The Fuse

Aramco’s Market Power to Grow With Expansion of Trading Unit

by Matt Piotrowski | September 27, 2017

Saudi Arabia’s shift to buy and sell third-party crude prompts concerns about how Aramco will use its market power.

News recently surfaced that Saudi Aramco’s trading arm would start purchasing crude produced by third parties. This move raises questions about increased market power for Aramco and Saudi Arabia in a market where they are already disproportionately powerful.

“We’ll keep selling our own oil as normal, and we want to get into trading third-party crude,” said Ibrahim Al-Buainain, chief executive officer of Saudi Aramco Products Trading Co. The trading unit currently buys and sells 1.5 million barrels per day (mbd) of refined products and operates as a subsidiary of Aramco.

Saudi Arabia’s shift to buy and sell third-party crude prompts concerns about how widely Aramco, the state-run oil company that has crude oil production capacity of 12.5 mbd, will expand its trading apparatus and how it will use its market power. The move to trade non-Saudi crude reflects the country’s long-term economic reform strategy to broaden its commercial opportunities and increase its customer base. Saudi Arabia, through growth in its trading arm, is poised to gain more access to information flow. Aramco will also likely search for top trading talent to provide leadership and guidance in an effort to gain more leverage in the global market.

Aramco owns crude production, refining assets, and petrochemicals facilities. It is primary a crude producer, but it is integrated along the entire supply chain. Although Saudi Arabia has experimented in spot trading in recent years, the OPEC producer mostly sells cargoes to customers through term contracts. Aramco prices its cargoes with differentials against regional benchmarks. The move into crude oil trading is a logical evolution for the company, and it increases Saudi Aramco’s already large competitive edge in the global oil market.

“One of my first thoughts is whether they’ll try to manipulate the market for their benefit,” one former trader said. “They can grab hold of spot barrels, hold onto them, and watch the price rise.” The trader added that another big question is whether Aramco will trade futures. Its traders could withhold supply while, at the same time, take large long positions in the futures market, a practice oil traders have allegedly used to game the market in their favor. “The market is complex, but they’ll definitely be more active,” he said.

Aramco’s dive into trading will likely prompt companies—whether producers, shippers, or refiners—to develop stronger relationships with the Saudis, given their market influence.

Aramco’s dive into trading will likely prompt companies—whether producers, shippers, or refiners—to develop stronger relationships with the Saudis, given their market influence. The Saudis, along with other OPEC members, have in the past year met with representatives of trading houses and hedge funds to exchange information and gather market intelligence. In November 2016, for instance, ahead of the OPEC ministerial meeting, oil traders from Vitol, Lukoil, and Andurand Capital flew to Vienna to meet with Saudi representatives. By increasing their presence in the trading world, the Saudis will likely seek similar meetings in the future to help position themselves in the market.

Aramco will be jumping into the physical trading space that is dominated by majors—such as RoyalDutch Shell, BP, and Total—and the merchants, which include the likes of Vitol, Glencore, and Trafigura. Shell is the biggest trader in the world, moving 12 mbd of crude and refined products, while Vitol is second at 7 mbd. BP at 5 mbd is third.

Oil trading, in both the physical and futures markets, provides opportunities to profit from price volatility and market downturns.

ExxonMobil does not have a trading unit that buys third-party oil, but it is exploring opening one. The Dallas-based major has always believed—similar to Aramco—that it is naturally hedged with upstream production and refining assets. However, crude oil trading, in both the physical and futures markets, provides opportunities to profit from price volatility and market downturns. In the past few years during the low-price environment, some trading houses saw their profits increase. Traders have been able to store crude at a profit and take advantage of arbitrage opportunities. Trading units for the majors helped them mitigate losses during the downturn. For instance, some industry experts put BP’s annual trading profits as high as $1 billion. According to the FT, the merchants have expanded their trading volumes by 65 percent since oil prices fell from over $100 in 2014. In addition to the physical advantages of trading, there are also informational advantages, such as access to time-sensitive data that is not public.

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Potential high profits are luring Aramco and Exxon to deepen their engagement in the trading arena. Trading sources suggest that these two giants may take small players out of the game, particularly with profits falling this year from tighter futures spreads and dampening volatility. The trading world has consolidated over time, and recent downturn in margins may be a harbinger of more adjustments to come. Even some of the larger players have taken big hits and have been reportedly looking to sell assets.

Besides the opportunity to trade cargoes, Aramco will give its refineries more flexibility.

Besides the opportunity to trade cargoes, Aramco will give its refineries more flexibility. The trading unit will provide access to arbitrage opportunities, allowing its refineries to run non-Saudi crude and increase margins. Saudi Arabia now holds more than 5 mbd of refining capacity and has plans to increase that amount to 6.5-7 mbd. Aramco has discussed boosting its downstream footprint in the long term to 10 mbd, a reflection of the company seeking to diversify its portfolio and move away from being known mostly as an oil producer.

Growth in trading & the IPO

The move into trading also prompts questions about the Aramco initial public offering (IPO), which is slated to move forward in 2018. A trading unit, although it has the potential to enhance profits, also carries increased risks. That could hurt the valuation of the company as it launches the IPO, and investors may be skeptical, given the volatile nature of oil trading, which Aramco investors will have to evaluate.

Market power to grow

Given Aramco’s gigantic size and high value, and the opaque nature of the trading world, the company’s foray into oil trading will raise a number of questions and concerns. Expect it to start slowly but eventually explore opportunities aggressively in order to diversify its asset and customer bases and mitigate risk.

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