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Analysis: DME Oman benchmark move backfires as open interest stalls

Highlights

Questions about underlying appeal of DME Oman as a benchmark

Open interest on DME Oman forward curve has flat-lined

Scratch trades underpinning DME Oman volumes, say traders

London — Almost a year since Saudi Arabia picked Dubai Mercantile Exchange's Oman benchmark to help set official selling prices for crude in Asia, open interest in the forward curve contract has stalled, leading some experts to question levels of underlying trading activity.

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"The Saudis have accepted DME Oman as a marker, but it has not helped liquidity on the contract and that is what is really disappointing," said Adi Imsirovic, a research associate at Oxford Institute for Energy Studies (OIES).

Open interest -- the number of outstanding contracts and a measure of how the market values DME Oman as a long-term hedging tool -- remains largely unchanged day-to-day in the forward curve, despite substantial volumes going through on a deferred month basis, DME data showed. That could suggest traders are closing off their positions instead of hedging their exposure.

From June 12-24, DME reported volumes of 5,613 lots in the second-month September futures, but open interest was largely unchanged. At the back of the forward curve, the February contract saw open interest unchanged for almost two weeks, despite daily volumes of 300 lots, or more, on several trading days.

"It goes to show that people do not really have a lot of exposure to forward month Oman," said a senior oil trader with a Chinese oil major. "When they do have that exposure, it is easier to manage it through other contracts such as Brent or Dubai that are more liquid." Saudi Aramco started last October to sell oil to Asian refiners based on the monthly average of Platts Dubai and DME Oman. Previously, Riyadh priced Asia sales on the average of Platts Dubai and Platts Oman assessments. The DME launched its Oman contract in 2007.

DME did not respond to a request for comment sent July 4. Some Middle East crude oil assessments published by S&P Global Platts compete with DME Oman in the Asian oil benchmark space.

Weak liquidity in deferred month Oman contracts is not new. However, the issue has resurfaced after the prospect of a more active forward curve following Aramco's decision to adopt the front-month DME Oman contract in its pricing formula for oil sales to Asia fell flat.

"It seems that Asian refineries do not care about the variability of Oman relative to Dubai. In the past, there was a swap market for MOG [Oman]/Dubai differential, but nobody seems interested in trading Oman swaps," Imsirovic said.

Instead, volumes on the forward curve appear driven by market makers, primarily derivative traders who have been financially incentivized by the exchange to beef up volumes, traders say.

Normally, these market participants have little to no oil market exposure to carry forward their open positions. Market makers will often carry out offsetting transactions to close any positions, sometimes on the same day, boosting trade volumes but leaving open interest little changed.

Traders say the lack of interest in forward month Oman stems from the market structure where the forward curve for Dubai futures -- which financially settle on Platts cash Dubai assessments -- remains the primary hedging instrument for Asian firms managing exposure to Middle East oil.

Beyond Dubai, market participants often use the much more liquid forward curve for Brent futures to hedge exposure to global prices.

Reflecting the strong price correlation, DME Oman forward inter-month spreads continue to closely track the Dubai forward curve.

In June, the Dubai July/August intermonth spread averaged 60.8 cents/b, while the corresponding DME Oman September/October spread averaged 58.6 cents/b. DME Oman intermonth spreads align with Dubai intermonth spreads two months ahead because of the difference in pricing period. For example, in July the DME October/November spread aligns with Dubai August/September spread.

"There is no point for people to trade forward months for Oman. The lowest value that Oman can go is at Dubai level. So if the spread is 10 cents/b, the downside for Oman is only 10 cents/b. What is the point?" a second crude oil trader said.

DME Oman opens interest lags global benchmarks

Click here to see full-size graph.

Scratch trades

On the surface, DME Oman trading volumes appear healthy. Total trading volume in the forward curve in February reached 43.9 million barrels compared with 16.9 million barrels in February 2018, DME said in a March statement, attributing the increase to "customers' growing need for longer-term risk management".

Quite often, the open interest is little changed day to day, despite substantial volumes going through on deferred month contracts, suggesting much of the exposure is squared off the same day. Open interest in DME Oman's forward curve futures compares poorly with derivatives contracts in the crude oil space of similar liquidity such as WTI Houston, or WTI Midland.

"Everybody is scratching and trying to zero off," said a third trader with direct knowledge of the market making activity. 'Scratching' refers to a practice where a trader makes an equal and opposite transaction to offset an open position at the same price without making any gain, or loss.

"What if someone [a counterparty] does not want to scratch?" the trader said. In most cases the market maker would then hedge the open position on the Dubai forward curve and try to unload the position as soon as possible, prior to settlement at the end of the month, he said.

The trade itself is not always risk free, but volumes continue to grow because of the lucrative financial incentives offered by the exchange under its market maker program, traders say.

"There is a valuable rebate program, and if you get your volumes high enough you can be getting back 10k-plus (more than $10,000) per month," said a fourth trader familiar with the program.

However, on the forward curve, experts said market makers do little to develop interest, or draw in new participants.

"For market making they need companies who are physical players and have some weight behind them; who can take some exposure in the market. Instead, what they have got currently are very small paper traders who avoid taking any risk," Imsirovic said.

-- Gurdeep Singh, gurdeep.singh@spglobal.com

-- Additional reporting by Avantika Ramesh, avantika.ramesh@spglobal.com

-- Edited by Andy Critchlow, andrew.critchlow@spglobal.com

-- Edited by Daniel Lalor, daniel.lalor@spglobal.com