Chapter 14 - Petroleum Trading Flashcards
Give a summary of Petroleum Trading.
A myriad of buyers, sellers, brokers, traders, shippers, and other parties seek to discover and act on information about the supply/demand and prices of a wide range of energy commodities—crude oil and raw natural gas, as well as products ranging from jet fuel and industrial lubricants to gasoline, LNG, butane, and petrochemicals.
Crude oil trading traditionally has involved oil from seven major regions:
The North Sea The Russian-Caspian region The Mediterranean West Africa The Arab Gulf The Asia-Pacific region The Americas
Petroleum trading takes place in two largely discrete by occationally intersecting worlds:
The first is the wholesale, or physical, trade of actual volumes of oil; the second involves more-speculative, future- oriented, or paper, trading by use of specialized financial instruments.
Physical Trading
In physical trading, one party agrees to purchase X barrels from a seller and then pays for and takes actual physical delivery of those X barrels (either right away or at a future date).
Paper Trading
Paper trading spells out the right or opportunity to buy or sell agreed-to quantities of oil by a specified date.
What are three common trading instruments?
futures contracts, options contracts, and swaps. These instruments allow buyers and sellers to hedge against possible future swings in oil prices.
Exchange
Futures and options are traded on an exchange, which is a marketplace where parties can buy or sell a commodity for delivery at some point in the future.
What are the two major exchanges for trading?
the NYMEX and the London subsidiary of Atlanta-based Intercontinental Exchange (ICE)
What are other principal exchanges for trading?
Other principal exchanges are in Singapore and Tokyo. In addition, the Dubai Mercantile Exchange (DME) in 2007 launched its Oman Crude Oil Futures Contract (OQD). DME reported almost 745 million barrels of crude traded in 2010 through the OQD.
Futures Contract
A futures contract obligates the buyer to purchase (and the seller to deliver) a specific quantity of oil at an agreed-to price at a specified future date.
Options Contract
The purchaser of an options contract has the right (but not the obligation) to buy or sell a specific amount of oil at a specified price, at any time during a specified period. If the option is not used (exercised), then it expires; no sale occurs and the money spent to buy the option is lost.An option trade can be conducted through an exchange or over the counter (OTC), meaning privately negotiated.
Swap Contract
In a swap agreement, a floating price for a specific amount of a specific type of oil is exchanged for a fixed price over a specified period. There is no transfer of physical oil; both parties settle their contractual obligations by a transfer of cash. The swap is an OTC transaction.
Netback Pricing
By 1985, Saudi production had plunged. In response, traders switched to an approach called netback pricing, in which crude prices were set by adding a normal refinery profit margin to the price of a collection, or basket, of refined products.
Term Supply Contracts
The majority of oil is traded today using the former, in which a seller agrees to supply a specific quantity of oil to the buyer for an agreed-to price at one or more future dates.
Spot Supply Contracts
In contrast, spot supply contracts are for delivery of a quantity of oil at a specific location as soon as possible (often, within a day or two).
Spot Price/Cash Price
When sold for immediate delivery, the price of oil is called the spot price or cash price
Forward Price
When sold for delivery at a specified future date, the price is called a forward price
How are benchmark oil prices set?
Benchmark oil prices (also called price markers) are set at the close of each business day on the basis of two sources of data: (1) exchanges (e.g., the NYMEX and the ICE) on which oil futures contracts are traded; and (2) a group of well-regarded oil trade journals (of which Platts Oilgram and Petroleum Argus are the two most widely used).
List some well-known benchmark oil prices:
NYMEX WTI (or Light Sweet) Crude Light Louisiana Sweet Crude NY Harbor Jet Fuel ICE Brent Crude Dated Brent Crude Rotterdam Barges Fuel Oil Dubai Crude Singapore Gas Oil
OPEC Reference Basket
Also notable is OPEC’s collection of price data on a basket of crude oils (and blends) and their calculation of average prices for these oil streams to develop an OPEC Reference Basket price to monitor world oil market conditions.
