SIMON SAYS: CP – What goes up...must go even higher

Submitted by Simon Hill on Sun, 09/29/2019 - 17:00
CP – What goes up….must go even higher

I’ve always found it difficult to understand how on earth anyone makes money with an LPG purchase deal based on Saudi Aramco’s Contract Price (CP). In fact, I’ve rarely found anyone else who knows how it’s done either. But around this time of year, every year, CP becomes the talk of the market, as if it possesses this mesmerizing draw, sucking in believers and non-believers by the score. It’s this belief that develops in the market, that somehow CP is able to levitate itself above all the other mere pricing mortals of our industry, whether it be the Far East Index (FEI), North West Europe’s CIF ARA price or even the new “mega” price in the U.S., generically referred to as Mont Belvieu; albeit split between TET (LST), non-TET (Enterprise) and other non-TET (Targa). The question has to be why?

Over the years the Saudi Aramco CP has physically, as well as emotionally, dominated the LPG market. From the early 1970s, and all the way through to less than ten years ago, the growth of the fully refrigerated seaborne LPG trade has been well and truly centered on the Middle East producers, especially its unofficial leader Saudi Arabia. Not only has the Kingdom led in LPG export volumes, but it has also led in setting the price for the region, dominating the ultimate cost of imports into nearly all Asian countries, and at times even as far as the Mediterranean, Brazil and parts of Africa.

In the early days of Middle Eastern export cargoes, the only other countries with volumes of LPG to move were the Kuwaitis, and small volumes out of ADGAS in Abu Dhabi and Sharjah. It was only logical that they would follow the Saudi Aramco CP, in fact they stood by it to the letter, or in this case, the number. Discounts were shunned, contract terms were almost identical, CP was protected at all cost, even if cargoes were made to disappear via net-back deals to Texaco into the U.S., or into the vast unknown of Saudi Arabia’s aquafer storage system.

I remember from my early days at the start of the 1980s, working for the British National Oil Corporation (BNOC), that trying to set a monthly price was, to say the least, extremely difficult, especially as we had to negotiate a price that both suppliers and customers would agree to. And while the small suppliers appreciated the price setting role we performed, the big boys, especially Shell, Exxon and BP, loathed our very existence, specifically the fact that we had the legal rights under “participation” to buy 51% of their production. As one of my many bosses at the time said, “our job is to make everyone equally unhappy”. But in Saudi Arabia the words “CP price negotiations” were rarely used.

The Japanese and Koreans had to buy, as they needed to import over 90% of their energy needs, especially crude oil, but also LPG. Therefore, there was an acceptance that the Middle East producer, and especially Saudi Arabia, held nearly all the power strings in the commercial relationship. Nobody from the Japanese or Korean sides were prepared to put any aspect of that overall relationship in potential danger, too much was at stake and the alternatives were limited.

This made setting CP each month a lot easier!

The Saudi Aramco prices for propane and butane are set, some may say posted, just prior to the beginning of every month, come rain or shine, (well, really just the shine bit). They are set for the month, but I have known in the past that they have been changed mid-month, normally upwards, but this is very rare. Typically, the price is set on the last working day in Saudi Arabia before the end of the previous month, so weekend announcements are common. Certain sceptics have even ventured to suggest that announcements come later when prices are going up, and earlier if they are heading down, but that’s like saying Boris Johnson prorogued parliament to deliver the “Queen’s Speech” earlier not later. Sorry we won’t get into that.

I have made my view clear in a recent SIMON SAYS…..that the Saudi Aramco CP is somewhat outdated. Not only because it is set on just one day of the month, when international prices are changing by the second, but that the greater global volumes emanating from outside of the Middle East, especially from the U.S., should be putting more pressure on Middle East suppliers to compete, especially on price. Even the fact that since 2010, Saudi Arabia have also lost their dominance in the Middle East, as the natural gas fed LPG export volumes of Qatar and Abu Dhabi have hit the market and Saudi have themselves grown their domestic consumption, especially in the petrochemical sector, at the expense of exports.

Both Qatar and Abu Dhabi fell in line, and adopted the Saudi CP pricing structure, when significant volumes became available, but there was certainly unease as to whether such a system as CP would enable these new powerhouses of the Middle East to easily sell their production. The Qataris tried to move towards using their own fleet of VLGCs to be able to offer CFR deliveries, in an attempt to subtly camouflage the netback FOB price they were selling at. Market chatter has also suggested that both naphtha related, as well as FEI linked deals, have been made, as the new producers try to respond to the huge growth of U.S. cargoes entering the Asia market.

But how have players made money throughout all this? The Japanese and Korean buyers have been able to pass the cost of CP down the line, with the wholesale and retail prices being based on the CP price, but with margins added along the route. Then the big boys with storage in Japan also played the end of financial year stock valuations, trying to ensure that the level of CP was highest in the final month of the year. Therefore, any cheaper tons held in stock would be valued at the latest CP price. Simple really, and who was going to disagree with them if, as a buyer, they wanted the price up, especially as they have historically been LPG’s largest importer. These were the accounting rules, and they offered the Japanese trading houses the chance to make money, as well as losing it if they got it wrong.

For the traders, they were the additional lubricant in the cogs of the Middle East to Far East conveyor belt of LPG cargo movements. They were able to make money logistically, sorting out the plethora of smaller Japanese importers, with individual Saudi and Kuwaiti contracts, in need of cargo, ship and timing swaps, (not the paper swap variety, which will make an entry tomorrow). They also happily played any role that would mean achieving higher prices for their cargoes, even though these prices were somewhat artificially being driven by the importer.

It’s this combination of buyers into Japan, who had the price of stock clearly on their minds, fuelled by more than willing traders, that I believe is the real forerunner as to why CP is again, at this time of year, becoming the focal point for the industry, and especially a few players keen to prove that you can make money out of the “CP”. I’ll explain more tomorrow.