The Fuse

Blockchain and Oil Trading

by Matt Piotrowski | March 20, 2018

The blockchain media frenzy has generally focused on the craze surrounding Bitcoin or other cryptocurrencies. But if you ignore the speculative excitement, you can see blockchain developments among high-profile companies that could significantly shape the future of industry, trading, and data-sharing.

“There’s a lot of creativity going on out there [with blockchain], trying to figure out its uses and applications,” said John Kingston, Executive Editor of FreightWaves and the former Director of News at Platts, last week at the New York Energy Forum. “There are going to be a lot of initiatives. Some are going to flop, but some might make it.”

Traders see blockchain as particularly attractive since they are competing in a thin-margin business and look for cost savings at every opportunity.

Incumbent firms in the energy sector, such as oil majors and commodity merchants, are experimenting with blockchain technology, and see it as a disruptive data solution that will alter the logistics of oil trading. Companies are in favor of moving to blockchains—decentralized distributed ledgers that record online transactions—to improve efficiencies, reduce back-office practices, boost transparency, and increase the speed of transactions. Traders see it as particularly attractive since they are competing in a thin-margin business and look for cost savings at every opportunity. Some companies have already applied blockchain technology to their portfolios, an indication that the environment is favorable for major changes to occur and that industry will operate completely in another way in the next decade.

Last year, independent commodity trading house Trafigura joined with French corporate and investment bank Natixis and IBM to form a blockchain for U.S. crude oil deals. Another consortium, with BP and Royal Dutch Shell leading, are establishing a digital platform with a number of trading firms and banks. BP has also been working with Eni, the Italian oil major, and Wien Energie of Austria to commercialize its system after running tests last year. Much less known, but just as ambitious, is the Energy Web Foundation, an international nonprofit looking to implement blockchain technology in the energy industry.

Benefits of blockchain technology

Blockchain is seen by its advocates as a way to streamline the “antiquated” arena of physical crude oil trading.

Blockchain technology, despite its potential, will not change futures trading on the NYMEX and ICE, both of which have fast and efficient systems. Instead, it is seen by its advocates as a way to streamline the “antiquated” arena of physical crude oil trading by providing a platform for trade documents, shipment updates, and payment status. Users of the blockchain can instantaneously view and share the status of deals, from the confirmation of the transaction to its delivery. Ideally, data digitized along a blockchain will provide an efficient logistics operation for trading companies, and it can easily add other parties involved in the transactions. It may, however, make it less likely for companies to trade with other partners outside their blockchain.

“All signs point to logistics as the primary focus of blockchain efforts,” said Kingston. “The reason is enormous cost savings. What drives the savings? The smart contract.”

The motivations for these companies are in stark contrast to those involved in rampant speculation in Bitcoin and other tokens or Venezuela’s launch of its cryptocurrency, the petro, to circumvent dollar transactions.

There are, generally speaking, three types of blockchains.

  • Public – A public blockchain is open, and anyone can join and participate in the network. Bitcoin is the prime example. One main problem of a public blockchain is the large amount of resources and energy needed to maintain a ledger of such size. Another issue is that an open blockchain takes away privacy for participants and can easily be hacked.
  • Consortium – A consortium blockchain is a group that shares data but needs to keep it protected and therefore will not allow the ledger to be public. Under this system, no one entity in the consortium will consolidate power.
  • Private – A private blockchain is an exclusive network and the host must accept users, who will follow an established set of rules. Businesses that use a private blockchain will create a “permissioned”

Hurdles for blockchain—there are many

Although blockchain is seen as enhancing crude oil trading, there are, of course, many hurdles to implementing this technology. It is still in its early development, and many critics are and will remain skeptical, particularly because of bad press surrounding cryptocurrencies. Moreover, using blockchain requires immersion in “teamwork” and dealing with other firms and their competing interests and ideas.

With the instability and skepticism surrounding the proliferation of cryptocurrencies, any blockchain will come under scrutiny and will be condemned by purists in the industry.

One obvious issue is participants gaining trust of others in their networks. Firms using blockchain will have to be transparent, but the scope of transparency that is necessary is not yet fully understood. Allowing others to have access to their data would constitute a major shift for companies, particularly oil traders, which have kept their activities mostly private to gain a competitive advantage with proprietary data. Companies hope that any strategic advantage they lose through greater transparency will be offset by cutting costs. The fact that there is no legal or regulatory framework for these new systems also weakens the trust factor in early stages of development.

Challenges to blockchain technology

Second, a number of platforms will likely emerge, forcing companies to operate on several blockchains. A solution will have to be formed to bridge the different ledgers to streamline activity. However, such a solution could raise even more problems as every player along the merged blockchains would have to agree on parameters.

Third, at a certain point, participants would have to agree on the use of tokens to pay for transactions. A cryptocurrency reduces transaction times and allows for continuous commerce without being slowed by banking systems or currency conversions. As a result, companies would undergo another radical shift by agreeing to a token system, with obvious concerns about its stability and value. Kingston pointed out that this adjustment would mark a big cultural change for firms, but a token system would increase the efficiency of the system.

The world of cryptocurrencies and blockchain ledgers are new territory for many both inside and outside the industry. With the instability and skepticism surrounding the proliferation of cryptocurrencies, any blockchain will come under scrutiny and will be condemned by purists in the industry. But the fact that incumbent firms in the trading world are looking to blockchain for solutions in commodity finance suggests that this technology will eventually become commonplace, even if it will take years to fully establish. The obstacles won’t go away anytime soon.

“The bottom line is that the technology isn’t hard,” said Kingston. “The socialization and implementation will be.”

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