SIMON SAYS: Saudi Contract Pricing – If you can’t beat’em, join’em

Submitted by Simon Hill on Mon, 09/30/2019 - 17:00
Saudi Contract Pricing – If you can’t beat’em, join’em

In yesterday’s SIMON SAYS we started to explore the Saudi Aramco Contract Price (CP) and asked the question “how do parties really make money from CP related contracts out of the Middle East?” We went a little way down memory lane, but what seemed to be the answer, maybe not the only answer, lay in the end year activities, both calendar and fiscal, of the Japanese LPG importers and the value of the product they hold in storage. The simple logic was that they bought cheap tons in the summer, keeping as much in storage as possible, allowed winter buying to influence the price upwards, and then when the stocks were valued higher, everyone went for a quick Saki or two to celebrate. 

But why does CP suddenly move above other prices, what makes it so special?

I think a lot of what makes it special lies behind the fact that you only need to hit one target, one day, each month. It means traders can focus on a plan they want to try and achieve. There’s certainly something taking shape right now on CP, especially before October CP was announced at $420/ Mt for propane and $435/ Mt for butane. What makes it even more unusual is that Friday’s paper markets were betting that October’s propane CP level was probably going to be set between $420 and $425/ Mt. It’s unusual because October’s Far East Index (FEI) paper quotation is languishing nearly $12-13/ Mt below CP. CP is the FOB price you normally buy at, and the other (FEI), is the one you normally sell at, that’s after chartering in a vessel at $66/ Mt, the value of Friday’s Baltic.

Now of course there will be some very well-argued and rational reasons for why this inversed price relationship has happened. As I said earlier, they are two different prices similar only in relation to the time period they cover. Both are October prices, but the FEI is an average of the whole month, while CP is the price set on the day it is announced, i.e. Monday, 30th September, applicable for October. If it says anything, it suggests that the FEI levels in relation to CP must be lower at the end of the month, but although CP spreads are in backwardation October to November, FEI is still in contango.

There will also be arguments made saying that the cutback in Saudi LPG volumes, as a result of the drone attack, coupled with the squeeze on LPG exports resulting from the heightened tensions and tightening of Iranian sanctions, the continuing impact of the U.S. / China tariff war, combined with renewed buying interest into India, are likely to distort buying interest towards the Middle East. Furthermore, the FEI price is influenced far more by the flow of U.S. sourced cargoes into Japan, Korea and Indonesia. It’s a fair point.

In fact, the slightly stifled news coming out of Saudi Arabia, over the last couple of weeks, suggests that LPG will probably be more affected, than crude oil, by the drone and missile attack on Abqaiq. Initial delays and quasi cancellations, shifting contract liftings out of near months to later months, even quarters have given Saudi Aramco time to assess what is, or is not, likely to happen. Without doubt there is a strong line of reasoning to suggest that Saudi Aramco would themselves be expecting to see a far higher CP level for October, given what has happened. The only frustration to this premise is that the repair to the crude oil market, and the facilities in Saudi Arabia, is happening a lot faster than had been expected. And even Friday’s announcement that Saudi Arabia has agreed to a partial ceasefire in Yemen can only bring uncertainty to the final CP levels that will be set.

The Iranian situation has been somewhat misleading as well. Clearly the U.S. is keen to tighten the knot around the exports of oil, condensates and LPG. But the arrest, and ultimate failure to detain, of an Iranian crude oil tanker passing Gibraltar, destined for Syria, was met with a tit-for-tat response from the Iranians arresting a couple of non - U.S. operated ships close to the Straits of Hormuz. But now the U.S. has announced sanctions on Chinese tanker owners and their executives, again as a deterrent against Chinese parties lifting Iranian cargo. LPG ship owners such as Kunlun Shipping and COSCO have been added to the Office of Foreign Assets Control (OFAC) list. This is again bullish for the region and for CP prices. But these factors are not the driving forces in themselves, they are simply what makes a push on CP likely, viable and lucrative. What’s vital  is a shortage of availability in Saudi Arabia and that’s certainly the case right now.

There seems to be two methods that the pricing committee in Saudi Arabia use to determine what level they are going to try and set CP. Firstly, they have two rounds of price indications from their customers, mainly in Japan, Korea and China. In most cases this probably sets a floor to the price level, rather than suggesting the actual numbers themselves. The market is interested when they hear the levels as an indication of what might follow. The second way is to measure market interest in spot cargoes loading from either Ras Tanura or Yanbu in Saudi Arabia. This can be very worthwhile for Saudi Aramco, especially when the market is as tight as we are seeing today, with traders and Chinese customers constantly pushing for cargo in a short market, and more prepared than ever to put in higher and higher bids, even though they are unlikely to secure spot cargoes.

But let’s face it, all that the traders want to do is make money, and being sat in the hot seat, having to pay premium prices above market for physical cargoes isn’t going to make them rich that quick. But they know that if they are pushing Saudi Aramco to buy a cargo, and potentially pushing up the market in a way that will also give impetus to the probable CP levels, then why not run with it on the paper too. All this is happening close to the CP decision day, so crude risk, although always there, is less of a risk (since there less time) than the movement in a monthly index price over an entire month.

So, the traders load up on paper CP swaps. The Japanese and other CP physical buyers tend to come out of the woodwork at this time of the month anyway to hedge cargoes, so there are sellers of CP exposure, but the buyers start stacking up on CP swaps. Who cares if they get awarded a very high price on a physical 46,000 Mt of propane loading, in say, Ras Tanura in October, if at the same time they have double, maybe triple that in paper CP. If so the paper will more than compensate for any losses they might, and I say might, incur on the physical? But why worry, there isn’t any spot physical available anyway.

We have a saying “if you can’t beat’em, join’em”, so in our virtual trading room we’ve bought 10,000 Mt of November propane CP against an equivalent amount of December Brent crude. It’s too late now for October CP, but why should LPG supply start to appear and suddenly frighten off buyers, whether they’re buyers of both spot physical cargoes from Saudi Arabia and/or buyers of CP paper!