In December, South Africa’s Government sold its entire strategic fuel reserve, 10m barrels of crude oil, at a substantial discount to the price at which the commodity traded. It was a stinky transaction. Firstly, the oil market is in a contango, a period where selling oil for future delivery translates into a progressively higher premium over the spot price. So the further forward you contract the sale and delivery of the oil, the higher the price. Yet SA’s reserves were sold with immediate effect. For another, the country dumped its oil reserves at $28 a barrel, at least $10 below the market price ruling at the time. Plus there is no international precedent – to our knowledge this is the first time any nation on earth saw fit to expose itself to actually having no oil reserves. The International Energy Agency suggests countries hold 90 days of net imports in their strategic stockpile. To get to the bottom of the issue, I approached an international oil trader. He spoke on condition of anonymity. His conclusion is clear: those who engineered the sale of the country’s strategic fuel fund on the conditions reported, did it solely to enrich themselves. They stole at least R1.5bn, perhaps as much as R2.2bn, from South African taxpayers. Guess we have an #Oilgate on our hands.2 – Alec Hogg
I’m with an experienced international oil trader who has agreed to talk on condition of anonymity. Let’s start at the beginning – what exactly is a Strategic Fuel Fund and why does a country need one?
Strategic Petroleum Reserve Agencies (in SA’s case, the Strategic Fuel Fund) have been around since the late 1970s and as a response to oil supply disruptions brought about firstly by the Arab oil embargo and after that the Iranian Revolution. OECD Governments acting through the International Energy Agency imposed policies to hold roughly 90 days of net oil (crude oil and refined petroleum products) imports as strategic stocks to have adequate crude oil and/or refined petroleum products to meet any future major supply disruptions, whether caused by geopolitical events or natural disasters.
During Apartheid, did South Africa have a bigger oil reserve than most – and post 1994 has that been reduced?
Yes. While secrecy governed the levels of SA’s reserves of crude oil under Apartheid, it is believed that South Africa would at one stage have had significantly more than 90 days of net imports of crude oil stored inland in disused coal mines as well as in Saldanha Bay, which is a major storage depot/hub that can hold more than 40-million barrels of crude oil, a facility built in the Apartheid era. Presumably in response to political changes as well as understanding you could never justify having that much oil sitting around, South Africa started to work the reserves down during the 1990’s to just over 10-million barrels – it has been common knowledge that the stock level reached this level before the end of that decade, and at which level the reserve has remained ahead of the recently reported sale.
How many days of usage were the 10-million barrels of strategic reserves?
As South Africa imports around 400 000 – 450 000 barrels a day of crude oil on aggregate, the strategic reserve translates into around 22 – 25 days of crude oil imports. If you add refined petroleum product imports of around 300 – 400 000 barrels a day, then the reserve count drops to 11- 14 days of net liquid fuels imports.
Where exactly were these strategic stockpiles held?
In the Apartheid era, it was held mainly inland in old coal mines. The rest was at Saldanha Bay, which by global standards is a very large (and now well-known) crude oil storage and trading facility.
South Africa has sold its strategic fuel reserves, those 10-million barrels. Are there international precedents for this?
No, not for a net sale of a substantial part, or all of the stocks, or a sale of almost any volume which is not linked to a planned or hedged replacement of the oil sold. There are international precedents for countries net selling their gold reserves but never for a strategic reserve commodity such as oil. Most governments are increasing strategic stocks of oil – China and India being notable examples of significant stockpilers. Also, several Eastern European countries that have joined the EU are obliged to build up reserves and hold 90 days of net imports as reserves. There is no precedent of disposing of the nation’s entire oil stocks as South Africa has done.
Therefore, this would have surprised oil traders like yourself?
Is the rationale that was given for the sale of these oil stocks by the South African government one that makes sense?
