Forties flow – would Brexit scotch it?

In the depths of the worst downturn for a generation or more, the North Sea public relations machine has cranked into action. The region, home to some of the highest costs and most challenging working conditions, is “open for business”, a conference in Aberdeen was told this week.

Trade body Oil & Gas UK said industry has worked constructively with government and regulators to deliver changes – which, when coupled with cost base reductions – “make the North Sea the most fiscally competitive in the world.”

But the challenges are huge. Sorting out supply-side issues may not even be enough, if you buy into the thought, propagated this week by analysts at Bank of America Merrill Lynch, that price elasticity now mostly sits on the demand side.

And should the UK vote next week to leave the EU, the region could face another demand-side issue – Brexit may shut off an important outlet for North Sea output.

Forties crude has been heading east, to South Korea, on very large crude carriers (VLCCs) in increasing volumes ever since the EU struck a free trade agreement (FTA) with Seoul in 2011 – the deal exempted shipment of North Sea crude from a 3pc import duty payment and effectively offset the cost of shipping crude from the North Sea to the Korean peninsula.

The result: South Korea was the largest export destination for Forties grade last year, taking 100,000 b/d from the loading terminal at Hound Point, Scotland.

There have been months in the five years since the FTA was signed in which double that has headed to South Korea. The IEA this week named South Korea as one of the nations at the core of its projections for continued oil demand growth this year and next.

Post-Brexit and the advantage that Forties exporters gain from the FTA is gone. Could the UK strike a similar deal? Well, the EU-South Korea FTA took five years to construct, confirm and implement. Seoul has concluded or is negotiating FTAs with crude exporters such as Canada and the US, with the potential for USGC exports to head to Asia-Pacific now eased by the imminent opening of the expanded Panama Canal.

The IEA estimates this route could take 13 days off a voyage from the USG to Japan, at a steady 15 knots, cutting down on costs.

Uncertainty is unhealthy. FTAs have supported the arbitrage of UK oil out of the region, says consultancy Petromatrix, which sees a Brexit as a bearish risk for oil but one that is difficult to price as it is not an immediate risk (the unwinding of the UK’s positions in the EU could take years). And as this year’s exports show, China – which does not have an FTA with the EU – is now taking more Forties than South Korea.

But a risk is a risk and one that may be, if not priced in, at least kicking around in the back of physical traders’ minds. In 2013 a possible change to South Korea’s product export tax weighed on Forties differentials, as traders fretted that such a move could make the North Sea-South Korea arbitrage less attractive.

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