Does Saudi Arabia have the clout to destroy Nymex?

By Garry White
The Telegraph, London
Sunday, November 1, 2009

http://www.telegraph.co.uk/finance/markets/6480746/Do-Saudis-have-the-cl...

For Saudi Arabia, it is a philosophical issue that the black gold pouring out of its deserts should be treated as a tangible, physical commodity -- not the paper plaything of traders on Wall Street hedging against the weak dollar. This thinking is at the heart of the Middle Eastern country's decision last week to abandon its long alliance with West Texas Intermediate crude -- the famous oil used by most global producers to price their exports to the US.

It is both a technical issue and a symbolic shift that strikes a blow to the dominance of the New York Mercantile Exchange, the world's biggest centre of oil trading where the most popular products relate to WTI crude.

Saudi Arabia exports around 1.5 million barrels per day of oil to the US, making it the second largest supplier after Canada, but its physical crude output is not actually traded on the exchange. This is done separately through contracts between countries and oil companies -- but Saudi Arabia still bases its prices on the dominant benchmark, WTI.

For several years now, Saudi Arabia has argued that it has not been well-served by the New York Mercantile Exchange's faith in this oil. Saudi Aramco, the national oil company, is fed up with being given a price for WTI crude that it claims fails to represent the global picture of supply and demand.

This year, the dominant crude oil's volatility and disconnection from the fundamentals of the physical market went one step too far.

Frustration began to mount 18 months ago when the oil price hit record highs of $147 per barrel. This seemed to suggest that there was not enough oil being produced to meet demand. But Saudi Arabia complained that it could not shift the extra 500,000 barrels of oil per day it dumped on the market to try and meet this phantom shortage. Aramco blamed speculators that NYMEX had not kept under control.

At the other end of the scale, when the oil price hit rock bottom earlier this year, the WTI crude benchmark appeared to be too low in relation to global demand. The WTI crude is usually about $1 more expensive than London Brent, but at one point in January, it fell $12 below the rival European benchmark. The problem was inadequate storage at Cushing, Oklahoma, where physical WTI crude is delivered. The reserves were full to bursting point, creating the illusion of an oversupply in the international markets when the severity of the glut was in reality localised to this particular terminal.

A more general complaint has been that Oklahoma is not close enough to the coast, making actual physical delivery against contracts difficult and divorcing it from the global trade of oil that crosses the ocean in supertankers.

There was clearly little keeping the alliance between Saudi Arabia and its traditional benchmark together. WTI crude, being sweet and light, is not even the best match of oil for the Middle Eastern nation, where the produce is sour and heavy. Aramco will now price its oil based on a basket of sour US Gulf crudes more representative of global oil production, according to an index designed by Argus, of London.

The question now is: How much clout does Saudi Arabia have to destroy the dominance of NYMEX and who could be next to follow its rebellion?

The exchange moved quickly to assure its customers that it would launch two products linked to the new Argus sour crudes index. But the new benchmark will not be so inextricably wedded to the famous Wall Street exchange.

In practice, the shift may not after all make an immediate difference. But all oil market observers will wait to see whether the Saudis really do get a better, more stable price for their oil with the benchmark of sour crudes. Brazil, Venezuela and even Canada could all follow suit if they see that Saudi Aramco has made a smart move.

Some analysts even believe that a total shake-up of global oil pricing benchmarks is possible. There have been signs that the Saudis are looking to experiment with different ways of getting better returns, frustrated by the refusal of Western exchanges to reform the way that oil is priced and sold.

Smaller exchanges, such as the Dubai Mercantile Exchange, which is aligned with the physical market rather than futures, could eventually start stealing market share from the bigger London and New York trading forums.

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