 45% of the 7.2 mb/d increase. Figure 3: Global oil demand by region, mb/d 120 100 80 60 40 20 0 2018 2019 2020 2021 2022 2023 2024 North America Central and South America Europe Africa Middle East Eurasia Asia Pacific Source: IEA. The contents of this paper are the authors’ sole responsibility. They do not necessarily represent the views of the Oxford Institute for Energy Studies or any of its Members. 4 Net refinery capacity additions in the global downstream sector will also play their role in this eastward shift. Of approximately 9 mb/d of new capacity expected to come online over the next five years, around two-thirds of this capacity is due to be built in Asia.8 With Europe having already seen a number of refinery closures and asset divestments, the onslaught of highly competitive refining assets is likely to drive more closures, further impacting European oil demand balances and refining margins. On the supply side, the rise of US crude production and exports has played a major role in shifting flows and regional balances. According to the US Energy Information Administration (EIA), US crude production averaged 12.3 mb/d in August 2019 – more than double 2010 levels. Since the lifting of the US export ban in 2015, exports have continued to grow, reaching an average level of 2 mb/d in 2018 (see Figure 4).