By Robert Campbell
NEW YORK, April 13 Dated Brent, the Frankenstein's monster of a benchmark that underlies a huge proportion of the global oil market, needs yet another restructuring as North Sea production problems have again winnowed its basis down to a relative trickle.
Output of the four crude streams used to determine the Dated Brent price will fall to only 875,000 barrels per day in May as natural decline rates and the shutdown of Total's Elgin/Franklin field combine to leave the benchmark on a perilously thin basis.
That's a record low output for the four streams and worse than in the spring and summer of 2011 when the modest underlying basis of the Brent contract played havoc with oil prices.
This May a mere 45 cargoes of oil will be eligible to set the price of Dated Brent. The actual number is likely to be far lower as equity crude holders can -- as they often do -- opt to keep cargoes for their own use rather than trading them to others.
The very limited number of available cargoes means the Dated Brent price could be easily "squeezed" higher by a trader amassing a (legal) commanding position in eligible cargoes.
Probably the only major obstacle to a squeeze right now is the feeble state of oil demand with refinery maintenance and a relatively well supplied spot market keeping premiums low.
But with output of the four streams -- Brent Blend, Forties Blend, Oseberg and Ekofisk -- now struggling to stay above 1 million bpd in good months, the time has come to broaden the benchmark again.
Platts, the McGraw-Hill unit that assesses the Dated Brent price, has previously expressed a willingness to add additional crude streams to the benchmark to compensate for lower output.
But until an overhaul is implemented, the narrowing basis of the Dated Brent price leaves it open to the charge of opacity and a growing risk of "squeeze" trades.
The longer the Dated Brent price goes unreformed the more awkward will be the questions from the outside world, particularly as politicians and regulators are starting to take an interest in the minutiae of oil price reporting mechanisms.
MAJOR CHANGE NEEDED
Things were not supposed to happen so fast. Platts widened the assessment window on Dated Brent out to 25 days in January in an effort to add liquidity to the physical Brent market.
That tinkering was supposed to buy enough time to allow Platts to consult further with the industry about more fundamental changes to the benchmark to be implemented later this decade.
Instead, if April and May are any guide, the situation this summer may be as challenging as the summer of 2011, when unplanned outages in North Sea output as well as routine summertime maintenance slashed liquidity in the physical market.
Platts has already suggested it may consider the pricing of additional North Sea grades when it assesses Dated Brent. Statfjord has been mooted as well as Troll and DUC.
But the problem here is that, in the current methodology, which uses the lowest priced eligible crude grade to determine the daily Dated Brent assessment, differences between the grades means that the lowest quality stream, Forties, almost always sets the Dated Brent price.
The other grades provide a cap in the event of Forties spiraling higher, but do little to provide competition on the downside.
Adding more grades to this mixture will not eliminate this problem of market fragmentation, but will really only disguise the very narrow basis of the purported global oil benchmark.
The time for a more profound overhaul of Dated Brent has been long at hand. A major change that deepens market liquidity and provides a more credible and transparent basis for pricing is needed.
Accomplishing that may be difficult. Big players in the Dated Brent market have resisted change in the past when it has gone against their interests.
The current market structure mainly suits entrenched interests who benefit from opacity and the very high barriers to entry into the market.
More tinkering is nothing more than pretending the problem of fragmenting liquidity at the heart of the global oil trade doesn't exist.
But given the huge vested interests in maintaining the current contract, more tinkering may well be all we get.