As of October 2011, the OPEC Reference Basket was made up of the following:
Saharan Blend (Algeria) Girassol (Angola) Oriente (Ecuador) Iran Heavy (Iran) Basra Light (Iraq) Kuwait Export (Kuwait) Es Sider (Libya) Bonny Light (Nigeria) Qatar Marine (Qatar) Arab Light (Saudi Arabia) Murban (United Arab Emirates) Merey (Venezuela)
How are prices established for nonbenchmark grades of oil?
Prices established in contracts for nonbenchmark grades of oil are set at a premium or discount to one or more of the benchmark grades, based on quality differences, transportation costs, and taxes for the oils being compared.
Prices for physical oil are often quoted in relation to a certain point in the delivery chain.The crude oil price, established early in the process, accounts for most of the price charged for the final product (e.g., gasoline), but each step in the refining and transportation chain adds to that final price. Not all grades of oil follow the delivery sequence shown below, or they may move through the steps noted in a different order; nonetheless, the details are informative:
Wellhead Price Cargo Price Refinery Gate Price Barge Price Pipeline Price Rack Price Dealer-tank-wagon Price Retail Price
Wellhead Price
The price of crude at the point of production
Cargo Price
The price of crude or product on a large oceangoing tanker
Refinery Gate Price
The price of crude entering a refinery or of finished products leaving a refinery
Barge Price
The price of oil on a barge vessel typically used on a river or close to shore, with a typical capacity of 8,000–50,000 barrels
Pipeline Price
The price of oil at a specified point in a pipeline
Rack Price
The price of oil at a wholesale terminal from which tank trucks take oil to be carried to filling stations, homes, and businesses
Dealer-tank-wagon Price
The wholesale price of oil delivered to retail outlets, such as gasoline stations
Retail Price
The price of oil to the end user, which typically includes a retail tax and a markup imposed by the retail station owner
Posting
Another mechanism that affects global oil prices is the posting of oil prices. Refinery owners use this approach to specify (post) an offer price each day that they are willing to pay for various crude oil grades.
Posted Prices
Posted prices are for oil delivered at a specified point and of a specified quality—oil produced from a particular field or a blend of common crudes.
Knowing the source and quality of the crude allows refiners to do what?
Knowing the source and quality (e.g., API gravity) of the crude it buys allows a refiner to better estimate how much of various refined products can be produced from the crude feedstock.
Knowing the price that refiners are willing to pay will do what?
The price that refiners are willing to pay will shape relative crude prices for particular fields and for oils of different quality.
What takes place at Hubs
Much of the market-related activities associated with price discovery and transfer of ownership for crude oil (and natural gas) take place at hubs.
Hubs
In general terms, a hub is a point at which pipelines come together. A hub on the coastline is called a marine terminal; when it draws together output from several oil or gas wells,it is called a gathering station. Substantial storage capacity is also typically put into place at or near hubs.
What is the best known Hub?
There are several major crude oil pipeline hubs in the United States. Perhaps the best known is at Cushing, Oklahoma, where the NYMEX crude oil futures contract is physically deliverable (if necessary).
What are other primary hubs and marine terminals for oil-price discovery in the United States?
New York Harbor The Gulf Coast (along Texas and Louisiana) Group Three (Tulsa, Oklahoma) Chicago Los Angeles
Important international locations for oil price discovery include the following pipeline hubs or marine terminals:
ARA (Amsterdam, Rotterdam, and Antwerp), in the Netherlands/Belgium
Genoa/Laverna, on the Italian/French Mediterranean coast
Singapore
The Arab Gulf—particularly Ras Tanura (Saudi Arabia) and Dubai (United Arab Emirates)
Market hubs for petroleum products:
New York Harbor,
Houston Ship Channel
Los Angeles
Group Three
NGL market centers
Mt. Belvieu, Texas;
Conway, Kansas;
Sarnia, Ontario;
Los Angeles Basin
Transportation services
An important component of the midstream petroleum sector is the transport of crude oil and petroleum products by pipeline, tanker ship, railcar, and tank truck. Some large producers own and operate their own transportation equipment, but most use independent transportation operators for some or all oil movements.
