Beijing's Saudi gamble

Shanghai Futures Exchange looks to change global oil and gas pricing

Commentary - Executive magazine, February 2013

 

It is one of those economic oddities that Saudi Arabia, regularly the world’s top oil producer, does not set the price for the oil it sells. While potentially wielding great influence over global supplies of oil through ramping up or decreasing production, the kingdom limits itself to operating within the Organization of Petroleum Exporting Countries’ (OPEC) quota system; Saudi Arabia is a price taker, not maker, using OPEC’s Secretariat Crude Oil Basket Daily Price — a reference basket weighing crude from all 12 OPEC member countries — and a market-related base price to sell its oil.

So when a delegation from the Shanghai Futures Exchange (SFE) showed up in Riyadh over the new year to petition the Saudis to sell their crude via the Chinese marketplace, it came as a bit of a surprise. The kingdom has long indicated it is in no mood to directly market its oil, let alone through one single market. 

What the SFE’s initiative showed, and here is where there is no surprise, is China’s increasing importance on the global oil markets. Indeed, it is the number two consumer of crude at 11.4 percent of global consumption, according to British Petroleum figures. But just as Riyadh has little direct say on market prices, neither does Beijing, which is frustrating the rising superpower as it is forced to make purchases through the dominant futures markets — Brent in London and West Texas Intermediate (WTI) in New York ­— to offset spikes in domestic demand not covered by long-term contracts with producer countries. 

The Shanghai benchmark, which is slated to start this year, could give the Chinese pricing influence in the oil futures markets. However, Saudi Arabia would be key to making the SFE a success, not only because of its contribution to China’s imports, but as the dominant member of OPEC. 

If Riyadh were on board, other Middle East and North African (MENA) oil producers would presumably follow, and with the International Energy Agency (IEA) forecasting that within a decade 90 percent of the region’s oil will be destined for Asia, the SFE could dislodge the global prominence of Brent and WTI.  

With China being Saudi Arabia’s third largest petrochemicals customer after the United States and Japan, forward-thinking policy makers in Riyadh were undoubtedly weighing the merits of the Shanghai option. The two countries’ state-owned oil companies are also in a $10 billion joint venture to build a 400,000 barrels-per-day refinery on the kingdom’s Red Sea coast. 

The gambit was certainly a clever move by Beijing to try and tie-up the Saudis, but given Riyadh’s past tumultuous experiences with oil pricing policies, Saudi Arabia is not likely to be easily shanghaied. 

Options that are worth considering by Riyadh would be exposure to multiple futures markets, or directly selling Saudi oil, like a government bond, through auction. Deciding on either of these options may prove inevitable as non-OPEC production ramps up — and at cheaper prices — while OPEC output has already dropped to 40 percent of global production. 

Riyadh, though, has not even opted to sell on the Middle East’s sole pricing benchmark, the Dubai Mercantile Exchange (DME), which in 2007 set up the Oman Crude Oil Futures Contract to market Dubai and Omani oil. An estimated 40 percent of the DME’s contracts are bound for China. 

With China and other Asian economies demanding increasing amounts of oil, and demand dropping elsewhere, the Saudis will be keen to keep Beijing happy, but will almost certainly carefully sidestep the Shanghai proposal, at least for the time being. 

Currently neither the kingdom nor anywhere else in the Middle East and North Africa is in the mood for any further radical changes, be it oil pricing or the socio-political status quo. Messing with oil prices that could affect revenues is not on the table — even if going directly to the markets could be a boon in the long run. 

For now it is business as usual and stability is the name of the game. Chinese brokers, however, will be banking on the rising global clout of Asian consumers for the SFE to secure a spot in the futures markets.