Global Insight Perspective | |
Significance | The Dubai Mercantile Exchange (DME) will see the start of trading of a new oil futures contract today, seeking to set a new world oil pricing benchmark that is more relevant to Middle Eastern-type crudes. |
Implications | If successful, a new price mechanism that better reflects the realities of the world oil markets will be created, potentially revolutionising the pricing of some of the world's most common crude types. |
Outlook | The DME's placement, between Europe and Asia, as well as its over-23-hour-long trading day, will make it particularly relevant for Asian traders, who have lacked a relevant pricing mechanism and a transparent market by which to price their imports. |
The Black Sticky-Stuff Souk
Today the Dubai Mercantile Exchange (DME) will start trading its Oman Crude Oil Futures Contract, providing the world with a tradeable sour crude futures contract representing the Middle Eastern crudes, and providing refiners and oil traders buying and selling Middle Eastern oil with a better way to manage financial risks and reach pricing in a transparent way. While this has been tried several times before, the current attempt is based on physical delivery of Omani and Dubai crudes, thereby providing a fundamental base for the trading and having the opportunity to become a dependable benchmark, like its North Sea Brent equivalent and the U.S. WTI standard.
The DME is a joint venture between Tatweer, a part of Dubai Holding, a government-controlled corporation investing and supporting ventures strengthening Dubai's role as a financial, business and tourist hub; the New York Mercantile Exchange (NYMEX); and the Oman Investment Fund. Trading will be held on a physical trading floor, although the settling of the contracts will be completely electronic, enabling full international participation. The involvement of Oman, which has committed to using the DME settlement prices for its own crude sales, will from the outset give the contracts a tangibility otherwise lacked by previous attempts to create new sour crude benchmarks. Yesterday also saw Dubai commit its oil exports to be priced by the Oman Crude Oil Futures in a move that, although not fundamentally surprising, will add a sense of diversity to the contract. DME would probably not have achieved the sense of international relevance for its contract had it not been for Oman's participation, sine Dubai is a very small producer by international standards.
The Dubai Factor
Dubai has been rising rapidly on the international finance scene and has as its strong point—from an oil trading perspective—not only that it is closer to Asia, the main consumer of Middle Eastern crudes, but also that it fills a "gap" in the world's financial markets between the European exchanges' closing time and Singapore's opening. When the crude contract commences trading late tonight, at 22.00 GMT, it will be 06.00 in Singapore on 1 June and 02.00 in Dubai, while in the U.S. city of New York it will still be 31 May, at 18.00, on and trading will just have closed. Trading on the DME will, however, be open for 23 hours and 15 minutes per day, offering the entire world the opportunity to participate and follow the settlement of the contracts.
Sour Standards Needed
Asia, which imports two-thirds of its oil from the Middle East, has been particularly lacking in a relevant benchmarking mechanism that reflects the crude it uses. While using heavy, sour crudes, refiners and traders have been having to hedge for price changes by trading in the sweet, light standards of Brent and WTI, leading many Asian traders to greet the DME initiative as one of the best efforts to this point and banking on its success. Also, the state-controlled oil pricing mechanisms in the Middle East have been notoriously lacking in transparency, and prices for the different types of Middle East crudes, when being adjusted according to the world market prices, have often been subject to very different mechanisms employed by the NOCs of the region. These figures are then reported in the media, often providing the only attempt at giving a full picture of how prices were comparing and moving.
With hopes of a publicly traded sour crude benchmark taking off, there are hopes that the feeling of arbitrariness that has surrounded the pricing—for instance, of Saudi oil exports—will ease somewhat, as a close nearby contract gaining popularity among Asian traders will exert a certain pressure and influence on the region's producers over time.
Outlook and Implications
It is widely hoped that the DME oil futures contract pricing commitment will spread in the region, so that more and more producers will let their crude be priced in relation to the benchmark. That will naturally follow only if the contract's trading is deemed a success. Already, however, there has been much interest in applying for trading licences with the DME, and the fact that the exchange fills not only a convenient time gap, trading-wise, but also provides a more relevant pricing benchmark for the vast Asian market, has raised hopes and anticipation for the project.
The fact that NYMEX is a partner in the DME will also reassure the finance industry worldwide, seeing as this will bring experience and knowledge to the young financial hub of Dubai. Additionally the DME is situated in a free zone, governed by British law, providing an even greater sense of security for traders.
Certain quarters within the Middle Eastern oil establishment will certainly view the new project with suspicion, as transparency naturally undermines control. If the Oman Crude Oil Futures do reach popularity among mainly Asian traders, as it seems at present, a sea change might be happening in the way the world's biggest exporters are pricing their crude. Change will probably not come rapidly—it rarely does in the Gulf region—but nevertheless the DME is set to provide an impetus and its progress is worth studying closely.
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