Fixing a charter
Individual owners usually use brokers to find cargoes, using a process called fixing a charter.
Fixing a charter, step 1.
First, the party initiating the charter (e.g., a refiner or oil trader desiring transport service) contacts a broker or a shipowner. The initiator is ready to specify the product or crude to be carried, the size of vessel needed, the route, the time period for delivery, and possibly the ports of loading and unloading at either end of the route.
Why are tanker vessels sometimes chartered as stationary floating storage tanks?
Tanker vessels are sometimes chartered as stationary floating storage tanks—for periods when storage costs onshore are very high or when onshore tanks are full.
Fixing a charter, step 2.
The charterer and owner agree to a price for the transaction and provisionally book the vessel. In most cases, the parties refer to a document published annually by the not-for-profit Worldscale Association that lists nominal voyage costs (in U.S. dollars per metric ton of cargo)
What does the document published annually by the not-for-profit Worldscale Association contain?
The book contains rates for travel between regions (e.g., U.S. Gulf Coast and the Baltic, Caribbean, and Black seas), as well as between individual ports. It is the responsibility of the charterer to ensure that the vessel meets all requirements (e.g., has a double hull) pertinent to ports at which the vessel may load and unload.
Fixing a charter, step 3. When all terms are agreed to and all issues are in good order, the charterer and vessel owner select one of three types of charter agreement:
Spot charter (also called voyage charter) Contract of affreightment (COA) Period charter
Spot Charter (also called voyage charter)
The spot charter is for use of a specific vessel in the immediate future to move cargo between specified loading and discharge ports; it is a “one-shot” arrangement.
Contract of affreightment (COA)
The major difference between a spot charter and a COA charter is that the COA agreement does not stipulate the use of a specific vessel.
Period Charter
Whereas spot and COA charters refer to Worldscale Association data for pricing, period charters establish an agreed-on day rate (in U.S. dollars per day) for a particular vessel.
Standard trade terms used in global shipping have been developed by the International Chamber of Commerce. Among the most common terms used in defining tanker freight charges are five methods of delivery pricing: FOB
FOB (free on board):The seller is no longer responsible for the oil once it has been loaded onto the ship; the buyer assumes all risks and costs of ownership from that point.
Standard trade terms used in global shipping have been developed by the International Chamber of Commerce. Among the most common terms used in defining tanker freight charges are five methods of delivery pricing: CFR
CFR (cost and freight; also called C+F):The seller pays all costs incurred to bring the oil to the delivery port, but the buyer is responsible for insuring the cargo while in transit. Once the cargo leaves the ship, all further costs accrue to the buyer.
Standard trade terms used in global shipping have been developed by the International Chamber of Commerce. Among the most common terms used in defining tanker freight charges are five methods of delivery pricing: CIF
CIF (cost, insurance, and freight):The same as CFR, except that the seller also is responsible for insuring the cargo while in transit.
Standard trade terms used in global shipping have been developed by the International Chamber of Commerce. Among the most common terms used in defining tanker freight charges are five methods of delivery pricing: Landed Cost
Landed cost: The same as CIF, plus the seller pays the import duties at the delivery port.
Standard trade terms used in global shipping have been developed by the International Chamber of Commerce. Among the most common terms used in defining tanker freight charges are five methods of delivery pricing: DDP
DDP (delivered duty paid):The seller is required to deliver the oil to the location specified by the buyer with all insurance, freight costs, and duties paid; in short, the DDP price includes all costs.
Petroleum Administration for Defense Districts
After crude oil is converted into refined products, the products are transported and sold to end users around the United States.The collection and dissemination of data regarding this aspect of the petroleum industry is conducted using five Petroleum Administration for Defense Districts (PADDs). They are named after a government agency, the Petroleum Administration for Defense, established in 1950 in conjunction with the Korean War effort; even though the agency was eliminated in 1954, the name is still used.These districts (see tables 14–2 and 14–3) were created during World War II to help organize the allocation of fuels derived from petroleum products.
