Dubai's commodities exchange to affect shipping, refining and prices

The trading of fuels and crude futures on Dubai’s exchanges next year will have profound changes on the Middle East’s energy sector that may have a global impact, according to some industry insiders.

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By  Nicholas Wilson Published  November 13, 2005

Dubai's futures markets to affect shipping, refineries|~|Photo-1-Mkts-24--27.gif|~|Will futures bring price transparency?|~|Next year, Dubai’s fledgling commodities exchanges will offer crude and fuels futures, which some industry experts say will bring much-needed price transparency to the region’s market, boost its demand for refinery capacity, and allow oil shipping companies to budget transport costs at a time of seesawing prices.

It will help turn the Middle East into a mature and complete market, not just an oil-producing region.

This month Dubai Gold and Commodities Exchange (DGCX), the only commodities market between Europe and the Far East, opens. It aims to be world’s first exchange to sell fuels futures in dollars, when it offers them after March 2006. It will provide bunker fuel, used to power ships, at a fixed price on a predetermined date in the future.

Today cargo firms buy fuel at over-the-counter daily (spot) prices in Singapore.

The only place in Asia selling fuels futures is Shanghai, which is not an international market, as they are sold in China’s currency, the yuan, exposing traders to currency risk.
Dubai-based Omar Najia, a trader with BB Energy, which sells oil and fuels globally to other traders, majors, and Chinese firms, said the move will result in more oil being refined at UAE’s Fuajairah instead of shipped to Far Eastern refineries.

“Futures will increase demand for more fuels, so local refineries will gear up to provide them,” he said.

“Refining will shift to India and the Arabian Gulf in the next five years, marginalizing Singapore.”

Singapore has invested a lot in storage and refineries, but it will be bested by India and the Arabian Gulf, predicts Najia. There is more money to be made from refined products than in producing crude, but it means a tremendous investment.

“For 20 years refining was bad money,” said Tilak Doshi, executive director, Energy of Dubai Metals and Commodities Centre. “But it’s changed in the past two years.”
Not everyone, however, is convinced that the futures market will make such an impact.

And it may be an uphill struggle to get enough firms to use Dubai’s futures exchange to ensure that there are enough buyers to match the number of sellers. Old habits die hard.

Gloria Arthur, a bunker fuel buyer for Teekay, which carries 10% of the world’s maritime-transported crude oil and refined products, said that the shipping firm will continue buying in Singapore. “Most of our lifting is done in the Far East, because that is where our customers buy. So we refuel in Singapore because that makes most economic sense,” she said.

She did, however, say that in the event of Teekay’s customers moving to the Middle East market, then Teekay would buy bunker fuel there.

It may be a chicken and egg situation where lack of refinery capacity in the Middle East keeps customers shopping elsewhere, even if the UAE is the only place on the continent that offers fuels futures.

The Middle East is beefing up its refining capacity, with the Iranians and Saudis upgrading their refineries, and Kuwait and Oman building new ones.

UAE’s Fujairah, the region’s bunker fuel centre, also plans to massively increase production from new refineries, to complement its sole 105,000 barrels per day (bpd) plant. However, these refineries will take up to three years to come on stream, which is too far ahead for 2006 futures trading.

It is widely rumoured that one of the refiners leading the charge is Abu Dhabi Oil Refining Company (Takreer), which plans to massively increase production with a vast, new, 300,000 bpd, refining facility in Fujairah, costing US $4 billion. Its crude oil will come from the UAE, and its products will serve overseas buyers.

However, Oil&Gas Middle East was unable to confirm it.
When on stream, the new refineries could catapult Fujairah into top world place as a bunker fuel centre. With an annual sale of 11 to 12 million metric tons, Fujairah vies with Rotterdam for the No. 2 slot in the $25 billion bunker fuel market, which is lead by Singapore with 16-million metric tons.

Doshi, however, thinks the growth will not necessarily be at Singapore’s expense, but is part of a pattern of increasing global consumption.

Adding to refinery demand is the growth in the region’s trade and shipping, which are burning up more bunker fuel. “As the Middle East gets richer, it demands more commodities,” Doshi said.

