Revolution or Evolution? Iraq Mulls Oil Trading Changes

 

Iraq's state oil marketer SOMO has asked its customers for feedback on a planned move to use Oman futures traded on the Dubai Mercantile Exchange (DME) instead of the average of Platts' Oman-Dubai quotes in pricing its main Basra grade.

 

While this may seem an esoteric issue to those outside the cosy world of physical oil trading, it represents a potential seismic shift in the way that more than 12 million barrels per day (bpd) of crude is bought and sold in the Middle East, which is still the world's major source of exports.

 

The Platts system has been used for decades by the region's top oil exporters, led by Saudi Arabia, as the method of setting their official selling prices for customers in the biggest consuming region of Asia.

 

Platts assesses prices based on trades of four regional crude grades in its proprietary Market on Close system.

 

This system of price discovery, referred to by participants as the "window", is well understood by market players and its efficiency over many years gives it the advantage of incumbency.

 

However, the system is not without some issues, namely that it is dominated by three major players, the trading arms of the two large state Chinese oil firms, Unipec and Chinaoil, and Royal Dutch Shell (RYDAF).

 

The vast majority of the trades in the Platts system has one of those three as a counterparty, which raises the risk that a relatively small number of big players can exert strong influence of the direction of prices.

 

This became an issue in 2015 when trading plays by the Chinese majors saw all the available physical cargoes in the Platts window being snapped up, driving up the price of Middle Eastern crudes relative to other global benchmarks such as Brent.

 

Platts responded by adding Qatar's Al-Shaheen crude to the three existing grades in the window, but the risk remains that the limited amount of physical crude available can still be traded in such a way as to move prices in the direction desired by one of the major players.

 

It's also the case that the majority of the crude traded in the Platts window is a grade other than Oman, but it is Oman that the Iraqis are most keen to use as their benchmark for pricing Basra Light.

 

It seems that part of the motivation of the Iraqis in mulling a switch to the DME is that they feel the price discovery for Oman is superior.

 

The DME's contract is now 10 years old and has seen increasing volumes and participation in recent years, although it is still a minnow compared to Brent and West Texas Intermediate contracts traded in London and New York.

 

But the DME contract is well designed and in recent years more of the contracts being traded have been taken to actual physical delivery, rather than just rolled over.

 

It's also a market where no single player dominates. It's highly unusual to have more than 10 percent of the trades in any given month featuring the same participant.

 

As it stands, the DME offers a viable Oman futures contract that can be used for physical purchases, for hedging and for investment.

 

Iraq's SOMO has asked customers for feedback on its potential switch to the DME by the end of August, a relatively short time frame.

 

It's likely that responses from refiners and traders may be somewhat mixed, with those more focused on compliance risks likely to be attracted to the DME's status as a clearing house, and those more comfortable with the less transparent, more insider-focused Platts system unwilling to change.

 

It's probably too simplistic to characterise this as a simple old versus new debate, but it is perhaps an effort to break from the traditional way oil has been traded between the Middle East and Asia, a sort of insiders club that resisted scrutiny and participation from outsiders.

 

If Iraq does go ahead and switch to the DME, no doubt Saudi Arabia, the United Arab Emirates and Kuwait will be watching with interest.