Crude Oil Across the Asia Region
Benchmarks play a crucial role in the pricing of crude oil around the world. Most crude oil streams price as a spread differential to a global benchmark. The differential of these crudes is determined according to the basis differential which include both quality and location basis. Light sweet crude grades have a tendency to trade at a premium over the heavy sour crude grades.
The rise in importance of the U.S. crude market comes at a challenging time for other crude oil markets globally. The catalyst for this transformation was the sharp rise in U.S. oil production and the lifting of the export ban on U.S. crude that occurred at the end of 2015. Moreover, a number of new terminals are in the process of being built along the U.S. Gulf Coast to handle the rising number of ships arriving to load crude oil destined for the international markets.
WTI in Asia region
The WTI Crude Oil benchmark continues to increase its presence in a growing role throughout the Asia region. Crude oil can be sold via spot or term sale. It has a tendency to be sold on a fixed price basis. The most well-known oil benchmarks are WTI, Brent and Dubai. The WTI benchmark price is based on a blended series of crude oil streams produced in the U.S. mid-continent. It is physically delivered into Cushing, Oklahoma from the U.S. Gulf Coast and mid-continent, via rail and inter-connected pipelines. Asian clients can use WTI Crude Oil futures to hedge their downstream production, as this benchmark futures contract provides robust liquidity and high price correlation to most crude oil streams.
Look at a few examples from the perspective of a refiner and producer. A short hedge is the sale of a futures contract and is characteristically used by producers, refiners, distributors and traders. Whereas a long hedge is the purchase of a futures contract, and is typically used by refiners, distributors, traders, retailers, and end users.
LONG HEDGE EXAMPLE
In the first scenario we will look at an oil refiner with a long hedge. Assume an oil refiner wishes to protect its acquisition costs from rising prices On July 15, a refiner enters into a term agreement to buy 300,000 barrels of crude oil per month from an oil producer for delivery starting in December. The refiner is at risk to rising prices between July 15 and the December delivery but could hedge its acquisition costs by buying NYMEX WTI futures. In this case, the refiner would buy 300 December WTI contracts at the price of $50. In December, the refiner purchases the 300,000 barrels of crude at $55 per barrel, and then sells 300 December WTI contracts at a price of $55.
The result is a final per barrel cost;
$55 (physical) - $5 (futures) = $50/barrel
SHORT HEDGE EXAMPLE
Now look at a short hedge example. Assume an oil producer wishes to protect its oil revenues from falling prices. On July 15, a producer enters into a term agreement to sell 300,000 barrels of crude oil per month for delivery starting in December. The producer is at risk of falling prices between July 15 and December delivery. One way the producer could hedge his revenue is by selling the appropriate number of NYMEX WTI futures contracts. In this case, the producer would sell 300 December WTI contracts at the current price of $50. In November the price drops to $45. The producer will sell the physical oil for $45 per barrel. In addition, he will buy 300 December WTI futures contracts at $45. This will result in a $5 per contract profit.
The result is a final per barrel cost;
$45 (physical) + $5 (futures) = $50/barrel
CME Group offers Crude Oil futures and options products to allow participants such as producers, refiners, consumers, importers and exporters, the ability to hedge their risk. For more information on this product please visit the CME Group product specifications page.
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