Petroleum Marketers
Any individual or company that takes possession of refined petroleum products for the purpose of reselling those products is considered a petroleum marketer; this definition spans a wide range of commercial businesses, both wholesale and retail.
Independent Marketers
Independent marketers are companies that purchase refined products (from major or independent refineries) and sell them at retail outlets. This classification includes firms whose primary business is gasoline sales (e.g., Speedway and QuikTrip), as well as large retailers (e.g., Costco and Walmart) who sell gasoline in addition to other merchandise.
What are the two trade groups that represent Independent Marketers?
Two trade groups represent this group: the Petroleum Marketers Association of America and the Society of Independent Gasoline Marketers of America.
Distributors
Distributors are companies without refining operations that own and operate their own gas stations. Distributors may also supply gasoline to dealers who are independent gasoline stations with no distribution capabilities.
Branded/Unbranded Stations
Gasoline is sold at branded and unbranded stations. Branded stations include company-owned facilities, distributors, and dealers. Company- owned stations—which are owned and operated by a petroleum refining company (e.g., ExxonMobil and Chevron)—usually focus more on fuel sales than do operators of convenience stores. Branded operations allow distributors and dealers to market gasoline under a recognized brand. Unbranded stations can operate as either retail or commercial entities.
Nomination
the customer also is contractually required to submit a nomination to the pipeline company, specifying how much of that gas to deliver in the next 24 hours and where to deliver it. Using this information, the pipeline company takes action to ensure that gas flow through the delivery system will be properly balanced.
Interruptible Delivery Service
In some cases, a customer may opt for lower-cost, interruptible delivery service. This gives the pipeline operator flexibility to deliver gas first to firm customers, after which the remaining capacity is made available to interruptible customers.
Henry Hub
The most prominent U.S. market center for natural gas is the Henry Hub, the location of a gas plant on the natural gas pipeline system in Erath, Louisiana (approximately 15 miles south of Lafayette and 60 miles southwest of Baton Rouge).
European Gas Hubs
Market hubs for natural gas trading also arose in Europe over the past several decades, where substantial volumes of gas flow between and within many countries. In 2010, for example, physical spot trading on the seven leading continental hubs reached 4.94 tcf (140 billion cubic meters).Traded (non–spot-market) volumes were about three times that figure.
Seven Major European spot-market gas-trading hubs:
Zeebrugge, Belgium
TTF (Title Transfer Facility), the Netherlands
NGC (NetConnect Germany), Germany
Gaspool, Germany
PEGs (Gas Exchange Points) North and South, France
PSV (Punto di Scambio Virtuale), Italy
CEGH (Central European Gas Hub), Austria
Market centers or hubs offer two key services:
Transportation between (and interconnection with) other pipelines; and the physical coverage of the balancing needs associated with short-term gas receipt or delivery.
Financial Gas Market
The players in this part of the arena are traders and brokers, who, unlike marketers, never actually take ownership of the gas. They often make short-term deals—with terms ranging from a few months to as short as one day—seeking to capitalize on anticipated or actual changes in gas prices in different locations.
Tools of the Financial Gas Market
These market participants use a variety of financial tools to spread risk, stabilize prices, and enable an owner of a quantity of gas to quickly convert that asset into cash if desired. The information provided earlier in this chapter about physical versus paper trading, the spot market, and the use of futures contracts, options contracts, and swaps in oil trading applies equally in the natural gas market.
Unbundling programs
Reflecting developments in the industrial and large-volume gas sales market, LDCs have offered customer-choice programs—also known as retail unbundling programs—since 1998 to residential and commercial customers. Under these programs, consumers can select their own gas provider. When a customer buys gas from a provider other than the LDC, the LDC still delivers it, even though the LDC is not involved in the sales transaction. In essence, the customers who switch to another provider become transportation-service customers for the LDC.
