Korean buying spree boosts Brent price

The price of the world's most important oil benchmark is being boosted by South Korean refiners buying on the back of a tax loophole involving North Sea oil.

The buying pressure started in December when refiners began exploiting the EU-South Korea free trade agreement signed in 2011, but, according to industry estimates, has now peaked with the Asian country's refiners buying in May more than a quarter of the monthly production of Forties, the oil variety that largely sets the price of the Brent benchmark.

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The purchases have supported the price of Brent in spite of weak domestic European demand for the different varieties of crude oil produced in the North Sea. Earlier this week Brent fell to a 15-month low of USD 95.64 a barrel, but on Wednesday it recovered to breach the crucial USD 100 a barrel mark, in part helped by new Korean buying.

The mechanics of calculating the Brent price explain the importance of the Korean spree. The benchmark is a basket of four oil streams from the North Sea - Brent, Forties, Oseberg and Ekofisk - that trade independently in the physical market. The cheaper of the four varieties sets the price of the basket and, thus, of the Brent benchmark. Traditionally, Forties is the cheapest grade, so demand for it is the key to the price of the benchmark.

The free trade agreement - directly and indirectly covering the crude oil production of the UK and Norway in the North Sea - waives a 3% tax that Korean refiners have to pay to import oil from other regions. That waiver offsets the costs of shipping the crude for 45 days from the North Sea into the Atlantic Ocean, around the Cape of Good Hope to enter the Indian Ocean and from there into the Pacific to Korea.

In May, Korean refiners bought about 3m barrels of Forties crude - roughly 26% of the stream's output of 11.4m barrels in May - according to industry estimates. "The South Korean buying has become a new feature of the Brent benchmark," said one senior London-based North Sea oil trader.

Oil traders said Korean refiners had already booked another 2m barrels for June delivery and added there were indications they were looking for a further 1m barrels.

South Korean refiners appreciate the quality of Forties oil, particularly because it has a higher sulphur content than other streams in the North Sea, which make it more similar to the Middle East oil that the Asian country usually buys. Over the last six months, Korean refiners have bought at least 15m barrels of Forties.

Nonetheless, traders said South Korea has bought other streams in the North Sea, including supplies of Statfjord, Troll and Gulfalks crude, with a lesser impact on the price of the Brent benchmark. In addition to its purchases of Forties, traders estimate it has bought around 9m barrels of other North Sea oil over the last six months.

Olivier Jakob, of Swiss-based oil consultancy Petromatrix, said the danger for Brent would be if "the artificial economics of Forties to South Korea starts to have too significant an impact on the price-discovery value of the Brent contract".

"The shipments of Forties to South Korea have nothing to do with supply and demand factors," he added, referring to the tax advantage of the trade agreement.

Oil traders said the Korean buying was not only inflating Brent prices, but also putting pressure on the price of crude for immediate delivery, keeping it at a premium over forward-dated contracts, a condition known as backwardation. The backwardated market generally hurts the profitability of the refining sector.

Brent last week fell briefly below USD 100 a barrel for the first time in seven months as weak Chinese and European economic data prompted investors to sell commodities. The drop below the triple-digit barrier on June 1 broke the longest period of USD 100 a barrel-plus prices on record. Brent stood above the USD 100 level for 240 consecutive days, from October to May, compared with 170 consecutive days in 2008.