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Ultra tight market for medium sour crude and middle distillates

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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!

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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.

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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.

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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

Crude oil comment: Lack of clear direction

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This week, Brent crude prices have declined by USD 2.3 per barrel (2.8%) since Monday’s opening, driven by fundamental market factors. The current price is near its weekly low at USD 81.8 per barrel, down from Monday’s high of USD 84.5 per barrel.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

The price has fallen by nearly USD 1 per barrel since yesterday afternoon. This week’s downward trend can be attributed to three main factors:

1. Upcoming OPEC+ Meeting:

OPEC+ is scheduled to meet on June 1st for the Joint Ministerial Monitoring Committee (JMMC). Initially planned as a physical meeting in Vienna, it will now be fully digital, suggesting no major discussions or changes. We anticipate that the meeting will result in the extension of current production cuts into Q3 2024. OPEC+ aims to signal a tight yet well-supplied market, maintaining the status quo and minimizing significant market reactions.

2. U.S. Inventory Report:

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Wednesday’s U.S. inventory report had a bearish impact on the market, showing a build in commercial crude inventories (excl. SPR) by 1.8 million barrels, contrary to the expected 1.9-million-barrel draw. This was slightly more bullish than the American Petroleum Institute (API) forecast of a 2.5-million-barrel increase released on Tuesday.

Commercial crude inventories now stand at 458.8 million barrels, about 3% below the five-year average for this time of year. This build is counter-seasonal, as we usually see a draw at this time of the year. Gasoline inventories decreased by 0.9 million barrels, less than the anticipated draw of 1.2 million barrels. Distillate (diesel) inventories increased by 0.4 million barrels, against a consensus expectation of a 0.3-million-barrel draw, further defying typical seasonal trends and adding a bearish tone to the market, even though they remain about 7% below the five-year average. Overall, total inventories (crude + gasoline + distillate) rose by 1.3 million barrels.

Additionally, U.S. crude oil refinery inputs averaged 16.5 million barrels per day last week, an increase of 227 thousand barrels per day from the previous week. Refineries operated at 91.7% of their operable capacity, the highest since mid-January, as they ramp up following maintenance. Gasoline production averaged 10 million barrels per day, while distillate fuel production averaged 5.1 million barrels per day. A marginal improvement in refinery margins indicates healthier demand prospects leading into the driving season.

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3. FOMC Minutes and Economic Concerns:

The continued decline in oil prices can also be attributed to bearish pressure from hawkish Federal Open Market Committee (FOMC) minutes, which raised concerns about persistent inflation. This could result in prolonged higher U.S. interest rates, potentially limiting future oil demand growth.

In summary, the combined effect of the upcoming OPEC+ meeting, the U.S. inventory report, and economic concerns highlighted in the FOMC minutes has contributed to the weakening of Brent crude prices this week.

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Analys

German solar power prices are collapsing as market hits solar saturation

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German solar power producers got a price haircut of 87% over the past 10 days. German solar power producers have over the past 10 days received a volume weighted power price of only EUR 9.1/MWh. The average power price during non-solar-power-hours was in comparison EUR 70.6/MWh. Solar power producers thus got an 87% cut in the power price they get when they produce vs. the power price during non-solar-power-hours. This is what happens to power prices when the volume of unregulated power becomes equally big or bigger than demand: Prices collapse when unregulated power produces the most.

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

Massive growth in solar power installations in Germany in 2023 is leading to destruction of solar hour prices and solar profitability. Germany installed a record 14,280 MW of solar power capacity According to ’PV Magazine International’. That is close to twice as much as in 2022. Total installed solar capacity reached 81.7 GW at the end of 2023 according to ’Renewables Now’. Average German demand load was in comparison 52.2 GW. So total solar capacity reached almost 30 GW above average demand. Solar power produces the most during summer when demand is lower. The overshoot is thus much larger than the 30 GW mentioned when it matters.

The collapse in solar-hour-power-prices implies a collapse in solar power producer earnings unless the earnings of the installations are secured with subsidies or by PPAs. It also means that there is a sharp reduction in the earnings potential for new solar power projects. The exponential growth in new installations of solar capacity we have seen to date is likely to come to an abrupt halt. There is however most likely still a large range of solar power projects under construction in Germany which will be finalized before growth in new capacity comes to a halt. The problem of solar power production curbs (you are not allowed to produce at all) and solar power price destruction is likely to escalate yet higher before new growth in supply comes to a halt. 

