Analysis: Brent oil supply woes undermine futures strength

LONDON Thu Jun 23, 2011 9:46am EDT

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LONDON (Reuters) - Brent's growing momentum as a global oil price benchmark sits at odds with problems frustrating dealers in the opaque physical market that underpins the millions of barrels of daily Brent futures trade.

Production glitches at a key North Sea oilfield have shown Brent is not without local drawbacks that can distort prices, the same sort of problem critics say has bedeviled rival benchmark the New York Mercantile Exchange's West Texas Intermediate (WTI) contract.

Supply from Nexen Inc's Buzzard oilfield has been lower than expected, leading to deferrals and cancellations of cargoes. Buzzard's oil is important for world markets because it is part of the Forties Blend crude stream, which usually sets the "dated Brent" oil benchmark used around the world.

"Clearly with all these deferrals, it raises the issue of the credibility of the benchmark," said Peter Stewart, analyst at KBC Energy Economics. "2011 is proving to be anything but an easy year for the dated Brent marker."

Reduced supply in the North Sea has helped to boost the price of Brent crude futures relative to U.S. crude, analysts say. Brent's premium to U.S. crude last week hit a record high above $23 a barrel.

Stewart said in a report the spread was related to the "inflated" value of Brent as well as to a sharply weakened price of WTI. The U.S. marker has been depressed by excess inventories at its Cushing, Oklahoma delivery point.

Benchmarks are used in the oil industry to avoid needing to agree an outright price for every deal. Brent has gained momentum in its longstanding rivalry with WTI this year with some of its supporters arguing it is a more global price marker.

Up to 70 percent of the world's physical oil is based on the price of dated Brent. Yet Buzzard itself at full production of about 200,000 barrels per day (bpd) accounts for just 0.2 percent of global supply.

"It's not a good thing -- I think it is a bit daft -- but this is the way benchmarks work," said a North Sea crude trader.

DECLINING SUPPLIES

The shipment of millions of barrels of Forties crude has been delayed in May and June because of the Buzzard field problems, irritating oil traders and boosting prices.

This, temporarily, has exaggerated the steady decline in production of the crudes the Brent contract is based on -- Brent, Forties, Oseberg and Ekofisk, also known as BFOE.

In July, the four were initially scheduled to pump 970,000 bpd, down 10 percent from June's 1.08 million bpd and down 33 percent from 1.44 million bpd in July 2007, soon after Ekofisk became the fourth crude to be included in the benchmark.

On Tuesday, it emerged that more Forties cargoes would be delayed in July. This steepened the backwardation in the Brent futures market -- a structure indicating tight supplies where prompt prices trade at a premium to future prices -- even though the amount of oil is relatively tiny.

"While the volumes involved are not significant from a global perspective, the loss of supply from part of the global benchmark BFOE market accentuates the price impact," said Lawrence Eagles, analyst at JP Morgan.

Harry Tchilinguirian at BNP Paribas said while drawbacks in WTI could be solved by building more pipelines to or reversing flows from Cushing, Brent faced a more terminal problem.

"Unlike WTI, Brent's handicaps are not reversible," he said. "The Brent benchmark faces a declining production base that makes it upwardly sensitive to outages of similar-quality oil, be it Nigerian oil or more recently Libyan oil."

The physical decline is in contrast to the trend in Brent futures trade. The volume of Brent futures being traded is rising, more investment class money is flowing into Brent and it has gained ground as a benchmark in 2011.

INFORMATION FLOW

The Forties loading delays have also highlighted the lack of information about supplies of crude affecting Brent.

Some participants found out about the delays and cancellations to Forties cargoes before others.

"There's no requirement to disseminate the information to the market," a North Sea trader said. "The physical markets are unregulated, so it doesn't matter."

There are efforts to increase the flow of information.

In the futures market, the IntercontinentalExchange energy trading platform this week narrowed the regulatory gap between the U.S. and Brent oil benchmarks with its first public breakdown of who is dealing its contracts. [ID:nLDE75J1EM]

And an official at Platts, the oil pricing service owned by McGraw Hill which publishes an influential dated Brent quote, sees room for improvement in the level of disclosure.

"It seems there is enough but there could always be more. There is a (view) that the dropping of a cargo should be immediately notified to the media services," said Jorge Montepeque, Platts' global director of markets and prices.

For now, Platts is looking at lengthening the assessment period for dated Brent cargoes to address liquidity concerns. It does not see the need yet to increase the amount of oil Brent is based on from the four BFOE grades, he said.

Still, many traders in the market are not losing any sleep over drawbacks in benchmarks or volatility in the Brent/WTI spread. Rather, they are enjoying the increased chances it has brought to make money.

"People actively trade the spread, the forward curve, the spread between forward curves," a commodities trading executive at a major bank said. "It is the best thing that happened in oil trading in many years."

(Additional reporting by Dmitry Zhdannikov and Barbara Lewis)