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Analys

Ultra tight market for medium sour crude and middle distillates

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SEB - analysbrev på råvaror

The world is craving for medium sour crude, middle distillates and heavier products. Deep cuts by OPEC+ has created a super tight market for medium to heavy crudes. So tight that Dubai crude now trades at a USD 0.6/b premium to Brent crude rather than a normal discount. All of Russia’s crudes are now trading above the USD 60/b price cap set by the US. Scarcity of such crudes, rich on middle distillates and heavy products, is naturally leading to a scarcity of middle distillates and heavier products. Global inventories of such products are now very low and refining margins are skyrocketing with diesel in Europe now at USD 125/b. There is no sign that Saudi Arabia will shift away from its current ”price over volume” strategy as it is expected to lift its official selling prices for October. Crude oil at USD 85/b is a blissful heaven for Saudi Arabia. As long as US shale oil is shedding drilling rigs at a WTI oil price of USD 80/b there is no reason for Saudi Arabia to fear any shale oil boom which potentially could rob if of market shares. So ”price over volume” is the name of the game. 

Bjarne Schieldrop, Chief analyst commodities at SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Production by OPEC+ has declined by 2.7 m b/d from Sep-2022 to Aug-2023. Most of this reduction has taken place since February this year. Global demand on the other hand has increased by 2.4 m b/d from Q3-2022 to Q3-2023. This counter move between supply from OPEC+ vs. global demand has been partially eased by a 1.4 m b/d increase in supply by OECD producers, mostly US shale oil (light sweet crude).

There has thus been a massive tightening in the supply of medium sour crude (medium weight and sulfur > 1%) from OPEC+. Naturally so because this is the type of crude which OPEC+ predominantly is producing. So when the organisation makes deep cuts it leads to a tightening of the medium sour crude market.

The situation has been exacerbated by several factors. The first is Europe which no longer is importing neither crude nor oil products from Russia. The EU28 used to import 4.3 m b/d of crude and products from Russia before the war in Ukraine. Predominantly medium sour crude (Urals), lots of diesel but also lots of heavier components like VGO and different kinds of heavy refinery residues like bunker oil etc. Refineries are huge, complex, specialized machines which are individually tailor made for specific tasks and feed stocks. Without the specific feed stocks they were made for they typically cannot run optimally and have to run at reduced rates thus churning out less finished oil products. Europe has to some degree been able to import medium sour crude from the Middle East and other places to replace the 4.3 m b/d of lost supply from Russia, but it has also been forced to replace it with light sweet crude from the US which is yielding much less diesel or heavier products. The Vacuum Gasoil (VGO) and other heavy feed stocks which the EU used to import from Russia were typically converted to diesel products in deep conversion units. The second factor which has added to the problem is that more than 5 m b/d of global refining capacity has been decommissioned globally since 2020. Global refining capacity actually contracted in 2021 for the first time!

But bottom line here is that the global market for medium sour crude is now super tight. Predominantly as a result of deep cuts by OPEC+. This has amplified the factors above and led to a super tight situation in medium heavy to heavy products (diesel, jet, bunker oil, etc). It is so tight that bunker oil (HSFO 3.5%) in Europe recently traded at a premium to Brent crude rather than a normal discount of USD 10-20/b. This hasn’t happened since the 1990ies! Another sign of the tightness in medium sour crude is that Dubai crude (API = 31, Sulfur = 2%) now is trading at a premium to Brent crude  (API = 38, Sulfur = 0.5%) versus a normal discount of more than USD 2/b.

Global middle distillate stocks are very low as we now head into winter. Inventories of middle distillates and jet fuel in the US is almost equally low as they were one year ago.

The tightness in medium sour crude and diesel products has sent refinery margins skyrocketing. The price of diesel in Europe ARA is now standing at USD 125.2/b. That is down from the crazy prices we had one year ago when diesel prices in Europe almost reached USD 180/b. But current diesel price is on par with the price of diesel from 2011 to 2014 when Brent crude averaged USD 110/b. The diesel refining premium in ARA is now USD 40/b and the premium for jet fuel is USD 45/b. Refineries usually make a profit on diesel, jet and gasoline, a loss on bunker oil and a total refining margin for turning crude oil to products of maybe just USD 5/b before operating and capital cost leaving them with limited or even negative margins overall. Now they are making a killing. As a result they will buy as much crude as they can and turn it into the needed products. What they want more than anything is medium sour crudes which have rich contents of middle distillates. But the supply of that crude is now super tight due to deliberate cuts by Saudi Arabia and now also Russia.

