Analysis | The Almighty Brent Oil Benchmark Is Broken - The Washington Post

In the world of oil, Brent is the most important price benchmark — a reference point for the billions of dollars being exchanged via a complex web of physical, forward, futures and options contracts. In many ways, it’s oil’s equivalent to Libor — the discredited interest rate benchmark used in financial markets.

The analogy is pertinent because Brent is also broken. Don’t take my word for it. Listen to British oil major BP Plc: “As a result of insufficient liquidity,” it said recently, “we are seeing increasingly regular ‘dislocations’ in the value” of the benchmark. Sure, oil traders aren’t manipulating Brent the way banks did with Libor. But hearing the word “dislocations” alongside the price of oil should worry regulators and policy makers — especially with Brent hovering around $100 a barrel and contributing to global inflation.

The oil-trading industry is gathering this week in London for its annual get-together — known for decades as International Petroleum Week but now rebranded into the more politically correct International Energy Week. Fixing Brent should top the agenda.

Brent became a benchmark when North Sea oil production boomed throughout the 1980s and ‘90s. It was useful then because it was a representative reference price for a large chunk of the world’s barrels. But today it lacks liquidity, which in the oil market means actual barrels of the black, sticky stuff.

The world consumes about 100 million barrels a day, but the benchmark is priced out of just a sliver of that, as it only represents a portion of the production of the North Sea. In a good month, Brent is based on about one million barrels a day; in a bad one, just 0.5 million barrels a day. Not enough.

With so little Brent oil around being produced, the benchmark is vulnerable to squeezes — for example, if a party buys all the oil available and then holds the rest of the market to ransom. We’ve seen this in the past, and it’s a distinct possibility during the summer, when North Sea producers perform annual maintenance and output plunges to minimal levels.

The solution has been obvious for years — add more liquid. Originally, the benchmark reflected the price of barrels from the Brent oilfield, which started pumping in 1976. As its output fell decades later, other North Sea grades were added: Forties and Oseberg crudes joined in 2022, Ekofisk in 2007, and Troll in 2017. But that expansion route ended. Now that North Sea output of Brent-like oil is in terminal decline, there’s a need to include oil from outside the region.

The industry has been debating what to do for too long. In early 2021, S&P Global Platts, which assesses the Brent physical price and acts as a de facto regulator of the benchmark, proposed a revolutionary plan: Add to the Brent basket its main rival — West Texas Intermediate from the U.S. — and change the nature of the contract, from one that priced the crude at the North Sea terminals, excluding freight, to one that included freight in the regional oil-hub port of Rotterdam. Most of the industry balked. After a few weeks, Platts withdrew the proposal, although only after roiling the market.

A new proposal is now on the table, which also adds WTI crude into Brent but doesn’t change the nature of the contract. This plan, also put forward by Platts, appears to have good support from the industry. It isn’t what everyone would like, but it’s probably 80% good enough for most market participants, according to my informal survey of oil traders, brokers, companies and banks.

The solution has some problems: It leaves the Brent benchmark at the mercy of the White House. U.S. officials have floated, in the past, the threat of shutting down American oil exports. If that were to happen, the benchmark would get snared into it and disrupt the market. The plan is also disliked by some North Sea oil terminals, which fear a drop in revenue.

Next steps still remain unclear. In the arcane world of North Sea oil, trading in Brent is governed by the so-called SUKO-90 agreement. That document, which sets the general trading conditions, isn’t produced by a regulator or by Platts, but by Shell Plc, the British oil giant. Shell hasn’t yet said whether it supports the new proposal, or whether it would update the SUKO-90 agreement. For the first time, the industry may have to commission a third party to rewrite the rules of trading.

Even if everyone rallies behind the plan, the new Brent benchmark would not be in place until the summer of 2023. That means a few difficult months ahead.

Late last year, BP warned that without rapid action, the benchmark “will be less resilient over the next two years, resulting in even more frequent dislocations.” Regulators should have pushed everyone, including Platts and the InterContinental Exchange Inc., home of the Brent futures contract, to move earlier, and faster. As they did with Libor and the City of London, regulators let the oil traders self-regulate for too long. If something breaks, it would be on them, rather than on others.

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Analysis | The Almighty Brent Oil Benchmark Is Broken - The Washington Post

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