All of which is good news for Fujairah’s bunker fuel market.

Fujairah’s rise as a fueling depot started during the Iran-Iraq war in the eighties due to its strategic but safe position in the Indian Ocean at the mouth of the Arabian Gulf. Each year it receives more than 6,000 ships at its offshore storage facilities.

Some three quarters of the vessels are oil and gas tankers, including very large crude carriers holding up to two million barrels of oil. Tankers leaving the Gulf through the Strait of Hormuz between Iran and Oman’s Musandam peninsula carry an average 15 million bpd of crude, some 20% of world demand, according to the US Energy Information Administration.

Regional demand for bunker fuel will rise as oil producers export more oil and natural gas, said fuel oil traders in Fujairah.

Qatar, poised to become the world’s largest liquid natural gas exporter, aims to have its vast tanker fleet sailing within five years.
These vessels will account for about 4.5 million metric tons per year of bunker fuel by 2007, according to Hussain Sultan, CEO of Emirates National Oil Company (ENOC). Its refineries supply about a third of Fujairah’s demand.

Bunker fuel prices in Fujairah are lower than those in Singapore because its feedstock comes from the region, home to more than 60% of global oil reserves.
The price of 180-centistoke bunker fuel in Fujairah has averaged 2% less this year than Singapore’s. [Centistoke, a centimetre-gramme-second unit of kinematic viscosity, indicates the ease with which fuel flows.]

All of which makes the region set to become a major market in its own right.

“Having a futures contract for Fujairah will give the Gulf its first bunker fuel benchmark that will reflect local conditions rather than those in Singapore,” said Najia, the BB Energy trader. This will help the prices of regional bunker fuels to be determined locally, instead of in the Far East.

“With the DGCX, the market will have the chance to say ‘This is the price of Arabian Gulf fuels,’” he said.

Doshi said: “It will make history. Energy futures have never been done in the Middle East.”

Furthermore, the Singapore price setting depends on non-transparent assessments where the freight charge is added to the cost of oil after it has been loaded, making budgeting even more difficult. “You get hammered on that,” Doshi said. “Shipping businesses don’t know what’s going on. They can’t plan their cash flow.”

In addition to fuels futures giving refiners more incentive to keep local oil in the region for processing, the New York Mercantile Exchange (Nymex) also plans to start selling crude futures in Dubai next year, using Omani crude as a benchmark.

Crude oil is the world’s most actively traded commodity, and because there are so many different varieties and grades of crude, buyers and sellers find it easier to refer to a limited number of reference, or benchmark, products. Others are then priced at a discount or premium relative to it, according to their quality.

While Brent is generally accepted as the world benchmark, being used to price two-thirds of the world’s internationally traded crude oil supplies, the Organization of Petroleum Exporting Countries (Opec) has its own reference, known as the Opec basket price. This is an average of seven crudes, six produced by Opec members, including Dubai, and the seventh, by Isthmus in Mexico.

But in Asia’s over-the-counter markets Dubai is used as a benchmark for other regional crudes, because it is one of the few Gulf crudes available in on-the-spot sales as opposed to long-term supply contracts.

A spot transaction is an agreement to buy or sell one shipment of oil under a price agreed upon at the time of the arrangement. The oil industry uses the spot market to balance supply and demand. When a company temporarily has too much supply for its own needs, it will offer some for sale on the spot market. Likewise, if it needs additional volumes to meet a demand spike, or because supply is unexpectedly curtailed, it will purchase oil on a cargo-by-cargo, shipment-by-shipment basis. Spot prices are reported for transactions in these different markets, and prices in spot markets are relatively “transparent”—they are reported by a number of sources and widely available in a variety of media.

“Selling crude futures in the UAE will instantly create price transparency in this time zone,” said Tony Fay, managing director of Sydney-based Man Financial, an oil and gas futures broker.

It would also help move Omani crude into a more transparent market, which seems to be in line with Oman’s government’s plans.

Oman Oil Company (OOC) and Denmark-based Vitol are forming a company to trade crude oil and related products in the international market, beginning in 2006.

International traders see it as a sign that the government is set to abandon retroactive pricing of its crude, a move that will open up the country’s sour grade to a wider and much-needed role as a regional benchmark.