There is no sign that Saudi Arabia and Russia will back down any time soon. Saudi Arabia is about to set its official selling prices (OSPs) for October and indications are that they will increase their prices. That implies that Saudi Arabia will continue its ”price over volume” strategy. No signs that they will change on this any time soon. US shale oil producers are still shedding drilling rigs and supply growth there is slowing = Power to OPEC+ to control the market.

Saudi Arabia will also decide over the coming days what they will do with their unilateral production cut for October. Will it roll forward their current production of 9 m b/d or will they add some crude and lift it to for example 9.5 m b/d? Hard to say, but what is clear is that the global market currently is craving for more diesel, heavy products and medium sour crude. Our view is that Saudi Arabia will not risk driving crude oil prices to USD 100 – 110/b or higher through deliberate cuts as this will lead to elevated political storm from the US and maybe also from China. We think that Saudi Arabia is utterly happy with the current oil price of USD 85/b and want to keep it at that level. Getting it exactly right is of course tricky, but they do have the capacity to at least get it ballpark right. 

Russia should be super happy. The tight medium sour crude market has sent the price of all their crude  exports to above the USD 60/b cap. The price of Urals has increased from USD 50/b in May to now USD 71/b. This is of course a headache for the western who is trying to limit Russian oil revenue.

Deep cuts by OPEC+ over the past year. In total 2.7 m b/d since Sep 2022. But accelerating cuts since February 2023. Deliberate cuts by Saudi Arabia and in part by Russia. It has created a super tight market for medium sour crude as global demand has rallied 2.4 m b/d over the past year.

OPEC+ production graphs
Source: SEB graph, Rystad data

Price spread Dubai – Brent. Dubai usually trades at a discount to Brent crude. Now it trades at a premium of USD 0.6/b. Highly unusual! A sign of a very tight medium sour crude oil market.

Price spread Dubai - Brent
Source: SEB graph, Blbrg data

The price discount for Russian Urals crude is evaporating as the market for medium sour crude oil has tightened.

Discount for Russian Urals crude
Source: SEB graph, Blbrg data

ARA diesel prices have rallied since their low point in April. Diesel in ARA now costs USD 125/b and equally much as it did from 2011 to 2014 when Brent crude traded at USD 110/b.

ARA diesel prices
Source: SEB graph, Blbrg data

Refineries are making a killing as refining margins for diesel, jet and gasoline have skyrocketed while the usual loss making component, bunker oil, now almost trades on par with Brent crude. Refineries, the primary buyers of crude, will buy as much crude oil as they can to make yet more money. This should help to keep demand for crude oil elevated and thus prices for crude oil elevated.

Refining margins
Source: SEB graph, Blbrg data

Analys

More weakness and lower price levels ahead, but the world won’t drown in oil in 2026

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SEB - analysbrev på råvaror

Some rebound but not much. Brent crude rebounded 1.5% yesterday to $65.47/b. This morning it is inching 0.2% up to $65.6/b. The lowest close last week was on Thursday at $64.11/b.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The curve structure is almost as week as it was before the weekend. The rebound we now have gotten post the message from OPEC+ over the weekend is to a large degree a rebound along the curve rather than much strengthening at the front-end of the curve. That part of the curve structure is almost as weak as it was last Thursday.

We are still on a weakening path. The message from OPEC+ over the weekend was we are still on a weakening path with rising supply from the group. It is just not as rapidly weakening as was feared ahead of the weekend when a quota hike of 500 kb/d/mth for November was discussed.

The Brent curve is on its way to full contango with Brent dipping into the $50ies/b. Thus the ongoing weakening we have had in the crude curve since the start of the year, and especially since early June, will continue until the Brent crude oil forward curve is in full contango along with visibly rising US and OECD oil inventories. The front-month Brent contract will then flip down towards the $60/b-line and below into the $50ies/b.

