Oil traders prepare for bumpy DME ride

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The Dubai Mercantile Exchange trading floor.

The launch of Middle East crude futures may herald a more transparent Asian oil market but before that, physical traders are bracing for a period of uncertainty, prompting them to continue trading under the existing system.

Central to the issue is what underlying price buyers and sellers will use to sell the 30 or so shipments of Oman crude exported monthly. Until now, these cargoes were traded at a premium or discount to the Oman Ministry of Oil and Gas (MOG) price.

From Friday, however, the MOG price will not be based retroactively on published prices, but on the new Oman futures prices traded on the Dubai Mercantile Exchange (DME). The problem is that this new pricing mechanism has not yet been tested and conservative Asian refiners are cautious about trading on it.

As a result, oil trader Vitol effectively reverted to the well-established Platts price assessment system when it initiated trade on an Oman cargo loading in August - the front month to be traded on the DME - at a differential to Dubai quotes.

Vitol offered one cargo at a discount of 50 cents a barrel to Dubai quotes on Wednesday, down 10 cents from the previous day, a trader said.

"No spot cargo will trade with a DME basis after June 1. There is too much flat price involved," a Singapore-based trader said.

At the same time, that flat price risk may be the best chance for the DME to succeed where a half-dozen other sour crude contracts have failed in past decades by creating new hedging opportunities that derivatives traders will relish.

"There will be participants who have exposure as end users. If all refiners are forced to sell paper to hedge cargoes, it creates opportunities for speculators like myself," a trader with a bank said.

JUNE 1 DATE

The DME, a joint-venture between NYMEX, Dubai and Oman, will launch on June 1, going head-to-head with the IntercontinentalExchange's (ICE) Dubai contract, which is based on the existing Platts Dubai price assessments.

Oman's endorsement of the Dubai Mercantile Exchange (DME) gives it a credibility that no other sour crude contract has achieved so far, but has also caused unease among refiners who process Oman crude and the many traders who play the market.

June and July-loading crude will still be priced retroactively - as a differential to Dubai quotes as assessed by energy-specialised reporting agency Platts - and to a large extent determined by oil trading companies, refiners and majors.

But the price of August crude will be announced in early July as the settlement of month-average prices on the DME. This may attract a range of players including speculators, causing anxiety among refiners whose financial planning is entirely based on assessed Platts prices.

But refiners who have term contracts with Oman will have no choice but to take the cargoes based on DME prices.

This creates a strong incentive for them to hedge their Oman crude purchases and participate in the DME, either directly or via third parties.

Fewer complications will arise from news on Wednesday that the Dubai government will also begin pricing its oil exports against the DME Oman crude futures contract. The plan would involve less than 100,000 barrels per day (bpd) of physical Dubai production and most of that traded off published quotes, not a government price.

That move may aid the eventual shift toward a single Oman benchmark, signalling the effective end of dual Oman-Dubai pricing for some 8 million bpd of Saudi, Kuwaiti, Iranian and Iraqi crude heading to Asia.

"This is my long-term view," said another trader. "But Saudi Aramco is key for that."

Saudi Aramco officials have said they would adopt a wait-and-see stance. The kingdom is likely to only start trading or use DME pricing once it is well established and widely used on the market.

Middle East producers have traditionally exerted control on their oil revenues - the biggest share of their countries' revenues - by either using retroactive pricing, or exporting crude to different destinations.

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