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Oil Price Benchmarks Are Missing One Thing: The Climate Cost

A climate-wise oil market should reflect the true costs of production by incorporating emissions intensities of varying oils in benchmark pricing.

The price of crude oil is broadcast daily — and people pay attention. Over just the past three years, a glut due to the pandemic briefly drove prices negative, followed by a rally to triple digits as Russia invaded Ukraine. But even as these shocks can grab the headlines, exactly how oil is priced remains a mystery to most. Regional crude baskets, like West Texas Intermediate (WTI) in the US, have been created to track crude oil prices. Oil quality, economics, and geopolitics largely underpin benchmark crude prices. Oil and gas industry climate damages, however, are not factored into prices. Yet, these co-mingled oils’ wide-ranging climate footprints can vary by a factor of two to five. A climate-wise market should reflect the true costs of oil production and consumption by incorporating emissions intensities of varying oils in benchmark pricing.

What is an oil benchmark?

Global oils are typically identified by their country of origin and field names. To facilitate trading, oils with similar quality can be blended and cross-referenced against established crude benchmarks. These benchmarks serve as a point of reference for buyers and sellers of crude oil to determine prices. Examples include WTI (North American oil delivered to Cushing, Oklahoma for trade), Brent (comprised of North Sea oils from the UK and Norway), and the OPEC reference basket (13 types of oil from its member countries in the Middle East, Africa, and South America).

Historically, benchmarks have played a key role in pricing crude oils that are actively bought and sold in the global market. These benchmarks represent the price of oil of a certain quality, delivered at a certain location, at a certain time. The quality of crude is determined by its chemical characteristics — namely density and sulfur. Heavier and higher sulfur content crudes often trade at a discount because it takes more equipment and energy to transform them into petroleum products like jet fuel and gasoline. Location is also important because regional supply and demand balances, as well as the ease of shipping, can impact price and crude flows. Finally, time is very important, as supply and demand balances vary over time due in large part to the seasonality of oil demand. While each benchmarked oil barrel may be of similar quality, delivered to the same location, and priced the same, each barrel does not come from the same well — let alone the same state or country, as illustrated in the maps below.

Exhibit 1

Similar quality oils do not necessarily have similar climate footprints

Barrels contributing to each benchmark oil have wide-ranging climate footprints depending on the type of oil, how it is produced, and how carefully emissions are managed. As illustrated in Exhibit 2, there is a vast difference in the climate impact of different sources that contribute to some of the world’s key oil benchmarks. Each dot represents an oil field or basin that contributes to its respective benchmark.

For example, a barrel from Canada’s Kearl oil sands has three times the upstream production emissions intensity as a barrel from Colorado’s Denver-Julesberg basin. And yet these sources are blended as WTI, and the market price is essentially the same. Similar climate concerns affect other crude benchmarks, as plotted below. This makes it difficult for buyers to know the emissions associated with the crude they purchase.

Exhibit 2

Perverse pricing confuses market signals

The lack of connection between emissions and prices creates a perverse incentive for market participants. Heavy oils, such as those in California, Canada, and Venezuela for example, contain excess carbon. These oils also tend to be sour, with high sulfur contents. Extracting, shipping, and refining these oils requires energy-intensive operations like mining, steam injection, coking, and hydrogen addition. Moreover, the excess carbon is turned into additional petroleum products, increasing their end-use (Scope 3) emissions compared to other lighter oils.

Given the extra energy required to handle these unconventional heavier oils, they tend to sell at a discount compared to conventional lighter oils due to their lower quality. For example, the lighter and lower sulfur content of Algeria’s Sahara Blend is more easily turned into useful products than the heavy, high sulfur content of Venezuela’s Merey Blend (a blend of extra-heavy Orinoco Belt and Santa Barbara oils). As such, Merey currently trades at roughly $30 per barrel lower than Sahara Blend. Geopolitical concerns further depress its benchmark price.

While the price of crude oil is correlated with quality characteristics, benchmark price is not correlated with embedded greenhouse gas (GHG) intensity. Sahara blend’s quality characteristics helped it command the highest price of the main global crude benchmarks in 2022, but high flaring and methane leak rates result in a higher emissions intensity than its premium price might suggest. Conversely, Mars is heavier and sourer in comparison and priced accordingly, but minimal flaring and well-maintained equipment mean its emissions intensity is among the lowest in our sample. As buyers increasingly seek out emissions reductions along their supply chains, operators can take cost-effective steps to make their crude competitive on an emissions-intensity basis. A more direct relationship between price and emissions intensity is key to encouraging these improvements.

Exhibit 3

Climate benefits of accurately pricing oils from well to market

The Oil Climate Index plus Gas (OCI+) quantifies and compares the emissions intensities of oil and gas from extraction through end uses. Reflecting oils’ varying emissions in benchmark prices can facilitate climate action in market decision-making. For example, the recently decommissioned Brent field that was formerly contained in the Brent benchmark price could have been shut-in a decade earlier as its emissions intensity rose to more than six times the average of the other oils in the Brent basket (as shown in Exhibit 2 above). This would have prevented excess GHGs from being emitted into the atmosphere.

Incorporating OCI+ climate intelligence into current benchmark pricing would provide buyers with information on the sources and emissions of each crude, thereby improving the accuracy of emissions reporting and correcting the market signal for high-emitting resources. Increased emissions transparency can nudge operators to make cost-effective improvements to reduce the emissions intensity of their production. Global buyers, including traders and refiners, can more accurately account for their supply chain emissions starting at the wellhead.

Although the world will still fret about the fluctuations of oil prices, making sure that global greenhouse gas emissions make a permanent downward turn should be the greater concern. Through OCI+ and its shadow pricing features, oil buyers now have the data to make the smart climate decision.