24-01-2019

Analysis: OPEC cuts amplify supply side imbalances in crude oil

Despite seemingly well supplied global crude oil inventories, prices for heavier, sour grades are starting to show a more nuanced dynamic in the oil market — the imbalance between light and heavy crude oil supplies is growing, and price spreads between the two types of crude have narrowed as a result.

There is an “assumption that oil is a homogeneous market. It is not,” an analyst at a European refiner, who spoke on condition of anonymity, said.

Output complications from Iran, Venezuela, Mexico and other producers of heavy sour crude oil barrels were thought to have been more than sufficiently offset by higher production from the US, Russia and OPEC, guiding perceptions of oversupply.

However, the latter have released more volumes of lighter crude oil grades in the global market in recent months, compounding the disequilibrium between light and heavy crude supply.

“At the moment, OPEC is cutting heavy crude, [while supply from] Mexico, Venezuela is lower, the European analyst said, adding that light crude supply from the US, and the North Sea as well as the Mediterranean in Europe was growing.

As a result, the price premiums that lighter, sweeter crude grades typically command over heavier, higher sulfur ones has narrowed steadily in recent months.

The disconnect can be seen most evidently in the Middle East crude oil price benchmarks, notably Dubai and Oman. Most crudes sold by Middle East producers, which make up the core of OPEC, are priced using one or both of these benchmarks as the underlying bases.

The Dubai crude complex — the spread between prompt Dubai swap and cash — remained steadily in backwardation through the last quarter of 2018, despite both Brent and WTI seeing deep contango in their respective market structures during the same period.

The spread between Brent futures and Dubai swaps averaged $2.58/b in Q3 of 2018, according to Platts data. The same spread narrowed to $1.86/b over Q4, and has narrowed even further to $1.16/b to date in January.

A narrow Brent/Dubai EFS spread implies that medium to heavy sour Dubai-linked crude grades are getting relatively pricier compared to lighter, sweeter Brent-linked crude grades.

The spread dipped to 99 cents/b as of 0300 GMT during Asian trading hours on Wednesday.

“Sour [crude prices are] strong because the West is net short sour crude,” a Singapore-based trader said, adding that major OPEC producers, including Saudi Arabia, have aimed their output cuts at the US market, while keeping Asian customers well-supplied to maintain market share in that competitive region.

“Generally the picture looks abundant in Asia, but the rest of the regions are net short sour and that is pulling everything up.”

Saudi energy minister Khalid al-Falih and his OPEC counterparts have not detailed how they are distributing their output cuts across the different grades of oil that they produce, though heavier, sour grades typically get the first axe, given that they tend to trade at discounts to lighter, sweet crudes.

But Falih acknowledged at the December OPEC meeting, in which the supply accord was agreed, that “the premium we used to get on lighter grades is falling fast,” as differentials decline due to competition from ultralight US shale oil.

The cuts involve OPEC, Russia and nine other non-OPEC allies slashing a combined 1.2 million b/d through June in a bid to stabilize the market.

Some sour grades in Europe and the US are also being traded at premiums to sweeter crudes. Urals crude, a high sulfur grade from Russia, for example, has risen into premium territory from its typical discounted price range. Urals in Northwest Europe was assessed by S&P Global Platts at $60.775/b on Tuesday, a premium of 7 cents/b over the Med Dated Brent strip.
IMO SULFUR CAP COULD REINSTATE EQUILIBRIUM

The International Maritime Organization’s looming sulfur regulations could help restore some balance to the disarray between light and heavy crude supplies.

The rules, which include a new 0.50% global sulfur cap for marine fuels, will likely lessen demand for heavier sour crudes significantly in the shipping sector, therefore easing the sharp uptick in high sulfur crude prices.

Analysts estimate that the lead up to IMO 2020 will likely reach critical momentum in the third or fourth quarter of 2019. IMO itself has placed a December guideline for shipping vessels to switch to cleaner fuels, and several of the world’s largest shipping fleets have come on board with similar commitments.

The 0.5% sulfur cap comes into force effective January 1, 2020.

Platts launched daily cargo and barge assessments for Marine Fuel 0.5% reflecting residual marine fuels with a maximum sulfur limit of 0.5% across the globe starting January 2, 2019.
Source: Platts

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