The venture would also be the first step into oil trading by non-Opec producer Oman, with the help of Vitol, one of the world’s biggest private energy trading houses.

The new firm, based first in Muscat with a view to opening an outlet in Singapore, will buy Oman crude from the ministry and resell it on the spot market, as other lifters regularly do.
To critics of open markets, the developments are bad news. More traders deal in oil futures as prices surge, and people blame investors for high prices.

BB Energy’s Najia said, “Speculators don’t drive prices up. That’s just bollocks. The market isn’t stupid. It’s there to discover what the price is. If they’re going up, it’s because of hurricanes or refinery bottlenecks or wars. Not because of investors.”

On an exchange no one goes belly up or loses his shirt, which may happen with a contract where the seller goes bust and can’t deliver the goods, he said.

Futures also allow participants to “lock in” the prevailing price for future deliveries, such as heating oil prices for the winter season.

Futures allow more price transparency, unlike the long-term contracts between producers and consumers, which are not open to whomever wishes to look at their deals.

Contract arrangements in the oil market in fact cover most oil that changes hands. Suppliers grant pricing terms tied to a market indicator—the spot market, for instance, or the futures market. Thus while most oil flows under contract, its price varies with spot markets.

As world oil prices reached new heights this summer, the European Union renewed calls for greater transparency in oil markets and for major Middle Eastern producers to lift the veil of secrecy over how much crude oil they have in the ground and can pump.

Producer and consumer countries need to improve transparency in the market so that prices “better reflect” market fundamentals, said EU Energy Commissioner Andris Piebalgs.

He added that the countries should provide data on reserves, production capacities, stocks, and future investment plans, because closer cooperation among the EU, Gulf States, and OPEC could make an important contribution to the stabilisation of the market.

The region’s futures markets will create some of what the Europeans are looking for.

Unlike fuel futures trading, Dubai’s crude futures market will face direct competition.

In 2002, the Singapore Futures Exchange (SGX) launched the Middle East crude oil contract (MECO). Compared to Singapore, Dubai enjoys a host of advantages over these markets. The proximity of the six oil producers in the Arabian Gulf region alone is enough to provide substantial liquidity to this type of derivative trading, and the number of global oil majors that have their offices located in Dubai is also a major plus point.

A large money market with a high degree of volatility and the availability of similar contracts for spread trading is what the traders look for. And Gulf oil producers who pump around 14 million bpd provide more than enough for the contract holder to take advantage of any hedging opportunities that arise.
The least fluid and transparent energy market is liquefied natural gas, where spot trade accounts for less than 10% of total LNG shipments. Producers demand long-term contracts to support their billion-dollar investments. Furthermore, there are only about 170 LNG carriers worldwide compared with about 2,000 oil tankers, so logistics makes availability and quick purchase of LNG very difficult.

Despite building a vast tanker fleet, Qatar will not add much to the spot side because most of its ships are locked into 20-year contracts for moving between Qatar and one other country. Also, the ships will add little to the spot market because they are too big for most ports.

The Qatar gas boom has added to the spot market in one area at least, when Train 4 production plant came on stream without having a long-term buyer ready. When built the Rovigo regasification import terminal near Venice will take a lot of Train 4’s exports. Exxon has a global system: monster import terminals in the US, UK and Italy; monster liquefaction plants in Qatar; and monster ships running between them for 20-30 years. But the absence of a long-term buyer here and now sends the train’s gas to the spot market. BP’s Korea operation is widely believed to have snapped most of it up, for this year at least.

Also the Italian terminal being built by Exxon and Edison, may have lots of spot cargoes when it is up and running.
Further adding to the spot market, liquefaction plants tend to churn out up to 10% more than their design capacities, and that provides a cargo from time to time.

While these trades make the market more fluid, they do not always add to its transparency. The few spot trades there are, are mainly done by the majors behind closed doors. However, the growth of demand for LNG in Europe and the US, where buyers expect the flexibility of spot trade, is likely to push the market in that direction.

A commodities exchange, such as DGCX, selling a full range of energy futures would make the gas market more open.

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