Shell calls for stronger regulation to avoid Middle East oil price distortion

Calls for tighter regulations and support from GCC companies after China state firms suspected of distorting regional market.

The Shell move has surprised many of its oil trading peers. Toby Melville / Reuters

Royal Dutch Shell is lobbying to reform regional oil trading after a series of price squeezes, particularly by Chinese state oil firms.

In a highly unusual move, Royal Dutch Shell has called for greater regulation of the market to improve transparency and avoid price distortion.

Now, Shell is following up its public call with behind-the-scenes efforts to gather support for change, particularly from the regional state oil firms.

“There need to be safeguards to prevent the risk of distortion, and to ensure the Dubai benchmark price mirrors true market supply and demand fundamentals,” a Shell spokesman said. “Due to some of the unique characteristics of the Dubai market, it is susceptible to and can be heavily influenced by a market participant amassing a large portion of the available three crudes deliverable in that month.”

The Shell move has surprised many of its oil trading peers.

“When you get a major oil company calling for more regulation you know something must really be wrong,” said one senior member of the local trading community.

Although Shell did not specifically name the Chinese, the move follows what was seen as a blatant price squeeze in August when the trading arms of two of the country’s largest oil companies, PetroChina and Sinopec, were on either side of almost all the transactions that determined the price of the region’s crude oil for that month.

“Regrettably there have been times in recent months where the price of Dubai [benchmark crude] was assessed well in excess of the fundamental refining value of other, comparable Middle Eastern crudes,” the Shell statement said.

The main remedy to the market’s vulnerability to price manipulation would be to substantially increase volume via the Dubai Mercantile Exchange (DME), whose main contract is based on Oman, Dubai and Upper Zakum crude, which has daily output of about 1 million barrels per day (bpd).

Crude trading volume on the DME is about 8 million bpd, which is only about one third of the volume of North Sea Brent trading in crude futures, leaving it open to a squeeze by companies with big buying power.

This could be countered by equally powerful crude sellers. If Abu Dhabi National Oil Company, for example, were to price its crude oil sales in reference to the DME price rather than the physical market – and if other regional state oil companies followed suit – then exchange-traded volume would rise substantially and be less open to manipulation, proponents of reform argue.

“Regulated instruments come with strict rules of engagement, financial margin and performance guarantees provided by a clearing house,” Shell said. “They also come with restrictions on market share, [known as position limits] which would instantly put an end to the upwards price bias ... and clearing would instantly strengthen the image of Dubai as a benchmark – giving Asia’s oil-consuming economies something they deserve: an oil benchmark which is set on a level playing field at a price that accurately reflects market fundamentals.”

Shell’s argument for fairer pricing for consumers would not seem to hold much appeal to the region’s major oil producers, given the oil price crash of the past year.

But reform proponents argue that price manipulation is not good for producers either, saying that squeezes are often followed by a sharp decline. Also, distorted prices attract oil from other sources, such as Africa and Latin America, which has been the case in the past year.

The DME welcomed Shell’s efforts.

“DME is extremely supportive of any moves to increase transparency in the Middle East oil markets,” said Owain Johnson, DME’s managing director.

“DME Oman futures is a fully regulated benchmark and we are also working to bring greater transparency to the over-the-counter markets through our new DME auctions facility,” he added, referring to an open auction system introduced in September that has the Oman government’s support.

In the over-the-counter market, reference prices are determined by Platt’s, a reporting service which simply uses traders’ self-reported prices to set benchmarks. Platt’s has said that it is not a regulator and does not have oversight responsibility, but it reviewed its procedures in September and expanded the number of crude oil grades used to determine the regional benchmark.

Although it did not say so publicly, Shell was not satisfied with these efforts.

“They didn’t say anything after the August squeeze, waiting to see what Platt’s would come up with in September,” said one trader. “But they weren’t satisfied, and decided to act.”

But as Shell’s statement underlines, transparency in oil markets elsewhere in the world has mainly come from an increase in regulated exchange trading rather than any efforts in off-exchange trading.

The regional state oil companies mostly have not commented, although the head of Iraq’s State Oil Marketing Organisation has expressed dissatisfaction with the current system.

The trading arms of PetroChina and Sinopec did not respond to requests for comment.