Saudi Arabia and the price of crude oil

Here's an interesting report from over the weekend out of Saudi Arabia via The Telegraph. It appears that the Kingdom is unhappy with using West Texas Intermediate crude oil as traded on the New York Mercantile Exchange as a basis for its oil sales.

Who could blame them after what's happened over the last year?

That is, when huge spreads between WTI crude and brent crude developed and then, like clockwork every month when the near-month futures contract was about to expire, the price of that expiring contract would plunge - to as low as $32 a barrel at one point - as the next front-month contract was trading $10 or $15 higher.

The Saudis have dropped a key US benchmark for crude oil – but why?

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.

The decision is loaded with symbolism, but not likely much more than that.

It's not like they're selling the oil for yuan or rubles or some other far-away currency, though that may happen soon enough - that would be much more than symbolism.

Some details on how the Saudi oil export market works and what this change might mean...

Saudi Arabia exports around 1.5m 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.
...
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.

This is just one more, albeit quite small, step away from U.S. hegemony in global financial markets and part of the blame must surely lie with some Wall Street firms who, for years now, have profited from increased volatility in energy markets, everyone's favorite whipping boy Goldman Sachs topping that list.

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