At what point will OPEC+ turn to cuts? The big question then becomes: When will OPEC+ turn around to make some cuts? At what (price) point will they choose to stabilize the market? Because for sure they will. Higher oil inventories, some more shedding of drilling rigs in US shale and Brent into the 50ies somewhere is probably where the group will step in.

There is nothing we have seen from the group so far which indicates that they will close their eyes, let the world drown in oil and the oil price crash to $40/b or below.

The message from OPEC+ is also about balance and stability. The world won’t drown in oil in 2026. The message from the group as far as we manage to interpret it is twofold: 1) Taking back market share which requires a lower price for non-OPEC+ to back off a bit, and 2) Oil market stability and balance. It is not just about 1. Thus fretting about how we are all going to drown in oil in 2026 is totally off the mark by just focusing on point 1.

When to buy cal 2026? Before Christmas when Brent hits $55/b and before OPEC+ holds its last meeting of the year which is likely to be in early December.

Brent crude oil prices have rebounded a bit along the forward curve. Not much strengthening in the structure of the curve. The front-end backwardation is not much stronger today than on its weakest level so far this year which was on Thursday last week.

Brent crude oil prices have rebounded a bit along the forward curve.
Source: Bloomberg

The front-end backwardation fell to its weakest level so far this year on Thursday last week. A slight pickup yesterday and today, but still very close to the weakest year to date. More oil from OPEC+ in the coming months and softer demand and rising inventories. We are heading for yet softer levels.

The front-end backwardation fell to its weakest level so far this year on Thursday last week.
Source: SEB calculations and graph. Bloomberg data
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Analys

A sharp weakening at the core of the oil market: The Dubai curve

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SEB - analysbrev på råvaror

Down to the lowest since early May. Brent crude has fallen sharply the latest four days. It closed at USD 64.11/b yesterday which is the lowest since early May. It is staging a 1.3% rebound this morning along with gains in both equities and industrial metals with an added touch of support from a softer USD on top.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

What stands out the most to us this week is the collapse in the Dubai one to three months time-spread.

Dubai is medium sour crude. OPEC+ is in general medium sour crude production. Asian refineries are predominantly designed to process medium sour crude. So Dubai is the real measure of the balance between OPEC+ holding back or not versus Asian oil demand for consumption and stock building.

A sharp weakening of the front-end of the Dubai curve. The front-end of the Dubai crude curve has been holding out very solidly throughout this summer while the front-end of the Brent and WTI curves have been steadily softening. But the strength in the Dubai curve in our view was carrying the crude oil market in general. A source of strength in the crude oil market. The core of the strength.

The now finally sharp decline of the front-end of the Dubai crude curve is thus a strong shift. Weakness in the Dubai crude marker is weakness in the core of the oil market. The core which has helped to hold the oil market elevated.

Facts supports the weakening. Add in facts of Iraq lifting production from Kurdistan through Turkey. Saudi Arabia lifting production to 10 mb/d in September (normal production level) and lifting exports as well as domestic demand for oil for power for air con is fading along with summer heat. Add also in counter seasonal rise in US crude and product stocks last week. US oil stocks usually decline by 1.3 mb/week this time of year. Last week they instead rose 6.4 mb/week (+7.2 mb if including SPR). Total US commercial oil stocks are now only 2.1 mb below the 2015-19 seasonal average. US oil stocks normally decline from now to Christmas. If they instead continue to rise, then it will be strongly counter seasonal rise and will create a very strong bearish pressure on oil prices.

Will OPEC+ lift its voluntary quotas by zero, 137 kb/d, 500 kb/d or 1.5 mb/d? On Sunday of course OPEC+ will decide on how much to unwind of the remaining 1.5 mb/d of voluntary quotas for November. Will it be 137 kb/d yet again as for October? Will it be 500 kb/d as was talked about earlier this week? Or will it be a full unwind in one go of 1.5 mb/d? We think most likely now it will be at least 500 kb/d and possibly a full unwind. We discussed this in a not earlier this week: ”500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d”

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily. That core strength helped to keep flat crude oil prices elevated close to the 70-line. Now also the Dubai curve has given in.

The strength in the front-end of the Dubai curve held out through summer while Brent and WTI curve structures weakened steadily.
Source: SEB calculations and graph, Bloomberg data

Brent crude oil forward curves

Brent crude oil forward curves
Source: Bloomberg

Total US commercial stocks now close to normal. Counter seasonal rise last week. Rest of year?