We can only judge by the media reports that we have seen and which quote various Government officials – as none of the actual transaction documents have been made public – but the answer is No, it does not make sense. It is being presented not as a sale but a rotation but that is not borne out by the media reports where, if you look at the statements made by the Minister of Energy (Tina Joemat-Pettersson), members of the Department of Energy and the Strategic Fuel Fund, this was a sale and not a rotation. If this was a rotation, then the second leg of the transaction – the plans, contracts, and prices related to the replacement oil, would need to have been concluded simultaneously.
Therefore to present it as a rotation to any oil trader is not credible. In the current market circumstances where the market is in contango – future oil prices progressively higher than the current spot oil prices – you wouldn’t sell your oil stocks promptly and you wouldn’t exchange current oil for future oil. Because replacement oil bought for delivery in the future is already more expensive the moment you dispose of your current oil. By selling the strategic stocks now and leaving the timing of purchasing replacement oil open, the Government has furthermore left itself wide open to increases in the market price of oil which exceed the contango at the time that a replacement decision is made – as has indeed since happened. No oil trader would believe that the construction of a stock rotation can be placed on the transaction that has been reported. Therefore the obvious question is why sell the reserves in this way, now?
Do you have any idea?
First look at what is reported about the price that was achieved and the timing. If in December if you had sold the oil for a future delivery you could, depending on the date(s) on which the oil sale decisions were made, have captured anything between 10 and 15 percent more over the following 12 month period in US$ terms, than the spot price. If the US$ revenue stream had been sold forward against the Rand, a further 5-6% premium may have been secured in Rand terms. And if you then look also at the (sometimes contradictory) statements made to the media by various officials about the level of storage fees being paid by parties who bought the oil, then the only sensible answer is why was so much taxpayer’s money left on the table? You cannot escape the conclusion that there was a corrupt purpose.2
How much money was left on the table?
By our reckoning, at least $100-million or US$10 per barrel, perhaps as much as US$15 per barrel – regardless of whether you use the US$/ZAR exchange rate of the time or now, that’s at least R1.5 Billion. The oil reserves were sold for a purpose we don’t understand, at a price we don’t understand and at a price that no professional oil market participant would understand.3
It sounds illogical unless that $10 a barrel went into someone’s pocket?
Absolutely. I’m not commenting on the poor timing of the sale (oil prices in December were particularly low) or on the unprecedented decision by the South African Government that right now, they don’t need a strategic stockpile of crude oil and have to sell it promptly. The proceeds of the sale are reportedly sitting in an account somewhere, so if the urgency did not relate to the sale proceeds, there must have been an urgency about the deficit…So the issue, rather, is if you have consciously decided to sell the stockpile, why do it in the manner that it was done when there are many other alternative routes available to raise revenue (by borrowing against the stockpile) and/or rotating the oil.
The South African government is telling its citizens the country has not lost a strategic stockpile. The oil is in fact still there for the moment. But the country doesn’t own it anymore. The new owners are just storing it there for the moment as having bought the oil in December, they will have immediately sold the oil forward for future delivery and fixed/hedged a price which is at a premium to the cost of storage and financing that oil. The odds are that this oil will be exported, like so much oil which is being stored in Saldanha Bay.
The government is arguing that because the oil is currently in Saldanha the country still has access to a strategic stockpile. But the issue is twofold – the South African Government can buy oil from anyone presently storing oil in Saldanha Bay and it has gone from being an owner of the oil to somebody who will have to buy it at the prevailing market price if or when the country needs it in future. And there is nothing to stop the new owners from removing the oil as and when they choose – which they are likely to do when market conditions change.
Who bought the oil?
If you look at the reports, two major international traders and one other relatively small trading company. Glencore and Vitol are reputable, capable, financially sound businesses. The other one involved is a company called the Taleveras Group which has seen some media reports and market talk of a more troubled recent history, which SFF will or should have been aware of.
These companies bought the 10-million barrels of strategic oil reserves at least at $10 a barrel discount?
