Crude oil is liquid petroleum pumped out of an oil well and often classified according to its geographical region.
This classification offers little information about crudes quality and characteristics.
The classification scheme provided on the picture below is more useful, because it takes into account quality of crudes measured by:
• API that refers to the oil’s relative density based on the American Petroleum Institute gravity.
API measures how light or heavy a crude oil is compared to water. With API gravity greater than 10, oil is lighter than water.
• Sulphur content, sweet or heavy
The pricing of crude oils has become increasingly transparent through the use of three marker grades such as:
• Brent (North West Europe): 38 API and 0.3% sulphur
• WTI (USA) : 38-40 API and 0.3% sulphur
• Dubai (Middle East, Gulf benchmark): 32 API and 2% sulphur
The figure shows different crudes from around the world with their corresponding API and sulfur characteristics.
For many years the representative price of North Sea oil was Brent Blend, a mixture of crudes from different fields.
However, the production of Brent Blend declined and the definition was widened to take into account four crudes such as Brent Blend, Forties, Oseberg and Ekofisk (BFOE).
Approximately 2/3 of the world’s traded oil is priced based on waterborne Brent, i.e. crude oil from other regions is priced at a differential to Brent.
WTI is a dominant benchmark in the U.S. and Dubai is commonly used to price sales of other regional crudes into Asia.
There are two different but related physical Brent OTC markets: “Cash cargo” and “Dated Brent”.
Dated Brent
The Dated Brent price reflects the value of the cheapest FOB cargoes of BFOE, with a specific cargo, typically 600 000 barrels.
The most important market for Brent is a forward market based on 25 days advance declaration. Brent producers nominate “Cash cargoes” to buyers without fixing the approximate date or vessel. This is simply “I sold you Brent oil at fixed price with delivery in some future month”. The buyer can choose a loading date later but has to give 25 days advance declaration to the producer. After declaration, the cargo becomes wet and appears in a different market, namely Dated Brent. At this point the cargo can continue to change hands but “Dated Brent” specifies all of the details, including vessel and loading date (actually it can be a 2-3 days period known as the Lay/Can).
Previously, market used 7-15 Day Brent basis but the basis evolved over time into 10-21 days basis in 2002 (Forties and Oseberg were added so assessment period for cargoes loading increased) and became the 10-25 day basis since 6 January 2012.
Cash cargoes
These contracts can be referred as forwards. Several different names are used, like Cash BFOE, 25 day Cash BFOE, Cash Forwards (strange enough, I would never use this name), Paper BFOE or Paper Brent but the meaning is the same: the price is locked at the time of nominating by seller for delivery at a future point in time but beyond 25 days. For example, contracts can be traded in October for delivery in December. Brent shipping operators announce the loading programs to be wet in December, so the buyer can arrange for a vessel to arrive for loading in December.
These contracts can be cash settled if two counterparties do not wish physical delivery.
Contracts for Difference
These contracts represent one period swap between a Dated Brent and a Cash Cargo.
Brent Futures
The main contracts on the exchange market are ICE Brent futures, physical or cash settled. Futures settle against the 25 day Cash BFOE, that’s why 25 day basis is the most important.
WTI (West Texas Intermediate) is a pipeline market with a delivery point in Cushing, Oklahoma. This is the main crude oil in the U.S.
A variety of crudes can be delivered against the WTI contract which gives arbitrage opportunities to traders.
However, the price differences between two crudes should compensate delivery costs.
Other North American benchmarks are also used:
• Coastal crude grade LLS, Light Louisiana Sweet (St. James, Louisiana)
• West Texas Sour (Midland Texas)
• Mars (Clovelly, Louisiana)
• Bakken (North Dakota)
This is a third major benchmark crude. Dubai became the main price marker in the mid-1980s but the decline of output allowed adding Oman contracts to be settled against Dubai contracts in 2001.
Tapis (Malaysian; Asia Pacific benchmark) and Urals (Eastern Europe; Mediterranean benchmark) are also well known crude benchmarks along with the OPEC reference average basket of 15 different crudes.