Total US commercial stocks now close to normal.
Source: SEB calculations and graph, Bloomberg data

Total US crude and product stocks on a steady trend higher.

Total US crude and product stocks on a steady trend higher.
Source: SEB calculations and graph, Bloomberg data
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Analys

OPEC+ will likely unwind 500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d in one go could be in the cards

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SEB - analysbrev på råvaror

Down to mid-60ies as Iraq lifts production while Saudi may be tired of voluntary cut frugality. The Brent December contract dropped 1.6% yesterday to USD 66.03/b. This morning it is down another 0.3% to USD 65.8/b. The drop in the price came on the back of the combined news that Iraq has resumed 190 kb/d of production in Kurdistan with exports through Turkey while OPEC+ delegates send signals that the group will unwind the remaining 1.65 mb/d (less the 137 kb/d in October) of voluntary cuts at a pace of 500 kb/d per month pace.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Signals of accelerated unwind and Iraqi increase may be connected. Russia, Kazakhstan and Iraq were main offenders versus the voluntary quotas they had agreed to follow. Russia had a production ’debt’ (cumulative overproduction versus quota) of close to 90 mb in March this year while Kazakhstan had a ’debt’ of about 60 mb and the same for Iraq. This apparently made Saudi Arabia angry this spring. Why should Saudi Arabia hold back if the other voluntary cutters were just freeriding? Thus the sudden rapid unwinding of voluntary cuts. That is at least one angle of explanations for the accelerated unwinding.

If the offenders with production debts then refrained from lifting production as the voluntary cuts were rapidly unwinded, then they could ’pay back’ their ’debts’ as they would under-produce versus the new and steadily higher quotas.

Forget about Kazakhstan. Its production was just too far above the quotas with no hope that the country would hold back production due to cross-ownership of oil assets by international oil companies. But Russia and Iraq should be able to do it.

Iraqi cumulative overproduction versus quotas could reach 85-90 mb in October. Iraq has however steadily continued to overproduce by 3-5 mb per month. In July its new and gradually higher quota came close to equal with a cumulative overproduction of only 0.6 mb that month. In August again however its production had an overshoot of 100 kb/d or 3.1 mb for the month. Its cumulative production debt had then risen to close to 80 mb. We don’t know for September yet. But looking at October we now know that its production will likely average close to 4.5 mb/d due to the revival of 190 kb/d of production in Kurdistan. Its quota however will only be 4.24 mb/d. Its overproduction in October will thus likely be around 250 kb/d above its quota  with its production debt rising another 7-8 mb to a total of close to 90 mb.

Again, why should Saudi Arabia be frugal while Iraq is freeriding. Better to get rid of the voluntary quotas as quickly as possible and then start all over with clean sheets.

Unwinding the remaining 1.513 mb/d in one go in October? If OPEC+ unwinds the remaining 1.513 mb/d of voluntary cuts in one big go in October, then Iraq’s quota will be around 4.4 mb/d for October versus its likely production of close to 4.5 mb/d for the coming month..

OPEC+ should thus unwind the remaining 1.513 mb/d (1.65 – 0.137 mb/d) in one go for October in order for the quota of Iraq to be able to keep track with Iraq’s actual production increase.

October 5 will show how it plays out. But a quota unwind of at least 500 kb/d for Oct seems likely. An overall increase of at least 500 kb/d in the voluntary quota for October looks likely. But it could be the whole 1.513 mb/d in one go. If the increase in the quota is ’only’ 500 kb/d then Iraqi cumulative production will still rise by 5.7 mb to a total of 85 mb in October.

Iraqi production debt versus quotas will likely rise by 5.7 mb in October if OPEC+ only lifts the overall quota by 500 kb/d in October. Here assuming historical production debt did not rise in September. That Iraq lifts its production by 190 kb/d in October to 4.47 mb/d (August level + 190 kb/d) and that OPEC+ unwinds 500 kb/d of the remining quotas in October when they decide on this on 5 October.

Iraqi production debt versus quotas
Source: SEB calculations, assumptions and graph, Bloomberg actual production data to August
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