It’s very easy today to price oil. Markets are well-serviced by reporting agencies and therefore markets are transparent for most of the major traded grades, including the grades of oil that are generally known to have been stored by SFF in Saldanha Bay. While different grades of oil vary significantly in price at any one point in time, the value of that oil on any one day is transparent – you can often tell how much of that oil has been traded and the actual traded price-formula. Provided the pricing dates that were applied in the contracts of sale are known, any ten traders will tell you within plus or minus 20 cents a barrel what that oil would have been worth in Saldanha Bay as a spot sale – the price delivered including shipping costs on the days it was sold. That’s one element of the disparity between the reported sale prices achieved and what the market would suggest.
South Africa’s Strategic Fuel Fund also had the choice of either selling at that moment or selling the oil for future delivery. In other words, SFF could themselves have extracted a significant premium simply by selling for future delivery. Why not do that if the oil’s sitting in your tanks and you can get 15 to 20 percent more 12 months out than if you sell it to somebody today? You could even get a significant part of the cash today at a relatively modest US$ interest rate discount to the future value if the government needed the money to spend elsewhere. Why forego such an enormous premium? So it’s not only the disparity on the price of oil at the time the stockpile was sold. There was also a significant premium that the country should have received for selling it forward.
The world knows who bought the oil. Is it possible these global companies profited from South African public servants who weren’t necessarily corrupt but didn’t know what was going on?
I would expect part of the discount may have been due to that, but we have just explained how transparent the market price of oil is, so could one explain an ignorance factor of more than $1? To give up more than $10 is inexplicable and inexcusable.
Don’t forget, too, that others were (apparently) not invited to tender for the oil. For instance, Chevron, which operates a refinery in Cape Town which is linked by pipeline to Saldanha Bay, could have paid a premium to the spot price of some or all of the oil, because they would (a) not have had to face some of the uncertainties related to loading the grades of oil concerned (which are routinely impacted by delays or force majeure at the time of loading) themselves and shipping them or (b) would have offset the spot premium paid by holding the oil in storage for future consumption at a profit, themselves.
All round something very fishy going on here…
Sure. It makes no sense for SFF to be contracting with the parties who bought the oil at very low storage rates. Four years ago storage was empty because there was no demand and so you didn’t get much for your storage. Today you can’t find storage anywhere in the world for crude oil. So you would expect to be paying healthy storage fees, certainly such as would reflect the available contango net of interest rate levels at the time a storage agreement is signed.
Those companies that did the buying do have an exposure to the United States where there are some very strict rules on corruption. Are they not taking an enormous risk by getting involved in something where there appears to have been skulduggery?
I don’t know. I would think that companies such as Glencore and Vitol are all careful, apart from being reputable. But people may get blasé. Ten years ago some companies would have spoken about business in Nigeria as kind of, “You know this is the way it’s done and you don’t want to offend the local sensibilities”. The US and UK anti-bribery legislation should have changed all that. But how many prosecutions have you really seen in terms of these acts? I think the politicians beat their drums and trot out new laws that have ever-tougher sanctions – perhaps when there’s an element of national interest or pride involved, prosecutions don’t follow?
So yes there is a much higher premium on business values/ethics and therefore a bigger risk today than there would have been in the past. Perhaps “rewards” channels were very indirect and attributed to another company or class of asset elsewhere around the globe. The issue is whether such value was attributed to individuals or to the State.
I think the one thing you can’t get away from is was due process not followed – and none of these parties are new to doing business in South Africa. So they will know what due processes will have been required for the transaction to have legally been constituted. So I think the more immediate and real risk is not so much whether corruption took place, as that may take time or be difficult to prove. It’s that these transactions should be capable of being overturned and challenged. It could not have been legally concluded by the Energy Minister alone even if one has to look at it superficially. And as mentioned earlier, for Buyers to secure a spot margin of around $1 a barrel may be a legitimate business gain – but $10 a barrel and more beggars belief – and to most professionals in the business means that there has to have been corruption.
