North Sea oil contract changes bearish for prompt Brent

Fri Feb 15, 2013 5:54am EST

Related Topics

* Brent futures curve likely to flatten, analysts say

* Harder for companies to corner the market

* Changes will widen supply base

By Christopher Johnson

LONDON, Feb 15 (Reuters) - Spot Brent crude oil prices are likely to fall relative to forward futures due to contract changes imposed by Royal Dutch Shell and BP , analysts said on Friday.

Shell announced last week it would apply a quality premium for forward contracts from May onwards in the physical crude market on which Brent futures are based.

The reforms to BFOE - cash forward deals in the North Sea crudes Brent , Forties , Oseberg and Ekofisk crudes - will widen the supply base and make it harder for companies to corner the market, analysts say.

Nearby Brent futures are most likely to be affected once the changes come into affect, and this should flatten the North Sea crude futures curve, which is now in steep backwardation with prompt prices at a significant premium to later contracts.

"It should be slightly bearish for the Brent curve for the simple reason that there will be more liquidity in the BFOE market," Tamas Varga, an oil analyst at London brokerage PVM Oil Associates, said.

The forward Brent curve already appears to have responded to the changes, with the spread between June and July Brent futures - the first to be affected by the reforms - narrowing slightly.

The June/July Brent spread closed at 81 cents on Feb. 8, when Shell announced its changes, but has since fallen to around 76 cents, a trend that analysts say is likely to continue.

The cheapest of the four BFOE crudes - usually Forties - has set the value of dated Brent.

Forties output is in natural decline, however, and supply has often been disrupted by outages at oilfields including Nexen's Buzzard oilfield, Britain's largest, boosting prices and raising questions about the credibility of the benchmark.

IMPROVE LIQUIDITY

Shell and traders say the new mechanism will encourage market participants to deliver the full range of eligible BFOE crudes by allowing them to adjust prices to reflect the different quality of each.

Over time, these may not be restricted to just the four BFOE grades. Traders say there is the potential to include more - even from outside the North Sea - so long as they are of a specification that would value the grade above Forties, are traded free on board and have significant volume.

Meanwhile, a growing flow of Forties to South Korea - encouraged by a trade pact with the European Union - has supported prices and helped keep the Brent market in backwardation.

Allowing more grades and cargoes to be used could lessen the impact of this arbitrage trade to South Korea.

There will now be a mechanism giving "price manipulators a little less wiggle room to the upside when situations like the South Korea trade agreement emerge", one senior trader said.

Amrita Sen, chief oil analyst at London-based consultancy Energy Aspects, said the changes to the North Sea contract are "likely to impact the shape of the curve, as arguably the contract becomes less reliant on Forties as you can deliver other cargoes when Forties is sold out.

"It will generally improve liquidity," Sen said.

VTB Capital oil strategist Andrey Kryuchenkov agreed:

"I doubt it will immediately flatten the curve but certainly will have an effect," he said. "In the future, time spreads at the front end will simply have a little more (supply) to play with."

FILED UNDER: