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Opinion

The 'New' Brent Contract: Where Do We Stand?

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The controversial inclusion of West Texas Intermediate (WTI) Midland crude oil in the key Brent contract is not far away, with the “new” dated Brent assessments due to begin in May 2023, while the associated June forward BFOE assessment will start even earlier, in February 2023. There are still, however, some details to be ironed out. Tax and legal aspects of the commodities business must be considered carefully if the benchmark is to function properly. Latest amendments to key bilateral contracts or general terms and conditions (GT&Cs) are a start, but the nature of the cash “Brent” contract that includes WTI Midland is still under discussion.

On Jun. 8, 2022, Platts, part of S&P Global Commodity Insights, announced that it would reflect cargoes of WTI Midland crude oil in its dated Brent crude oil benchmark, with effect from June 2023 cargo deliveries. This has caused a fair amount of controversy, debate and argument, but the industry seems to be gradually reaching a consensus regarding the broad format of the new benchmark.

While the detailed mechanics of the workings of the cash market have not been fully agreed, they are likely to resemble dated Brent — in as much as the value of WTI Midland will have to reflect the realities of the North Sea cash market. In essence, any Midland crude delivered to a cash buyer in Rotterdam should have its price adjusted for freight, “as if it’s loaded in the North Sea” — with several versions of bilateral contracts or GT&Cs for the “new” Brent benchmark emerging.

Shell General Terms and Conditions

From the earliest days of the Brent forward trading, Shell UK (Suko) was the largest primary seller of Brent crude oil. It was only natural that the market would eventually settle for Suko GT&Cs, which had been revised on numerous occasions since the 1990s. The advantage of having a common set of GT&Cs is that traders can focus on negotiating the price, knowing in advance all the other important elements of an agreement such as quality, quantity, law, freight provisions and others. Equally, when all the cargoes are traded on the same terms, their price is easily comparable.

Since the original Platts announcement on Feb. 14, 2022, Shell has published proposed amendments to the Suko 1990 GT&Cs to reflect the inclusion of WTI in the Brent contract. Significantly the latest Suko amendments include only a c.i.f. delivery provision for WTI Midland where "risk and title of the crude oil shall pass from the seller to the buyer” immediately as the vessel carrying the crude leaves the economic exclusion zone of the US.

It is not clear why the proposed amendments to the Suko terms would only include c.i.f. delivery of WTI Midland, when in its proposal Platts stated that, on being nominated a f.o.b. WTI Midland cargo, “a buyer should charter a vessel acceptable to seller and the nominated terminal, with title and risk passing from seller to buyer in international waters.” One possibility is that Shell was trying to avoid any exposure to US jurisdiction and regulation of the contract.

The other important reason is avoiding possible exposure to the US tax authorities. Normally, any f.o.b. sale involves passing of the title and risk from the seller to the buyer at the loading port. Any other contractual arrangement regarding the title passing elsewhere, while remaining on an f.o.b. basis, may be seen as a breach of US tax regulations. For this reason, if most Brent players see the same problem as Shell, some form of c.i.f. cash contract may have to be considered.

Alternative Contracts Circulating

Two alternative contracts have also been in circulation in the marketplace: a BP Oil International draft of proposed amendments and Vitol GT&Cs. They are both designed to accommodate the latest Platts announcement by putting forward terms for f.o.b. WTI Midland cargoes. While it would be useful to have a one standard GT&Cs for the new Brent contract, it is quite possible that two or more “terms and conditions” may operate in tandem.

The industry will ultimately decide the terms to be traded and, if there are tax impediments to f.o.b. GT&Cs, alternative delivered terms may have to be implemented, while still preserving the f.o.b. nature of the Brent price assessment. A standardized Brent forward contract will aid in the calculation of the Brent Index, which ICE uses to settle the Brent futures contract.

The inclusion and the assessment of the value of WTI crude in the Brent basket also raises the issue of disparate payment terms. This difference has become more obvious with the recent rise in interest rates, which makes the value of the payment terms between delivered WTI and the BFOET grades of North Sea oil even more exaggerated.

WTI Midland Quality and Terminals

The quality of WTI Midland has been one of the main concerns for European buyers as the contractual crude quality can often be met by blending various heavy grades with condensates. Such blends may have very different refining properties, yielding lower volumes of premium products and impacting the refining value of crude oil. Platts has specified the quality for WTI Midland to include gravity, sulfur, mercaptans, certain metals and vapor pressure. The proposed Shell GT&C amendments have gone further, stipulating an organic chlorides content of no greater than one part per million and a high temperature simulate distillation that top and bottoms light ends and residual.

All crude oil streams are blends. This is particularly true of pipeline barrels where numerous inputs make up the end-product. WTI Midland has established itself as the US crude oil export grade of choice due to its consistently higher level of quality over WTI Cushing. Pipelines that deliver crude directly from the Permian Basin to the Gulf Coast are more likely to deliver “pure” WTI Midland. And correspondingly the loading facilities at the end of these pipelines in Corpus Christi, Texas City, Houston, Beaumont, Nederland and Port Arthur are logical choices from which WTI Midland loading programs should be accepted.

Next Steps

The issue of quality and terminals remains important, but this can also be implemented over time through a process of learning and agreement on commonly accepted parameters. There is no guarantee that some terminals will ever accept the constraints of a Brent contract. Transparency in terms of loading programs and quality is in the interest of terminals and sellers as it will enhance the value of their exports. However, it may take time for that value to become apparent.

It would equally be useful for the industry to settle on one standard set of bilateral contractual terms, simplifying the assessments of the price reporting agencies. However, if the history of the Brent contract is anything to go by, it is likely that two or more GT&Cs may be used in parallel, with the industry settling on one only after several years.

Finally, the payment terms issue should also be resolved before the first contracts trade to reflect the occasional difference in WTI Midland payment terms relative to BFOET grades.

Adi Imsirovic is author of the book Trading and Price Discovery for Crude Oils, published by Palgrave McMillan in June 2021. He is a senior research fellow at the Oxford Institute for Energy Studies (OIES), and a former global head of oil at Gazprom M&T in London. Kurt Chapman is an independent consultant based in London, and a former global head of crude oil trading at Mercuria. The views expressed in this article are those of the authors.

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