Middle East Benchmarks and the Demand Shock
In October 2018, Saudi Aramco changed the pricing formula it uses to price its long-term crude oil sales to Asia. Rather than using the equally weighted average prices for Dubai and Oman as assessed by the Price Reporting Agency (PRA) S&P Global Platts (referred to in this article as Platts Dubai and Platts Oman), Saudi Aramco replaced Platts Oman in the formula with the marker price of the Oman Crude Futures Contract traded on the Dubai Mercantile Exchange (referred to as DME Oman). Until recently, the market barely felt the difference, as historically Platts Oman and DME Oman have been closely aligned and the price difference was very small (a few cents) on most days. However, the current crisis has exposed the vulnerabilities of existing benchmarks, leading to very different price outcomes, with the divergence between DME Oman and Platts Oman assessment reaching $6.56 per barrel on 22nd April 2020. While this divergence could prove to be only a temporary phenomenon, caused by the massive oil demand shock due to the pandemic, it exposed the structural differences between the two benchmarks, methodologies, and the crudes they represent. Recent events have generated a healthy debate on the usefulness and limitations of existing benchmarks in the Gulf region, whether the PRAs need to adjust their underlying assessment methodologies, and whether the producers need to revisit their pricing formulas. This Energy Comment analyses some key aspects of this debate and explores the potential shifts in crude pricing systems. Given the tensions in the region’s existing medium sour benchmarks, the desire of a key regional player to introduce a new futures contract and a light sour benchmark, alongside the rise of China as the major importer of Gulf crude and its desire to shift pricing to its own futures contract, we expect the changes to the Gulf crude oil pricing system, which have already been occurring before the current crisis, to accelerate.