Fuel oil price indices: The challenges to market integrity

1. Fuel oil price indices: The challenges to market integrity London, Houston, Washington, New York, Portland, Santiago, Bogota, Calgary, Singapore, Beijing, Tokyo, Sydney, Dubai, Moscow, Astana, Kiev, Berlin and Johannesburg

2. Argus fuel oil market coverage

3. Who is Argus? • Reporting every energy market globally • Used worldwide in energy price indexation • Independent and owned by the family of the founder and by the employees • Over 300 employees

4. Fuel oil market reporting • Spot markets • New York • US Gulf coast • Northwest Europe • Mediterranean • Russia • Central Asia • China • Singapore • Mideast Gulf • Indonesia • Swaps markets globally • Bunker ports globally

5. What matters to Argus is what matters to our clients. Price risk The market Consistency Transparency Accountability Accuracy Independence Liquidity

6. The Argus methodology Argus looks at the entire day of trade. • Low and high of deals done. • Analyze transactions for fuel of all specifications In the absence of trade, Argus assesses the range within which oil could have traded through the day. Argus publishes deals done to increase transparency. In Europe deals are reported on a live bulletin board. • Live volume-weighted average is produced

7. Argus Fuel Oil Bulletin Board: Rotterdam

8. Argus Fuel Oil Bulletin Board: the transactions

9. Argus Fuel Oil Bulletin Board: VWA

10. Rotterdam fuel oil deals on Argus: average tonnage • 350 companies registered to view the Argus Fuel Oil Bulletin Board • Over 30 sellers and over 30 buyers recorded on the Argus Fuel Oil Bulletin Board • Average 20 - 25 deals a day • Argus captures around 75% of the total spot physical Rotterdam market in its VWA

11. Challenges to fuel oil market integrity

12. Supply/Demand issues that may affect market integrity Demand for heavy crude in the Atlantic basin is rising as more coking, hydrocracking and hydrotreating is built. • Refinery upgrading was in response to diesel demand that has now faltered in western nations. • Opec cuts hit heavy crude, not light. • Most heavy crude is flowing to Asia Pacific. • Will upgrading projects remain economic propositions? • Will fuel be both destroyed and in demand to feed cokers? Will Russian fuel oil exports continue at the same pace? • Europe to Asia trade route is really Russia to Asia. • Refinery upgrading has been slowed by recession, but the impact to European spot market liquidity could be significant.

13. Supply/Demand issues that may affect market integrity US fuel oil has permanently decoupled from natural gas. • US power producers burn just 75,000 b/d of petroleum (30,000 of this is Hawaii) • Henry Hub gas now trades at a $6/mmBTU discount to fuel oil • Influx of shale gas supply. No longer any long-term relationship between oil and gas in the US. • Power generators no longer provide baseload price stability to the fuel oil market value. • The US fuel oil market has been transformed into a long haul export market. • The net result is a more volatile fuel oil price.

17. Supply/Demand issues that may affect market integrity Chinese demand has been strong, but is it trending lower? • Power plants have been opting for coal. • Taxes and import duties on fuel oil have been raised. • The US Gulf coast and Caribbean have been driven by China, the buyer of last resort.

18. Supply/Demand issues that may affect market integrity Lowering of bunker fuel sulphur content • 3.5% fuel oil Rotterdam is the benchmark grade. • Northern Europe ECA bunkers from 1.5% to 1% as of 1 July. • Trade in 1pc fuel oil in Rotterdam jumped fourfold and many thought this would become the new benchmark. • But trade volumes fell back to normal and 3.5% remains the benchmark.

19. Trading regulation that may affect market integrity FTC 2008-2009 anti-manipulation rulemaking failed to cover fuel oil. Dodd Frank anti-manipulation rulemaking will rope in fuel oil. • Due to be issued tomorrow. • Previously CFTC showed primary concern for commodities tied to futures markets. Dodd Frank will also likely force swaps to clear on an exchange. • Costs of trading USGC fuel oil swaps will go up. • This could discourage some companies from participating.

20. Migration to clearing already occurring Source: CME Group

21. The net impact on the spot market Decreased liquidity. Increased volatility relative to other benchmarks. • Corollary: Inability for industry to accurately forecast the price of fuel oil. Less participant diversity and a continued dominant role for international traders. A need for more transparency. A need for standardization in market price reporting. • Platts has responded by instituting a window methodology • Argus has responded with an all-day methodology

22. How robust is the Gulf coast fuel oil market?

24. How deep and diverse is the Gulf coast fuel oil market? The USGC has enough liquidity to make an intelligent assessment: 2.1 transactions of 45,000 bls each per day in 2010. • But low in comparison to other products and to crude. However: From January 2010 to present, 3 companies have been parties to 87% of all deals transacted in 3% fuel oil. Is there enough participant diversity to guarantee a fair and open price? Can it be considered a true clearing spot market? Is there a connection between lack of diversity and price volatility?

29. What is the meaning of a trade in this market? The market is standardized around a highly specific 3% barge transaction • But non-standard specs are transacted, just kept underground. Fuel oil trades in the Gulf coast primarily to set the price of Platts, which then sets • The price of swaps • The price of export cargoes • The price of heavy crude oil

30. Fuel oil’s role as a broader benchmark

31. What is the price of Gulf coast fuel oil used for? Forecasting the profitability of building a coker. Maya crude formula: 40% Merey/BCF formula: 37.5% Mesa formula: 21% Asphalt breakeven analyses Complaints from all sectors of the industry about the integrity of the fuel oil markets.

32. Crude benchmarks are in a state of flux WTI has been regularly collapsing in price relative to global benchmarks. • Dips to parity to the Gulf coast sour market. • Lack of pipelines, storage, and continued Canadian imports point to no change in this trend. As a result, Saudi Arabia, Iraq, and Kuwait dropped WTI as a price benchmark starting in 2010. Argus Sour Crude Index (ASCI) replaced Platts WTI as primary benchmark for imported heavy crude. But the volatility of WTI is no match for the volatility of US Gulf coast fuel oil.

35. The intersection of fuel oil and crude oil When crude formulas using fuel oil were designed they were brilliant ideas. • No US Gulf Coast sour crude market existed. Now producers and refiners have a robust alternative in the Argus Sour Crude Index.

37. The intersection of fuel oil and crude oil If crude producers abandon fuel oil as an index, it will destroy much of the market liquidity that has kept the bulk spot market – just barely – alive for the last 5 years. • Asia Pacific demand would term up remaining volumes and spot market would disappear. • Consultants would fall back on yields and RGVs when valuing upgrading plant. The price of fuel oil in the US will eventually become simply the price of retail bunker fuel. But that would be no solution at all.

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