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In oil markets, the future looks sour

NEW YORK/HOUSTON (Reuters) - Saudi Arabia’s new method of pricing oil bound for the United States reflects the world’s growing reliance on sour crude, which is harder to refine.

The sour grades of crude may eventually displace tried-and-true light, sweet crude to become a benchmark.

That could help producers and refiners manage risk as they deal with increasing volumes of higher-sulfur oil, and it may also cut speculators’ influence on oil prices, analysts said.

Starting in January, Saudi Arabia will price U.S.-bound barrels against the Argus Sour Crude Index of three sour crudes produced in the U.S. Gulf. That will end 15 years of pricing against West Texas Intermediate, the reigning light, sweet benchmark.

The vast majority of oil futures contracts are based on WTI and Europe’s Brent oil. Sour crude -- whose higher sulfur content makes it harder to refine -- is meekly represented on exchanges but has come to play a central role in physical oil markets.

“There’s a growing need for sour crude markers,” said Carl Holland of Energy Trading Solutions. “In my view they will grow to be of equal or greater importance to sweet crude markers.”

Markets have taken notice since the Saudi pricing decision was made public last month. NYMEX and ICE, the world’s leading energy exchanges, have both introduced new contracts based on ASCI. They begin trading this month.

“They could be comparable to other benchmarks, including WTI,” said Bob Levin of NYMEX owner CME Group.

Trading in sour crude would need to reach hundreds of thousands of contracts per day for it to attain benchmark status, which could take years, Levin said. Past NYMEX contracts for sour U.S. crude failed amid low demand.

But the Saudi move, which analysts said may soon be copied by other major exporters, could spur demand for sour crude contracts. That could gradually change the way oil companies and speculators operate in commodities markets.

For one, oil producers and refiners could more effectively hedge their growing physical volumes of sour crudes.

A sour benchmark could share the stage with WTI and Brent, or cut their importance.

“The declining production base of both WTI and Brent are going to have implications for the reliability of those as benchmarks,” said Craig Pirrong of University of Houston.

Over time, WTI may remain the contract of choice for many financial investors looking to buy oil futures, while ASCI contracts may hold greater appeal for traders who also deal in physical crude, Energy Security Analysis Inc said.

As a result, ESAI said, a boom in sour crude trade could help curb financial speculators’ sway over oil prices, bringing markets closer in line with supply and demand fundamentals.

“We could see a gradual reduction in the financial influence on crude pricing,” ESAI said in a research note.

Some blamed speculators when NYMEX light, sweet oil futures surged to a record above $147 a barrel last July, before plunging below $33 in December. They have rebounded to $80.

Commercial traders of oil, such as producers and refiners, have historically held the largest positions in oil futures markets. But this decade, noncommercial traders including speculators have come to play a dominant role.

For now, sour crudes that make up ASCI remain tied to WTI, since they are priced in relation to light, sweet futures. Eventually, they could be valued separately.

FALLING CRUDE QUALITY

A rising share of world oil output is sour, as light, sweet oil fields from West Texas to the North Sea decline after decades of exploitation. OPEC oil, including Saudi exports, is largely sour like the ASCI crudes.

Through 2020, global sour crude supply should grow at an average pace more than three times faster than sweet crude, according to consultants Wood Mackenzie.

Typically, the more sour and heavy the crude, the lower its price. Companies like Exxon Mobil Corp XOM.N, Valero Energy Corp VLO.N and Royal Dutch Shell Plc RDSa.L have invested billions in technology to refine more sour crude along the U.S. Gulf Coast, home to 40 percent of U.S. refining capacity.

(To see how U.S. refiners have boosted sour oil use, click here )

After spending so heavily, refiners were dismayed when Saudi cargo prices began swinging wildly this year.

U.S. Gulf refiners blamed those swings in part on chronic oil gluts at Cushing, Oklahoma, the landlocked delivery site for WTI, which doesn’t supply much crude to the Gulf Coast.

In February, WTI for prompt delivery fell to a $12 a barrel discount to supplies for a month later, and some sour crudes traded at unprecedented premiums to higher-quality WTI.

That volatility meant the cost of U.S.-bound Saudi cargoes priced off of WTI could flail unpredictably in the 7-8 weeks they took to arrive. By contrast, ASCI crude prices have been less volatile, refining sources said.

Editing by Jeffrey Jones

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