Let’s just get the numbers in perspective. What did the South African government receive for the sale of its strategic stockpile?
According to the reports: $28 a barrel on average.
What was oil trading at during that month?
Dated Brent (the basis on which many crude oil grades, including the grades stored in the strategic stockpile, are priced) ranged between $35.63 and $43.24 per barrel during the trading days of December. Crude oil is routinely sold on a 5 day average of reference prices such as Brent. If at the worst 5 days in December you had said a $37 average price of Brent, then in the case of Bonny Light, it would be Brent plus whatever spot FOB (point of loading) premium it was trading at, at the time that the transaction was agreed (this could have been November, with pricing taking place in December, we just don’t know at this point), plus the market freight cost, insurance, inspection fees, in-transit losses, banking and other costs of transporting it to Saldanha Bay. Any junior oil trader will calculate this for you precisely. So there you would have said you should have achieved something North of say $38 or $39 a barrel, before looking at capturing future value on a deferred sale. In the case of Basra, which is a different quality of oil, it would trade FOB at a discount to Brent. But you would still, by no calculation have gotten to $28 a barrel for Basra. Again, depending on the contractual pricing dates agreed, we would have expected prices around the US$35 per barrel level. It is crucial for Government to ask its auditors about what the pricing dates agreed were, and to determine the reasonable market price of the oil within a very tight range of values.
When considering the mix in strategic reserves, Bonny Light, Basra etc, there is still a discount of at least $10 per barrel?
Yes, in terms of what might have been achieved not only as a spot sale but also capturing future value – though we’d need to see the contracts to say exactly. If we’re being generous, we’re saying there’s likely $10 a barrel that we can’t explain in terms of the spot price South Africa received. There’s the forward premium of the oil on top of that and then there’s also the storage fee component, which has been discounted very significantly. You could easily end up at $15 a barrel of value that’s been left on the table. But to do that accurately you need to see the contracts.
So $15 a barrel means $150-million disappeared.
$10 a barrel is the very least that’s been left on the table. It could well be $15 a barrel, which on 10-million barrels is $150mn, or close to R2.2-billion – obviously the US$/Rand exchange rate has moved a lot since December – though the rate ruling at the time should be relevant to evaluating the quality of decisions made then.
Bottom line, somewhere between $100-million and $150-million has disappeared because of bribery and corruption?
A significant number of oil market participants would say (and have said), “Absolutely, yes”. My figure of $10 a barrel wasn’t meant to be inaccurate, but it is representative. Whichever way you look at it there’s a minimum of $10 a barrel and it rises to $15 on an optimal sale. The crucial factor is why wasn’t there a public tender including Chevron and a global community of capable, financially sound oil trading companies and other oil majors, including all of those active in South Africa? At every other interaction with the South African Government’s SOE’s, there are tenders, there’s transparency, there’s competition. Yet not here….
I am assuming they were not invited – though we don’t know that for sure, as media reports quote officials as saying that a limited group of capable companies was invited whether this means only the three that contracted or more, or who they were, we don’t know. In any event, Chevron has in the meantime put its non-BEE share in the local business up for sale. Perhaps they also have much bigger fish to fry globally. The 10-million barrels of oil stored in Saldanha Bay on which they could have made some money is not going to move the dial for them. It’s a great trading opportunity, but they really have no direct concern with whether the government is being corrupt or not. I’d say they run their refinery, they have access to tanks in Saldanha Bay for their own oil, they probably optimise this structure very actively to make money and I suppose they might just be somewhat indifferent to all of this.
The Minister of Energy had signed off on this deal presumably. Did she not know what she was doing?
