Royal Dutch Shell (Xetra: A0ET6Q - news) and BP (LSE: BP.L - news) have instigated changes to their oil trading contracts in an attempt to help preserve the credibility of the Brent crude oil benchmark despite declining North Sea production.
The Brent benchmark is used as a reference point for much of the world’s oil trading , but falling North Sea output has reduced the volume of traded cargoes on which the benchmark is set.
Critics say the benchmark price can be unduly distorted by events affecting only one grade of North Sea oil, from the Forties pipeline system, and could be vulnerable to manipulation.
Shell (LSE: RDSB.L - news) announced changes to its oil trading contracts on Friday which it said would allow “for more crude grades and cargoes to be used in establishing the underlying market price”. This would therefore “contribute towards higher liquidity and better price discovery”.
BP said yesterday it had “agreed with Shell to trade on the amended Brent contract terms proposed by Shell” as it believed that this would “improve the effectiveness of the Brent contract as an international price benchmark”.
Both companies will now offer only the new contract terms for deliveries from May. However, not all North Sea oil traders are yet to adopt the changes.
Platts, one of the major price reporting agencies, said it would not start taking account of the deals under the new contracts until it had consulted with the industry more widely. Platts has itself instigated changes in recent years which it said were “necessary to maintain the quality of the Brent price assessment”.
The design of oil contracts currently means that oil from the Forties system, which tends to be the cheapest of four key grades of North Sea oil, influences the Brent benchmark more than other three grades.
If the Forties system is disrupted, for example by an oil field being temporarily shut down, this can cause the Brent benchmark to rise even though other, more expensive grades of North Sea crude may be unaffected.
But oil majors want a benchmark that “reflects underlying value of the North Sea market and isn’t prone to being unduly influenced by disrupution in one of the grades that isn't reflective of the wider market,” one industry insider explained.
Shell’s changes will mean buyers will pay a premium for the better quality grades of crude oil. This should make it more economic for suppliers to deliver the other grades of crude oil, reducing the reliance on Forties.