Shell’s North Sea Crude Benchmark Change Likely to Be Accepted

Royal Dutch Shell Plc’s changes to its pricing formula for benchmark North Sea crudes will probably be adopted by the market, according to a Bloomberg News survey of eight traders directly involved in the business.

The price of Brent, Ekofisk and Oseberg blends traded will be adjusted for their superior quality based on the difference to the more abundant, higher-sulfur Forties grade, Shell said in a Feb. 8 statement. These four grades make up the Dated Brent marker used to price more than half of the world’s oil. The new rules came into effect on Feb. 11 and apply to cargoes for May delivery onwards, according to the notice.

The modifications are designed to increase liquidity in Dated Brent trades at a time of falling North Sea production, the traders said. The amendment should incentivize delivering Brent, Ekofisk and Oseberg into the contract rather than only Forties, which is typically the cheapest, thus used to set the benchmark. Platts, a pricing agency whose assessments are used worldwide, hasn’t agreed to revise its methodology while BP Plc supports the new accord.

“We have Shell and BP backing it up so we will potentially see more cargoes being shown to the market,” Olivier Jakob, managing director of Zug, Switzerland-based analysts Petromatrix GmbH, said by phone today. “It will depend on what Platts do but I think it has a chance to be adopted industry wide.”

Other oil companies will follow BP in agreeing to the new terms, five out of the eight people surveyed said. Three people declined to comment on the matter.

Custodian, Creator

Shell is the custodian and creator of the so-called SUKO 90 contract, which since 1990 has acted as an industry standard for the trading of North Sea Brent Blend crude or Dated Brent. The company imposed a 25 percent premium for Brent and Oseberg based on their difference to the Forties differential while for Ekofisk it will be 50 percent.

“The new robust and transparent quality premium mechanism will support the Brent benchmark by allowing for more crude grades and cargoes to be used in establishing the underlying market price,” Jonathan French, a Shell spokesman based in London, said in the statement. “It will therefore contribute toward higher liquidity and better price discovery.”

Sellers of Dated Brent, which was changed in January 2012 to extend the delivery period by four days to 25 days forward, may deliver Brent, Forties, Oseberg or Ekofisk crude. Under the new rules, buyers of Brent, Ekofisk or Oseberg, will be obligated to pay a premium to account for those three grades’ superior quality, according to Shell.

Daily exports of the four main North Sea crudes will decrease by 12 percent in March from this month, loading programs obtained by Bloomberg News show. Production has fallen year-on-year since for at least five years with March output 36 percent lower than in 2008, the data show.

Narrow Backwardation

“We believe these changes will improve the effectiveness of the Brent contract as an international price benchmark,” Robert Wine, a BP spokesman in London, said by phone Feb. 11.

The knock-on effect of the change could be a narrowing of the time-spread between the front two Brent contracts, which have typically traded at a premium, or backwardation, according to Petromatrix. This price structure signals limited immediate supplies or weaker demand.

“The risk is that it will cut into the $1 a barrel backwardation on the Brent spread as you are potentially putting more cargoes in the chain, which will cap the spread, or certainly limit the upward pressure on it,” Jakob said.

Brent futures have been in backwardation since July with the spread between the front two contracts at 90 cents a barrel today on the ICE Futures Europe exchange in London.

Forties De-escalator

A separate clause already exists for the Forties grade that gives buyers a discount for that crude due to its higher sulfur content on a scale known as a de-escalator. Platts, the energy pricing and news agency owned by McGraw-Hill Cos., set the de-escalator at 30 cents a barrel from Feb. 1, meaning that sellers will pay that amount for every 0.1 percentage point of sulfur above an agreed 0.6 percent limit.

Platts said Feb. 8 that it won’t be using the quality premium in Shell’s contract in its own BFOE assessment for now.

“While the industry may be exploring alternative concepts, including the possible introduction of escalator mechanisms within BFOE, Platts’ assessments shall not reflect escalators until a formal methodology change has been proposed, announced, and reviewed with all interested stakeholders, and formally implemented,” it said in a Feb. 8 note to subscribers.

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