Gulf producers must adjust to China's oil pricing power

The growing dominance of China in Asian oil trading is a problem that will not go away for Arabian Gulf crude producers.

The question now is whether the new generation of technocrats that in recent months have taken over the national oil companies in Riyadh, Abu Dhabi and elsewhere in the region will act on pledges to be more transparent and efficient by modernising crude oil trading with their major Asian clients, especially China.

The fact that China has become not only Asia’s dominant oil buyer but the world’s swing consumer was underlined last week by Platts, an arm of McGraw Hill Financial whose oil pricing system is a linchpin of Asian oil trading.

China’s oil demand has exploded over the past decade, from 2 million barrels per day to a record above 8 million bpd in February this year, making it the biggest oil importer in the world, said Daniel Colover, a Platts analyst in Singapore. China will get even more dominant, as it will account for the bulk of the Asia Pacific region’s forecast demand growth of 800,000 bpd this year, Mr Colover added, which is two-thirds of forecast global demand.

China has added a new dimension by allowing its independent refining sector – the so-called teapot refiners – to import crude oil directly, which this year added about 1 million bpd. At the same time, the big Chinese state oil companies – China National Petroleum Corp, China National Offshore Oil Corp, and China Petroleum & Chemical Corp (Sinopec) – have been adding huge amounts of oil storage capacity.

Mr Colover estimates China’s current storage at about 290 million barrels, or about 30 days of demand. That will more than double to 600m barrels if China wants to match strategic oil storage levels in the West.

Growing demand is not a problem for Gulf producers – on the contrary, they have been fiercely fighting off competition from Russia, Africa and even Latin America to hang on to market share in China.

But China has made no bones about the fact that it intends to use its dominance to influence the region’s oil prices.

At a closed-door meeting at Opec’s headquarters in Vienna in March to discuss oil price volatility, Chen Bo, the president of Sinopec’s trading arm, told oil ministers and officials gathered straight up of China’s plans to dominate the Asian oil market.

“Obviously, the fact that Unipec [a subsidiary of Sinopec] said it is pretty significant as the voice of China. And the fact they said it in Opec headquarters is a pretty big deal,” said a top executive involved in regulating oil markets.

“The Opec guys had to listen to their biggest customer telling them he was going to move pricing power to China,” he added.

“To come into the belly of the beast and make a presentation like that, it takes a lot of [fortitude],” said Jorge Montepeque, an oil analyst who as a former employee of Platts designed the company’s oil pricing system.

There is general agreement that the oil pricing system for Asia is flawed and has allowed the big Chinese buyers to corner the market in physical crude trading, which determines the benchmark Oman and Dubai price, any month they choose to.

The effect of their action has been to highlight the lack of trading volume in the system and the ease with which determined large buyers can control oil pricing in Asia.

It also has led to lower relative prices for Gulf producers at a time when every cent on the barrel is crucial for government budgets.

Platts has sought in recent months to add more volume so that the Oman and Dubai benchmark is harder to manipulate. It added one crude from Qatar (Al Shaheen) and one from Abu Dhabi (Murban, Abu Dhabi’s largest stream of crude at about 1.5 million bpd).

The technical difficulties with that move became apparent in the first few months of the year as many sellers elected to deliver Al Shaheen, which has inferior qualities, while no one elected to deliver the superior Murban.

On Thursday, Calvin Lee, the head of Asia and Middle East oil markets for Platts, said it would introduce in July a “quality premium” formula for Murban to try to address this liquidity issue.

But the larger question is whether this kind of tinkering will solve a fundamental problem of transparency and regulation.

“There need to be safeguards to prevent the risk of distortion and to ensure the Dubai benchmark price mirrors true market supply and demand fundamentals,” said Mike Muller, the head of oil trading at Shell, who has been the most high-profile advocate of bringing Asian oil trading under a regulatory regime.

“This will enable what the marketplace needs to be – a level playing field for all to express their views and conduct their hedging as efficiently as possible. The two managing words here are very simple: transparency and liquidity,” he added.

Those arguing against the need for regulation include Mr Montepeque, who notes that regulators in other jurisdictions were not enough to fix badly constructed markets, while there is nothing stopping the Dubai Financial Services Authority (DFSA) from acting if they think the Dubai and Oman benchmark price is being manipulated.

But regulators say the DFSA only has jurisdiction over the Oman futures contract, not the physical oil market trading that sets Platts prices.

“If anyone has jurisdiction [over Platts physical markets], it would be the [Monetary Authority of Singapore, or MAS] because that’s where the Platts guys are based and where all the traders are, but even that is a moot point,” said a regulatory official. “Certainly, the MAS doesn’t try to ever claim jurisdiction as it’s never brought an action in the physical markets, despite plenty of opportunities.”

Advocates of regulation have argued that Gulf state producers – especially Saudi Arabia – should change their benchmark price from the murky Platts physical market to regulated futures prices.

While Shell does not argue for a specific futures exchange, Mr Muller says he supports the principle.

“We strongly support regulation that is intended and designed to make markets safer, more resilient and efficient,” he said. “Market participants – the Middle East producers, the Far East consumers and the Western companies with major assets in Asia – will have to agree on an appropriate venue to provide the regulation.

“The Asian market is currently facing an oversupply and a lot of the major resource holders in the Gulf are looking to fortify or expand their market share,” he adds.

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Anthony McAuley

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