For Dubai, The Oil Futures Are Now

May 31, 2007 (From The Wall Street Journal via Dow Jones Newswires)

Today, the eyes of the oil world will be turning to a souk in the desert.

At 6 p.m. Eastern time, a long-awaited effort gets under way in Dubai's opulent financial center to give the world a new crude-oil pricing benchmark. The recently organized Dubai Mercantile Exchange is launching its Middle East "sour" crude futures contract as an alternative to the bellwether New York and London contracts for the black gold of Texas and the North Sea.

The launch comes as powerful market players are increasingly questioning the relevance of the main crude-oil benchmark traded on Nymex Holdings Inc.'s New York Mercantile Exchange, the world's largest energy marketplace. Refinery and trading dynamics peculiar to the U.S. market have pulled the Nymex benchmark several dollars a barrel below other key crudes.

And with Nymex's primary grade -- West Texas Intermediate -- representing an ever-thinner slice of global production, supporters say it is time to build a more robust market around the world's most plentiful source of oil. The Middle East accounts for about a third of global production, and 62% of its proven reserves. The oil there is predominantly thick and "sour," a reference to its sulfur content, whereas WTI and similar blends are easier to refine into gasoline.

No one is claiming that Nymex's busy energy market will cease to matter. Nymex Chief Executive James Newsome predicts the Middle East contract launch will expand trading volumes, rather than rob Nymex of market share. Indeed, the DME is a joint venture of Tatweer, a unit of the Dubai government's investment vehicle Dubai Holding, and the New York Mercantile Exchange.

The contract's success isn't guaranteed. Some traders are vowing to sit on the sidelines until trading momentum builds.

Until now, Middle Eastern crude prices were set either by Arab states or through price-reporting services, such as the Platts unit of McGraw-Hill Cos., which draw conclusions from a limited sampling of transactions. The DME's new contract will give the sea of buyers and sellers of Middle Eastern crude -- particularly the voracious Asian oil consumer -- a more transparent, publicly traded pricing mechanism to gauge sour-crude prices and manage the risks of volatile energy markets.

The DME contract is based on physically delivered Omani crude. In a coup for the DME, the Oman government last year agreed to use the DME settlement price for Oman's own crude sales.

Previous attempts to introduce Middle Eastern crude-oil benchmarks have failed, because they allowed for traders to speculate but didn't involve physical delivery of oil, although the Intercontinental Exchange made another attempt May 21, when it launched a financially settled Middle East crude contract. Then, just yesterday the DME announced that another producer, the government of Dubai, also will use its futures contract to price its oil. "This is probably the biggest thing that's happened in trading in the oil markets in 25 years," says Gary King, chief executive of the DME.

Because Dubai is four hours behind Singapore and three hours ahead of London, its business day bridges the gap between two major markets.

Buying and selling will be done electronically, 23 hours and 15 minutes a day. But the DME -- not to be outdone in the Persian Gulf state's skyscraper-encrusted business center -- has built a tricked-out trading lair. The two-story, nearly 5,400-square-foot DME floor includes work stations with members' logos and a wall of video screens and price quotes. "We want an oil souk, so people can go down there and see what people are doing, talk about markets," Mr. King says.

Global oil players including Nymex have long sought to establish a publicly traded benchmark for Arab crudes. But Saudi Arabia, the world's biggest oil producer, hasn't allowed its oil to be traded on the open market since 1985, says Edward Morse, chief energy economist for Lehman Brothers Holdings Inc. Some analysts speculate that the oil kingdom may reconsider that with the launch of the DME contract.

"Massive political, cultural and economic barriers stood in the way," recalls John D'Agostino, a former Nymex executive who made scouting trips to Dubai starting in 2002. The year before, Nymex had tried to launch a Middle Eastern crude contract. It was financially settled but had no mechanism for physical delivery.

It also had an inauspicious launch date: Sept. 11, 2001. In the aftermath of the terrorist attacks, the contract was abandoned. Mr. D'Agostino says he became so "obsessed" by the potential of a Middle Eastern energy exchange that he was nicknamed "Johnny of Arabia" by the Nymex board. "To take the essence of capitalism, an exchange, drop it into the heart of the Middle East and use it to trade crude oil is truly a revolutionary concept," he says. Mr. Newsome says a turning point in the exchange's efforts came a few years ago when Dubai set up a financial-free zone with a regulatory regime based on British law, rather than Muslim law. That created more legal certainty for business transactions.

Refineries and their banking partners across Japan, China and elsewhere have long traded contracts for light, sweet crude oil on Nymex or the Intercontinental Exchange's ICE Futures Exchange in London as an imperfect way hedge against rising or falling prices for sour crude, the grade they usually use.

Hedging has grown more difficult in recent months because the unusual depression of the Nymex benchmark has distorted relationships between sweet and sour crude. Nymex long ago structured its crude contract to require delivery in the oil hub of Cushing, Okla. Recent refinery outages have reduced the demand for raw crude to process into gasoline and contributed to a glut of crude in Cushing's storage tanks. In addition, some trading strategies have made it profitable to hold crude for future sales.

Tony Nunan, a risk-management executive with an energy-trading arm of Mitsubishi Corp. in Tokyo, says using WTI is an even more imperfect hedge in Japan, where close to 90% of crude-oil imports come from the Mideast.

"A new benchmark is needed," he says, "and DME has the best chance ever to succeed."

Copyright (c) 2007 Dow Jones & Company, Inc.


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