The West Asian oil market is something of a misnomer. The bilateral bazaar is inefficient and lacks price transparency. Oil is traded via long-term contracts based on arbitrary prices dictated by state-owned companies.
The new Dubai Mercantile Exchange (DME), which was launched Friday, hopes that it can make the market more efficient by offering futures contracts on West Asian oil.
That would make nearly 30% of the world’s currently produced oil easier to trade. But the exchange isn’t backed by the region’s major oil producing countries—meaning it faces a slippery uphill battle.
Futures exchanges have tried for decades to create a contract that would allow hedgers and speculators to bet on the price of Persian Gulf oil. Nymex, which owns half of the new exchange, has failed twice.
The main problem is that the market underlying these contracts lacked two essential ingredients: liquidity and a diverse pool of participants. The region’s state-owned firms own all the means of production and transportation, giving them enormous pricing power.
Without a viable Persian Gulf benchmark, exchanges have been forced to base their futures contracts on oil produced in West Texas or the North Sea.
But these benchmarks don’t reflect prices in West Asia. So, they are of limited value to those seeking to take, or offload, exposure to that market.
The DME is positioning itself as an alternative to these unrepresentative western benchmarks. It will offer a futures contract for the physical delivery of crude from Oman, which has agreed to no longer dictate prices on its oil.
But that may not be enough to gain investor confidence. So far, only the Emirate of Dubai, which produces a negligible amount of oil, has agreed to price its crude off the DME benchmark.
Together, Oman and Dubai represent only about 5% of oil production in the Persian Gulf, a figure that is set to decline because their reserves are depleting faster than that of their neighbours.
Furthermore, the Omani government still controls all the means of oil production and transport—which gives it a lot of sway over the price.
Unless the DME can sign up some of the Persian Gulf’s big producers—like Saudi Arabia or Iran—it’s unlikely to flourish. And that would mean asking them to cede price control over the key to their economies—something they would be loath to do.