Light grades have shifted from discount to premium over the last few weeks, while prices have risen steadily. Simon Watkins reports
With September’s OPEC/NOPEC meeting not resulting in any increase in oil production beyond what was agreed to in June and the second wave of US-led sanctions against Iran due to hit, the global oil market remains tight.
In its latest quarterly analysis, JP Morgan raised its Brent forecast to US$85 per barrel (pb) over the next six months, up from a previous forecast in the low US$60s, adding that a spike to US$90 pb was likely. Meanwhile, a number of traders spoken to by NewsBase Intelligence (NBI) think a test of the key US$100 pb technical resistance level within that timeframe is a distinct possibility.
This tight market price dynamic has allowed some Middle East producers some leeway in easing up on their recent slashing of crude oil official selling prices (OSPs), given healthy demand for all grades, although competition to secure key oil export markets between the Middle East’s big producers remains absolutely cut-throat.
Discount to premium
The likely draining of up to 1.4 million bpd in crude oil exports from Iran, according to NBI analysis, meant solid price support last month to secure replacement barrels for the medium to heavy sour crudes previously bought from Iran.
Since the original announcement of the withdrawal of the US from the JCPOA and the corollary re-imposition of sanctions, the Dubai-centric physical and paper markets have rallied. The backwardation structure has widened sharply in both cash and swaps time-spreads, reflecting Asian end-users’ increasing concerns about the Iranian supply cut-off from November.
In conjunction with this, however, traders also told NBI that there was significantly higher than usual buying of light barrels across the board from Middle Eastern ports for November loading, headed to Southeast and Far East Asia.
The resultant rise in spot differentials meant that barely a month after trading at substantial discounts, light sour crude grades from the Persian Gulf moved into premium territory. November-loading cargoes of ADNOC’s light sour Murban and Das Blend crude grades, for example, frequently traded at premiums of around US$0.35-0.45 pb to their respective OSPs, while Qatari light sour Land crude traded even higher, at premiums in the range of US$0.55-0.60 pb to its OSP.
In tandem with this, ADNOC last week set its retroactive September OSP for Murban at US$80.35 pb, up US$5.30 pb from the previous month’s US$$75.05 pb price point.
Exactly the same price rise was effected on its Upper Zakum grade, which was priced at US$78.30 pb, compared with US$73.00 pb the previous month, and a slightly higher increase – US$5.35 pb – was seen for its Das blend, which was priced at US$79.80 pb.
Part of this switch from discount to premium was a result of the huge cuts in OSPs made by both Abu Dhabi and Qatar the previous month, as analysed by NBI.
Another part was due to the changing dynamics of the West of Suez-Asia arbitrage, which switched last month from open to closed. The principal barometer of this arbitrage for Brent-linked crudes into Asia – the Brent/Dubai Exchange of Futures for Swaps (EFS) – in August (for October delivery) averaged US$1.85 pb, whilst last month (for November delivery) averaged around US$3.34 pb.
The trading rule of thumb is that the West-East arb opens when the EFS is at less than US$3.00 pb. In the same vein, following the record-high 510,000 bpd of US crude exports to China in June, the ongoing appeal of the US’s benchmark grade, West Texas Intermediate (WTI), is being hindered by a less attractive spot arbitrage.
WTI is now roughly at parity with North Sea Forties crude on a delivered basis into China, whereas in June/July WTI traded at slightly more than a US$2.50 pb discount to North Sea Forties.
The final reason, which is set to continue until the end of the Chinese year on February 4, is the increasing demand for lighter Middle East crude grades for middle distillates from Chinese refiners, as a result both of healthy refining margins and on Chinese government quotas.
These are the caps that the Chinese government places on the volume of crude that each independent refiner can import in a year, with the key caveat being that those refiners that do not utilise their entire allocation risk it being reduced the following year.
Around this time of year, spikes in take-up from Chinese refiners are common as they rush to use up as much of their allocation as possible before the year ends.
China’s ongoing sustained heavy demand for these crude grades was underlined last week when the general manager of China’s Qingdao Port International (QPI) said that he was confident that crude imports by the Shandong-based independent refiners in 2019 would remain at least stable compared to 2018, alongside the start-up of two large integrated greenfield refineries – Hengli Petrochemical and Zhejiang Petrochemical – later this year.
Many traders regard QPI – which operates the Qingdao port and the Dongjiakou port in Shandong Province – as a bellwether of China’s crude oil demand trend months ahead. QPI accounts for around 16-20% of total crude imports into China, and around 46-50% of all crude oil imported by China’s independent refineries.
According to analyst estimates, the total crude oil imports by China’s independent refineries will hit 92 million tonnes (1.85 million bpd) by year-end, around the same as last year’s strong uptake.
Competition from ESPO
The problem for Middle East producers in this market configuration, though, is that China can also easily source increased supplies to counteract any drop out from Iran or from Russia, in the form of its light grade Eastern Siberia Pacific Ocean (ESPO) blend.
This switch has been evident since the withdrawal of the US from the nuclear deal was announced in May, when spot trading levels for ESPO crude were concluded at premiums of well over US$3.00 pb to Platts front-month Dubai assessment.
Last month, according to traders spoken to last week by NBI, cargoes from the ESPO Blend’s November-loading programme were picked up at premiums of around US$4.85 pb to as high as US$6.00 pb to the Dubai benchmark.
This pricing level was a result not only of China’s rush to secure quote barrels by the end of the year but also to the widening of the Brent/Dubai EFS spread, which typically leads buyers to justify paying higher premiums for Dubai-linked crudes such as ESPO, as they still look competitive to Brent-linked alternatives.
These premium spikes for ESPO may continue to be price supportive for similar middle distillate-rich sour crudes such as Murban and Das Blend in some parts of Asia, but for China any such switch is not so clear cut.
The fact that ESPO is more distillate-rich means that a quality premium over Murban and similar grades is entirely justified and the shorter shipping route from the port of Kozmino to China provides a relative freight cost advantage as well.
Technically as well, not all Chinese independent refiners that run ESPO have the capacity to switch easily to Murban or similar Persian Gulf crudes, so any additional China demand-powered upside in premiums for these Middle East grades is limited.