Issue 829, 16 May 2008

Aramco bids for regional trading hub status

Imbued by its growing market strength, senior Saudi Aramco figures have been engaging in a bout of blue sky thinking about ways of making more capital out of the burgeoning hydrocarbons sector – with ambitions for increased activity as a regional player, as well as maintaining the parastatal’s traditional Saudi focus; and their thoughts are turning, once more, to trading.

The Kingdom is in the midst of a programme to add downstream credibility to its considerable upstream prowess, with massive slugs of new refining capacity due on stream in the next five years. But one of the most hotly anticipated of Aramco’s recent sorties is a proposal to set up a new Middle East hub for trading products, unveiled in a speech delivered to a regional energy conference in Doha in April by Adil Al-Tubayyeb. Aramco’s vice president of marketing, supply and joint venture co-ordination argued that there was a need for a fully-fledged Middle Eastern trading hub, reflective of new consumption trends in the region. “Until now, prices in the region have been derived either from benchmarks that may not be representative of regional fundamentals or via netbacks from distant markets. Such price benchmarks may have been relevant at one time, but have now become too simplistic, and rarely represent the region’s own trading dynamics.”

Aramco has not followed up with much more detail on how the trading hub will work. But Tubayyeb gave voice to a growing strain of thought in the state energy company that believes Riyadh should house such a hub. Senior Aramcons believe regional prices would no longer need to be calculated as a netback to the biggest trading hubs such as Singapore, were Riyadh to emerge as a products trading centre.

Aramco has been here before, launching a botched effort to set up a products trading company targeting the Asian market in 2002. Aramco subsequently got cold feet, amid a welter of bad PR about energy traders in the wake of the Enron collapse, and the company was never established. But now, with Dubai and Oman pushing the envelope through the Dubai Mercantile Exchange (DME) – which trades an Omani crude futures contract – the Saudis appear to again want to grab a slice of the action, seeing Middle Eastern demand strength as a key driver.

In recent years, the Gulf has come to the fore as a regional consumption centre for oil and products, underpinned by growing populations and expanding industrial bases. Tubayyeb forecasts that regional requirements will increase by about 80% by 2020, on a par with Chinese consumption expansion rates.

Then, there is the GCC’s growing domestic refining capacity. Planned new capacity additions in Saudi Arabia will hike domestic refining capacity from 2.1m b/d to more than 3.5m b/d by 2013. Regional crude distillation capacity is set to rise from 7m b/d now to 10m b/d by 2015, Tubayyeb said – providing the essential “hardware” the region needs to reinvent itself as a trading hub (the hub provides the “software”).

Aramco still has a lot more thinking to do. The compulsion to price off the Singapore market is due to the large volume of products and NGLs that Gulf producers pump out to the Asian economy. But Singapore has another advantage to traders in that it doesn’t try to fix prices like OPEC producers do.

Past experience suggests that neither Riyadh nor any Gulf oil producer is ready to let the market determine pricing. The failed attempt to set up an Asian trading company was testimony to a wider corporate reluctance to lose control of pricing to the much-maligned speculators. And if the Saudis do try to set up a trading centre retaining price controls, the main reference point would still be Singapore netbacks. There would be little point in going to the effort of establishing a new centre still based on existing price points.

Aramco faces another, possibly more intractable, hurdle: simply getting traders to relocate from more liquid exchanges to a fledgling trading hub that is likely to be subject to state interference. A New York-based oil trader told GSN: “Every exchange in the world puts out marketing studies that show plenty of participation with interest in a new contract, but the problem is that if everyone uses the same criteria you don’t always reach that critical mass.” He added: “There are already liquid markets elsewhere with a relatively tight bid/ask spread and low transaction costs –what can this new exchange offer them in terms of trading opportunities. That’s the difficulty.”

The best place for Aramco to start might be on the DME – but this would mean granting the rival exchange more credibility. So far, Saudi plans are sufficiently vague that a location for a new trading hub – or hubs – has not been mentioned. But competing with Dubai appears a strong motivation behind this particular attempt to create a market for Saudi crude.

Aramco has taken note of the speed with which new trading centres like the US-based Intercontinental Exchange can corner market share. The ambition to create a trading mechanism that is more attuned to the regional dynamic makes sense – but it’s a different matter as to whether the Saudis are ready for the tough choices that would make that market a genuine success.