(Bloomberg) -- The halt of the Forties Pipeline System after the discovery of a hairline crack matters to global crude markets more than most such incidents. The North Sea oil price, its relative price and a measure of the strength of the Brent crude market all surged after the halt. Oil refiners’ margins for processing North Sea oil also slumped.
1. What is the Forties Pipeline System?
It’s a network of offshore and onshore oil and gas pipelines and terminals with the capacity to carry 575,000 barrels of crude per day from around 85 fields in the North Sea, including several in the Norwegian sector. Crude is piped via a terminal at Cruden Bay on the Scottish coast to the Grangemouth refinery and petrochemical plant, as well as to the Hound Point export terminal near Edinburgh. Average daily throughput in 2016 was 445,000 barrels a day, according to Ineos, which took control of the pipeline on Oct. 31 from prior operator BP Plc. The discovery of a crack just south of Aberdeen meant that the entire line has to be shut, which means all fields connected to the line will be affected. BP hasn’t commented so far on when it last inspected the area where the crack was found.
2. Why is the Forties system important to the world?
Its importance goes far beyond the fact that it carries about 50 percent of U.K. oil production. Forties is one of the North Sea grades that determines the value of the Brent futures contract. Brent, in turn, affects the pricing of crude oil around the world. A spike in Brent prices has a knock-on effect on crude exports from the Middle East and West Africa. Official selling prices for Middle Eastern crude from countries like Saudi Arabia, Iraq, Kuwait and Iran for buyers in Europe are often expressed as differentials to Brent. West African crude exports are also priced relative to Brent.
3. What impact might this have on futures?
The absence of Forties could bolster Brent assessments, even without the inflationary effect of a supply disruption. That’s because the Brent benchmark is based on the underlying physical market, with Forties the biggest constituent. The two are linked through the Exchange of Futures for Physical mechanism, which allows participants to exchange futures positions for physical ones, according to ICE Futures Europe. The value of the physical quote is set in part by the lowest of the constituent grades. This is often Forties.
4. What impact might this have on producers?
A spike in Brent prices relative to other benchmark grades, such as WTI or Dubai, could make West African and North Sea grades less competitive in Asia than rival Middle Eastern flows, which are priced relative to Oman and Dubai crudes for Asian sales. It could also make crudes from North and South America, which are priced against WTI, more competitive in Europe and Asia against those grades priced relative to Brent. The loss of around 400,000 barrels a day of Forties crude -- the amount that gets moved in practice -- will boost the price of other similar grades, as buyers of physical cargoes look for alternatives to meet their needs. Other North Sea grades, as well as West African and possibly Caspian Sea crudes, could see higher prices as a result.
5. What does this mean for traders?
Ineos said the halt represents a “force majeure situation," though it didn’t immediately declare one. Doing so would allow Ineos to miss contractual obligations. Either way, the simple fact is that for two weeks, Forties barrels will stop flowing. That will pose issues for traders, who won’t be able to collect the barrels they expected and supply them to refineries. Many will have to pay more for other benchmark North Sea grades, urgently seek cargoes from outside the region or consider purchasing barrels that are currently held in storage. Alternatively, refiners may have to reduce refining rates. For oil traders the bottom line is there will be a smaller pool of crude making up the physical benchmark grades for at least two weeks.
6. What’s the impact on Ineos?
The company says it can keep running its Grangemouth refinery, which takes around 20 percent of the crude piped through the Forties system. To do so, it will have to dig into its stocks or have crude delivered through its Finnart pipeline in the west of Scotland. Finnart doesn’t handle Forties, instead receiving barrels that are often imported from other locations.
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