Oman's endorsement of a new Middle East sour crude futures contract offers the best hope yet for an overhaul of Asia's beleaguered oil benchmark, although the true measure of its success lies not in Dubai but Riyadh.
Saudi Arabia, the world's biggest exporter, now prices its 5 million barrels per day (bpd) of Asian exports off the average assessed physical quotes of Dubai and Oman crude, in contrast to its European and US sales, both based on futures contracts.
But the kingdom has been exploring alternatives to its current Eastern pricing system, one of which would be a robust Oman-based futures contract, trading sources say.
"The key is the Saudis. If they support Dubai and Oman, which they well could do to get the first successful futures oil market in the Middle East, the exchange will succeed by definition," said a Singapore-based trader.
Odds of success for the Dubai Mercantile Exchange (DME) - a joint-venture between the New York Mercantile Exchange (NYMEX), the world's biggest commodities market, and private Dubai Holding - greatly improved on Tuesday after the exchange and Oman said the non-Opec producer agreed to support the initiative.
It is expected to launch in the fourth quarter after consultations with the industry on details of the contract.
It is the first time a Middle Eastern producer endorses such an exchange and could encourage neighbouring Opec members to change their pricing basis, although the contract may face a Catch-22 among conservative producers wary of any major shifts in the pricing basis of their most valuable commodities.
State oil firm Saudi Aramco may only switch to the DME once it sees the contract is successful, some traders say; its success, however, depends in large part on a Saudi endorsement.
"Now the Saudis use Platts so we all trade Platts. If the Saudi use something else, we will use it too," said the trader.
Most Middle Eastern producers - who sell about 12 million bpd of crude to Asia, around one-seventh of the world's production - price their crude at a differential to Dubai, or to the average of Oman and Dubai quotes as assessed by reporting agency Platts, a division of The McGraw-Hill Companies
Asian refiners and traders have long contended that this method, which relies mainly on bids, offers and trades during a 30-minute daily trading window, is less than ideal due to the relatively low number of participants and limited liquidity.
By contrast, NYMEX's flagship US contract and its main rival Brent, both sweet crudes, have thrived by attracting a mix of speculators and commercial players.
These two contracts trade more than 200 million bpd of underlying oil, more than twice the world output.
The time may be ripe for a shift, however, after several traders aggressively sold physical Oman last year, pushing down its relative value and undercutting exporters' revenues.
The last big change in export pricing came in 2000, when top Gulf producers abandoned the physical European Dated Brent benchmark - beset by repeated trading plays that warped its value - in favour of IPE Brent weighted average (BWAVE) futures.
Platts, whose daily Dated Brent prices are the most commonly used benchmark, later helped transform that market into a more robust system that included Forties and Oseberg crudes, but Saudi Arabia and its neighbours stuck with BWAVE.
US exports are priced at a discount to US crude futures on NYMEX.
But change is underway. Oman, whose output has fallen over the past few years, has found itself seeking alternative ways of remaining an influential market player.
It has set up a trading venture with European company Vitol to acquire trading experience and trade its own Oman crude on the spot market, and has signalled a willingness for its crude to assume a bigger role as a benchmark.
While many traders see an Oman futures contract as the best remedy for the market, Platts has also worked to shore up its benchmark by increasing the potential physical liquidity.
In February, Platts modified its window assessment to allow Upper Zakum crude to be delivered into Dubai contracts, to boost liquidity as Dubai output has fallen to a mere 100,000 bpd.
While Upper Zakum is rarely traded now, activity is set to pick up after Abu Dhabi sold a 28 percent stake in the field to US major Exxon Mobil Corp, which is expected to start selling up to 140,000 bpd on the spot market from July.
Traders welcomed Platts' attempt to broaden its Middle East crude benchmark, but remained sceptical.
"It certainly won't make things any worse but the Upper Zakum is flawed because it is OSP-based, not a mathematical or true marker, so it's still the same old problems," a trader said.
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