Quality is a key factor in oil price, as the expert witness will aver

Expert witnesses in oil sales and purchase contract disputes are often required to opine on the market values of various crude oils and oil products. Key elements in such determinations are usually the commodity benchmark price – for example, Brent Crude Oil or Euro 95 Octane Gasoline – the location, the timing of oil pricing under the contract and the oil quality relative to that of the benchmark commodity. Experts from Consilience Energy Advisory Group Ltd have written about some of those elements in previous issues. In this article the firm’s Senior Associate Ben Holt considers oil quality.

[OVER THE PAST FEW YEARS, the importance of oil quality on its value has been demonstrated clearly. In 2019 some Russian crude cargoes were contaminated with organic chlorides. Just tens of parts per million (ppm) were enough to cause discounts of $10-15 per barrel (bbl).

More latterly, the tightened limit on sulphur in marine fuel to 0.5%, introduced globally in 2020, has led to an increase in the premium for low-sulphur fuel oil over high-sulphur material from traditional levels of $10-20/tonne to recently over $100/tonne.

Now, the demand for crude oil in Europe to replace Russian supply has led to some West African grades trading at more than $10/bbl more than the previous norm because of their substitutability for Russian Urals crude. Diesel fuel, also short due to lost Russian supply, has increased by $40/bbl more than previous normal premia to crude oil.

Oil products are made by blending to meet a range of quality specifications. The market price applies to on-specification oil, but it is not always possible for refiners and blenders to exactly meet all the specifications, so that they ‘give away’ better quality, which has an impact on value. Crude oil and other refinery feedstocks, on the other hand, are not made to comply with specifications, so long as they are ‘merchantable’. Their qualities can vary considerably.

So how are differences in quality reflected in the price of oil? Products such as gasoline (petrol), diesel and kerosene are sold in bulk in Europe in tonnes (weight), but ultimately at the consumer level in litres (volume). So variations in density are reflected in proportionate increases or reductions in price because lower density means more volume to sell at the retail pump for the same weight purchased.

Density is measured in the oil industry using ‘API gravity’. Frequently, variations in API gravity relative to the specified norm are reflected in pre-arranged adjustments to the contract price of the crude oil. Generally, and with some exceptions, crude oil tends to be more valuable as its API gravity increases, up to a certain point. Above around 35º API, the value can be impaired by an associated increase in the naphtha content.

The sulphur content is another parameter often associated with price escalation in crude oil contracts. Such adjustments work reasonably over narrow quality ranges but can be problematic for wider variations.

The values of crude oils and other feedstocks can be more rigorously compared using the total value of the refined products that can be made from the crude. That requires data about the proportions of

The refined product contents of different grades of crude oil (wt%) each product (kerosene, diesel, naphtha etc) yielded from the crude in question – which vary considerably among crude oils, as shown in the chart – and the market prices or values of each product. However, each refinery has different equipment, extracting more or less of each product. Indeed, refineries in different regions were designed to make different proportions of products based on local demand. Furthermore, the value of an oil product to a refinery can change, depending upon whether it is used locally or must be exported and attract domestic or export tax. Experts valuing crude oils whose traded market prices are not transparent need to exercise judgement and make broad assumptions about the type of refinery configuration that is typical and competitive enough to set market prices in a region. We have seen how product yields are not alone in affecting the value of crude oil: the quality of the products yielded, the crude’s acidity, contaminants and handling properties such as viscosity are also significant; and then the politics, logistics and efficiency of the export facilities have a further impact on price. q • Consilience can cover all aspects of valuation of crude oil and oil products. Find out more at ceag.org/senior-associates. It’s new software product, Revenue Analysis Apportionment and Hedging (RAAH) was launched in May 2022: ceag.org/shop/web-apps/oil-fieldproduction-and-revenue/