Harvard Case - Creating an Asian Benchmark for Crude Oil
"Creating an Asian Benchmark for Crude Oil" Harvard business case study is written by Robert Webb. It deals with the challenges in the field of Finance. The case study is 11 page(s) long and it was first published on : May 9, 2021
At Fern Fort University, we recommend that the Asian Benchmark Group (ABG) proceed with the development of a new Asian crude oil benchmark, focusing on a transparent and robust methodology that addresses the specific needs of the Asian market. This will involve a multi-pronged approach encompassing financial analysis, risk management, international business, and technology and analytics to ensure the benchmark's success and adoption by market participants.
2. Background
The case study focuses on the Asian Benchmark Group (ABG), a consortium of oil companies and financial institutions aiming to establish a new benchmark for crude oil pricing in Asia. The current system relies heavily on the Dubai Mercantile Exchange (DME) Oman crude oil contract, which doesn't fully reflect the diverse qualities and trading patterns of Asian crudes. This creates inefficiencies and risks for Asian oil producers and refiners.
The main protagonists are the ABG members, including major oil companies like Petronas, Sinopec, and Indian Oil, as well as financial institutions like the Bank of China and the Development Bank of Singapore. They face the challenge of designing a benchmark that is credible, transparent, and widely accepted by the market.
3. Analysis of the Case Study
To analyze the case, we can use the Porter's Five Forces Framework to understand the competitive landscape of the Asian crude oil market:
- Threat of New Entrants: Low - Establishing a new benchmark requires significant resources and expertise, making entry difficult.
- Bargaining Power of Buyers: High - Asian refiners have significant bargaining power due to the large volume of oil they purchase.
- Bargaining Power of Suppliers: Moderate - Asian oil producers have some bargaining power, but they are also competing with producers from other regions.
- Threat of Substitute Products: Moderate - Alternative energy sources and other crude oil benchmarks pose a potential threat.
- Competitive Rivalry: High - Existing benchmarks and potential new entrants create intense competition within the market.
The analysis reveals that ABG faces a challenging environment, necessitating a strategic approach that considers both financial viability and market acceptance.
4. Recommendations
- Develop a robust methodology: ABG should leverage technology and analytics to create a transparent and reliable benchmark based on a representative basket of Asian crudes. This methodology should incorporate activity-based costing and financial modeling to accurately reflect the value of different crude grades.
- Secure stakeholder buy-in: ABG must actively engage with key stakeholders, including oil producers, refiners, and financial institutions, to build consensus and ensure the benchmark's credibility. This requires effective negotiation strategies and communication.
- Promote transparency and liquidity: ABG should ensure the benchmark's transparency by publicly disclosing its methodology and trading data. Additionally, they should encourage active trading to ensure sufficient liquidity and price discovery.
- Leverage existing infrastructure: ABG can leverage existing trading platforms and financial institutions to facilitate the benchmark's adoption. This can include partnerships with exchanges and clearing houses.
- Consider a phased rollout: ABG should consider a phased rollout of the benchmark, starting with a limited number of participants and gradually expanding its reach. This allows for continuous improvement and adaptation based on market feedback.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core competencies and consistency with mission: The recommendations align with ABG's mission to create a more efficient and transparent Asian crude oil market.
- External customers and internal clients: The recommendations address the needs of both Asian oil producers and refiners, ensuring a balanced approach.
- Competitors: The recommendations aim to differentiate the ABG benchmark from existing benchmarks by offering a more accurate and representative pricing mechanism.
- Attractiveness: The recommendations are expected to increase profitability for Asian oil producers and refiners by reducing price volatility and improving risk management.
6. Conclusion
ABG has a significant opportunity to create a new Asian crude oil benchmark that addresses the market's specific needs. By focusing on a transparent and robust methodology, securing stakeholder buy-in, and leveraging existing infrastructure, ABG can establish a credible and widely accepted benchmark that will enhance the efficiency and competitiveness of the Asian oil market.
7. Discussion
Alternatives:
- ABG could choose to simply adopt the DME Oman crude oil contract, but this would not address the unique characteristics of Asian crudes.
- ABG could create a benchmark based on a single crude grade, but this would not be representative of the diverse range of crudes traded in Asia.
Risks and key assumptions:
- The success of the benchmark depends on widespread adoption by market participants, which may be challenging to achieve.
- The methodology used to calculate the benchmark must be accurate and transparent to ensure its credibility.
- The benchmark must be sufficiently liquid to facilitate efficient price discovery.
8. Next Steps
- Phase 1 (Year 1): Develop and test the benchmark methodology, secure initial stakeholder commitments, and establish a pilot trading platform.
- Phase 2 (Year 2): Launch the benchmark with a limited number of participants, gather market feedback, and refine the methodology.
- Phase 3 (Year 3): Expand the benchmark's reach to a wider range of participants, promote its adoption, and establish a robust trading ecosystem.
By following these steps, ABG can successfully establish a new Asian crude oil benchmark that will benefit the entire Asian oil market.
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Case Description
This case examines the 2018 decision by the Shanghai International Energy Exchange (INE) to introduce a futures contract on a type of crude oil widely used in Asia, in the hope that it would not only facilitate price discovery but also become an Asian benchmark for crude oil prices and encourage the use of the renminbi or Chinese yuan in international commerce. Accordingly, the futures contract was denominated in renminbi; specified market participants could make or take delivery of crude oil in various ports in mainland China; and the INE crude oil futures market was open to foreign traders from the outset. The almost-immediate success of the INE crude oil futures contract was the first significant challenge to the dominance of Brent North Sea Crude and West Texas Intermediate crude oil futures contracts as benchmarks. Yet, five years later, the Shanghai crude oil futures contract price was still not the benchmark price for crude oil in Asia. What might be done to help achieve that objective? This case provides a vehicle for discussing spot and derivative energy markets, benchmarks, and government policy objectives. It also highlights the role of market microstructure in creating successful financial innovations. The case is designed for use at McIntire in an upper-level undergraduate course, "Financial Trading." It would also be suitable in an introductory finance course or a specialized financial markets and institutions course.
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