Analysis: Even a broken Brent benchmark is the best for now

LONDON (Reuters) - Brent’s popularity as the world’s most widely used oil benchmark is likely to grow as the industry dismisses its defects as less significant than problems with the alternatives.

ICE Brent futures have sported a huge premium to U.S. crude futures this month as new investment cash has flowed in.

At the same time, a single player’s dominant position on the physical crude market has revived debate about whether dwindling North Sea oil fields provide an adequate basis for helping to price more than two-thirds of global oil sales.

The discussion is fairly low key. Traders and analysts assume trading plays are likely and see no need for panic.

Goldman Sachs GS.N says Brent is still undoubtedly the best crude oil benchmark and that diminishing physical volume is not an issue.

“It does not matter. Physical and paper are two different things,” said Jeff Currie, global head of commodities research at Goldman Sachs, one of the most influential banks in the commodities market.

Compared with Brent, he described U.S. crude, also known as West Texas Intermediate (WTI), as “idiosyncratic” because of storage issues at Cushing, Oklahoma, the delivery point for U.S. futures, where inventories hit record levels last year.

Even assuming weakness in U.S. futures, strength in Brent futures since the start of this year has been remarkable.

“It (Brent) is definitely not perfect. But still, compared to the others that we live with -- WTI and the Asian benchmarks, which are even worse in a way -- it is clearly the best one we have,” said David Wech, head of research at JBC Energy in Vienna.

Its importance has grown as new oil streams have adopted it as a benchmark.

“From Australia to Latin America, Brent is the chosen benchmark. It has proven to be the most reliable,” said Wech.


A benchmark, even if flawed, is essential because it is not possible to agree an outright price for every oil sale.

“For all the oil that is sold, much of it is typically on some sort of term contract, and for that you need a price basis. A benchmark fulfils that need,” said Wech.

Light sweet benchmarks have been favored as they reflect the kind of crude any refinery can process. Any shift toward heavier and more sulfurous crude would be gradual as refineries grow more sophisticated and the international balance of oil production shifts.

Brent futures this month leapt to a more than $9 premium per barrel over lighter and better quality WTI, which historically has traded at a premium to Brent.

They coincide with increased investment fund flows following this month’s re-weighting of commodity indexes toward Brent futures and away from U.S. crude.

That in turn raises concerns.

Research has never conclusively proven the impact on price levels, but the welter of financial money drawn to U.S. futures has stoked debate about whether it limits their usefulness and has added to a clamor for tougher futures regulation.

As the market debated whether investor money was also inflating Brent futures, trading house Hetco built up a dominant position on the underlying physical market in Forties, one of the benchmark grades.

Compared with dominant trading positions of the past, Hetco’s acquisition of almost one third of the Forties program was modest, and it has since offered physical cargoes lower.

In 2002, a trading house was able to control an entire month of Brent cargoes, which then was the sole physical basis for the Brent futures contract.

A series of trading plays early that year led the Platts price assessment agency, a unit of McGraw Hill MHP.N, to oversee the addition of Forties, Oseberg and subsequently Ekofisk to the original Brent stream, making it much harder to dominate the physical market and drive up its price.

The futures market has also become more liquid as Brent futures volumes have expanded rapidly, most recently in response to the arrival of more institutional investors. Volumes are still far lower than U.S. crude futures on NYMEX, but last year they rose more quickly than for the main U.S. contract.

Jorge Montepeque, a director at Platts, has not ruled out bolting on more crudes to the BFOE benchmark but said an adjustment to the futures contract, rather than adding more physical grades, could be the answer.

The Brent mechanism “was less than optimum”, he said. Because of a time lag between the physical and futures markets, only 70-75 percent of Brent physical crudes are available for delivery against ICE Brent.

ICE was not available for comment, but in an interview earlier this month, an exchange director said Brent’s strength was a function of U.S. crude weakness.

Editing by Jane Baird