From what we’ve read in the media, the Minister signed a directive to approve some transaction or other and presumably, this would have been discussed, she would have been briefed. We don’t expect her to be an expert in crude oil trading or crude oil markets, but the people who work at CEF and SFF and many of those who serve on their boards have been around long enough to know – or be able to hire expert consultants to advise on the transaction. CEF/SFF would have briefed her on the transaction and what obviously is a concern is when you see all the comments that have come from the Minister and all the people at SFF to try and justify it once the story broke. They are making stupid claims like the need to apply a rotation of oil due to deteriorating quality etc. The product was simply sold.
Just explain the rotation before we go on.
Typically an oil stock rotation transaction happens if you want to change the grades of crudes that are in storage by bringing in a grade or grades that are more suitable to the current refinery operations of the country. This could mean more expensive or cheaper grades of oil. You would do this as a structured transaction so that you don’t expose yourself to any oil price risk. Depending on whether you are getting a dearer or cheaper quality oil than the grade being exchanged, and whether the exchange takes place simultaneously, it may cost you money or you may have some surplus arising from the exchange. But it’s typically a very structured transaction with no price exposure for the owners of the oil. When you hear the SFF, CEF, and the Minister saying it’s a stock rotation, they’re saying the crude oil is still owned by them until the exchange takes place. But what they’re not saying is that the oil has been sold and South Africa now has a commodity price exposure in terms of the timing, cost, and grade of the oil replacement.
We now know the oil price has since gone up from the $28 received to over $40, depending on the grade of oil and oil prices ruling on the day on which you make the evaluation. So if South Africa wants to buy back those 10-million barrels today it has to pay the market price, a very significant premium and exposure. Also what Government has suggested is the crude oil is available to them all the time. That’s only true while the market structure remains in contango. When the market structure changes, the companies that have bought the oil and are storing it in Saldanha Bay, will move it. And then there’ll be no strategic reserves of oil in South Africa – only the commercial, operational stocks kept by the refineries themselves. So as soon as the market moves towards or into backwardation the tanks in Saldanha Bay will be empty and South Africa will effectively have no stored crude available to its strategic stockpile.
Has this happened before, backwardation?
This is a regular feature of crude oil, gas and refined petroleum products markets. The forward price of the commodity relative to the spot price changes all the time. It is not uncommon for contango and backwardation to exist at the same time, depending on the underlying fuel type and its location. We happen to have been in a strong crude oil contango market for about three years now, at the same time as seeing low-interest rates (finance costs). Prior to that, you had backwardation. So to repeat, if it makes sense for traders to buy and store crude for as long as they can sell it forward at a premium to the cost of purchase plus finance and storage costs, it’s illogical for SFF to have considered a spot sale in a contango market unless the Government needed the cash immediately.
If the media reports quoting Government officials are to be believed, then the Buyers of the oil are paying less than 2.5 cents a barrel per month to store the oil, when the market rate for storage in Saldanha Bay could be anywhere between 10 and 20 US cents per barrel per month. That’s $1mn a month that they’re not collecting in storage fees. So they’re not gaining the future oil price premium in a contango market and they are sacrificing storage fees.
They’re doing everything wrong…
It makes no sense and I must say the way the Minister of Energy, CEF and SFF people have tried to argue that it was a good transaction leaves one really wondering what really happened there. They are also making deliberate misstatements because to say that the oil’s gone off spec, just can’t be true. Oil does not go off spec when stored in conditions such as Saldanha Bay, not unless it has been contaminated through third-party operations that have not been reported.
The fact that they said one of the crudes, Basra, was not environmentally suitable is also complete nonsense. Yes, Basra, like a lot of what else South Africa imports from the Middle East e.g. Saudi, Abu Dhabi, Kuwaiti crude, has high sulphur amongst other things. But the refineries extract that sulphur from the fuel ultimately produced to produce products that meet the SA spec – albeit that this spec is at a deficit to the European norms in terms of Sulphur content. Therefore, there was nothing from an environmental perspective that you could say was wrong with the Basra crude that was being stored and justified an immediate sale