Analysis: Brent trade tips toward BFO, but IPE jury still out

Traders of North Sea Brent crude oil are drifting toward a new three-crude benchmark contract, Brent-Forties-Oseberg (BFO), but the final verdict can come from only one place - the International Petroleum Exchange (IPE).

As the oil industry overhauls its benchmark forward contract - used as a marker for two-thirds of the world's traded crude oil - two new over-the-counter contracts have emerged as possible replacements for decade-old 15-day Brent.

BP is leading the drive for a Brent-Forties-Oseberg forward contract, which allows delivery of any three of those grades 20 days before loading.

Rival major Shell wants separate 20-day forward markets for each of the three grades.

Despite signs that BFO is winning over followers, traders warn that it is too early to declare a verdict as the final and deciding vote resides with the IPE - home of Brent futures, the most liquid and transparent contract in the complex.

Pressure is mounting on the exchange to make a decision about the index it uses to calculate the value of prompt Brent on expiry day - used to settle any outstanding Brent forward contracts.

Some market sources say this could happen as soon as the September futures expiry on August 15, but most do not expect a change at least until the October contract.

The IPE has said it is following the industry debate, but observers believe it will choose a new expiry method only after a new forward contract has achieved dominance.

Although the process is moving very slowly, some industry sources say the BFO contract is slowly gaining acceptance, partly because it has become the de facto pricing mechanism in the OTC Brent forward aftermarket.

Run by the industry's primary pricing service Platts after the IPE closes, the half-hour "window" is used to establish forward Brent prices, which form the basis of Dated Brent.

The most recent signal was Shell's decision to trade BFO in the so-called "window" from Wednesday evening in an effort to retain exposure to Platts pricing, although it continues to back its original idea of separate contracts for the three crudes.

The reason for the switch is clear -- because BFO includes a sellers' option to deliver three different crudes, it typically sells at a lower price than would a contract for just one grade.

As Platts now accepts BFO, Oseberg or Forties forward deals in the window in addition to the still-standard 15-day Brent, cheaper BFO values have recently held sway. This week, BFO partials have traded 7-15 cents below Brent.

Still, the trade of partial cargoes of 100,000 or 200,000 barrels in the window is never going to generate robust, liquid forward books - something that is vital before the IPE makes its biggest shift in years.

Thus far, new-style 20- or 21-day forward contracts are mostly in the form of spreads or partials and have not obscured 15-day Brent books built up over months. The numerous different contract permutations has also caused headaches, with some players carrying more than half a dozen different types.

Uncertainties over the IPE's future plan have also troubled futures traders, with anecdotal evidence suggesting a recent dip in overall volume as the BFO debate took centre stage. In June, IPE volumes were down, year-on-year, for the first time.

Shell and other players - both oil companies and trading houses - also have serious concerns about the BFO contract, namely that the sellers' option would cause it to undervalue all three grades. That could also have a knock-on impact for oil producers, who use Platts Dated Brent as their benchmark.

"Why would an equity producer want to sell a forward BFO if they could make more money selling forward Oseberg or Forties on their own?" asked one backer.

Smaller issues also remain to be ironed out, notably the discrepancy between Platts suggested 21-day market - which is the only basis it accepts in the window - and BP and Shell's proposal for a 20-day contract.

Industry sources say there is no appreciable difference between the two, but that for operational reasons a 20-day contract is much easier to adopt for field and terminal operators on Forties and Oseberg.

BP has said it will only trade 20-day BFO from October, but thus far 21-day partials dominate the window trade.

"Come October we could have a situation in which the market will be trading one thing and Platts will assess another," said one frustrated trader.

Platts has said it will be flexible and adopt a 20-day standard if that's what the industry wants.

Another bump in the road is the expiry days for IPE futures contract, which currently expire around mid-month.

This was ideal for the past decade when the 15-day Brent contract was the norm, allowing the first cargoes to turn wet typically one day after the futures contract expired. But if a 20-day contract takes over, dealers would be forced to handle wet Brent while the futures contract is still trading.