One of the side issues raised by the energy pricing disputes between China and Russia is an extension of an old argument about whether Asia needs an oil benchmark price of its own. Benchmarks are essential to unify the global oil market as crude streams vary so significantly in their characteristics in any given region. At present, the international crude market is priced against the U.S. standard, West Texas Intermediate (WTI), or the international one, the North Sea’s Brent. Both decreasingly reflect the new realities of the oil markets.
For one, there is a widening gap between the two, as much as $18 a barrel at times, and the historic trend of WTI trading at a premium to Brent has been reversed. The divergence is largely a reflection the increasing insularity of the North American market. That has become so great that at the start of last year, Saudi Aramco, Saudi Arabia’s state oil company, stopped using WTI to price its exports to the U.S. and switched to the Argus index. At the same time, output and demand for Brent oil is falling while, like so much else in the global economy, the balance of oil demand is tilting eastwards. Asia in now a sixth bigger an energy market than North America and twice a big as Europe.
That all suggests that the time is ripe to develop a Pacific-centric crude oil benchmark and futures market to replace the Atlantic-centric ones (and in the case of WTI, Cushing, Oklahoma-centric). All oil producing regions have some sort of benchmark, but only Dubai Crude has gained any credence from international oil traders. It is no WTI or Brent, though, and is mostly used in physical markets. Attempts to create a Middle East oil futures market off it have never got far though the latest attempt backed by the governments of Dubai and Oman is the best shot to date.
As Asia and particularly East Asia has become the center of the global oil trade it makes more sense anyway for the futures market to be in East Asia as that will give the most effective price discovery. Up until now, the region has been dependent on oil imports from the Middle East, so pricing based on Dubai Crude, which in turn is tightly linked to the Brent price, has been the order of the day.
The oil being shipped to the region via Russia’s Eastern Siberia Pacific Ocean pipeline (ESPO) will fundamentally change that. Once it is operating at full capacity, and supplying markets in South Korea, Japan and farther afield as well as China, East Asia will have significant exports of oil on which to base a new crude futures contract of its own. That might be ESPO oil alone, or a basket of ESPO, Chinese and other Asian crudes, much as Opec has devised a basket of seven crudes.
But where in Asia to locate such a futures market? Such markets thrive where there is significant production and consumption of whatever is being traded to give the market liquidity, developed financial markets to provide the financing infrastructure and speculative (in the technical sense) interest, and a common legal and regulatory system covering market participants and the underlying flow of the good. Nowhere in Asia yet meets all those criteria, though China would come closest. The Shanghai Futures Exchange has certainly had its eye on such a role for several years.
Even if the arrival of ESPO oil potentially gives the trading volumes to make it work, China’s regulatory regimes over both commodities pricing and financial markets, remain a big question mark. It is in Beijing’s hands to overcome those difficulties. There is no doubt that the traditional relationship between regional crude benchmarks and global prices have not been able to keep up with the change in the global flows of the oil trade. Therein lies an opportunity to be grabbed.