Focus will now shift from solar production capacity growth to grid improvements, batteries and adaptive demand. All consumers are of course happy for cheap power as long as they are able to consume it when it is cheap. At the moment they can’t. But the incentive to be inventive is now super high. The focus will now likely shift from solar power production growth to grids, batteries, adaptive demand and all possible ways to utilize ”free power”. This will over time exhaust the availability of ”free power” and drive solar-hour-power-prices back up. This again will then eventually open for renewed growth in solar power capacity growth.

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It is probably much worse down in the grid. What is worth noting is that these numbers are for all of Germany average. Solar power congestion is much worse in the local grids all around Germany along with local grid capacity constraints ect.

The problem of solar power is high concentration of production: 80% of German solar production was produced during 22.3% of the hours in the year in 2023. What is also worth mentioning is that solar power production is extremely concentrated in relatively few hours per year. It produces in the middle of the day and during summer. In 2023 German solar power produced 80% of its production in only 22.3% of the hours of the year. This basically implies that once solar power production reaches 22.3% of total power supply (without batteries), then solar-hour-power-prices will likely collapse. Solar power production reached 55 TWh in 2023. That’s a lot but it is still only 12% of total demand of 458 TWh in 2023. What it means is that the acute problem of solar-hour-power-price-destruction sets in much before the ”theoretical 22.3%” mentioned above.

On the 21 Feb 2024 we wrote the following note on this issue: ”The self-destructive force of unregulated solar power” where we highlighted these issues and warned that this will likely be a process of ”First gradually. Then suddenly”.

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German solar power capacity makes a big leap upwards in 2023 as the energy crisis hurt everybody. Demand went down. Now there is a large overcapacity in installed solar effect vs. demand load.

German solar power capacity makes a big leap upwards in 2023 as the energy crisis hurt everybody. Demand went down. Now there is a large overcapacity in installed solar effect vs. demand load.
Source: SEB calculations and graph, PV Magazine, Wikipedia, Blberg data on German power demand

German solar power producers got an 87% price haircut on average during last 10 days vs. those who produced during non-solar-power hours.

German solar power producers got an 87% price haircut on average during last 10 days vs. those who produced during non-solar-power hours.
Source: SEB calculations and graph, data by Blbrg

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.
Source:  SEB calculations and graph, data by Blbrg

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.
Source: SEB calculations and graph, data by Blbrg

Solar power production and German power prices over the past 10 days.

Solar power production and German power prices over the past 10 days.
Source: SEB calculations and graph, data by Blbrg

Solar power production and German power prices on 27 April 2024.

Solar power production and German power prices on 27 April 2024.
Source:  SEB calculations and graph, data by Blbrg
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Analys

Firm at $85

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SEB - analysbrev på råvaror

This week, Brent Crude prices have strengthened by USD 1.2 per barrel since Monday’s opening. While macroeconomic concerns persist, market reactions have been subdued, with price fluctuations primarily driven by fundamental factors. Currently, the oil price stands at its weekly high of USD 84.4 per barrel, with Wednesday’s low recorded at USD 81.7 per barrel, indicating relatively normal price movements throughout the week.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

The upward trajectory since Wednesday afternoon can be attributed to two main factors:

Firstly, Wednesday’s US inventory report, though mixed, conveyed a bullish sentiment to the market due to an overall decline in commercial inventories. The report from the US Department of Energy (DOE) revealed a draw in US crude inventories of 1.4 million barrels last week, surpassing consensus estimates of a 2.0-million-barrel draw –  the American Petroleum Institute’s (API) forecast of a 0.5-million-barrel build on Tuesday.

Additionally, a marginal improvement in refinery margins hints at healthier demand prospects leading up to the driving season. While commercial crude oil inventories (excluding Strategic Petroleum Reserve) decreased, standing approximately 3% below the five-year average for this period, total gasoline inventories saw a notable increase of 0.9 million barrels compared to the consensus forecast of a decrease of 1.1 million barrels. Distillate fuel inventories experienced a more moderate increase in line with expectations, rising by 0.6 million barrels but remaining approximately 7% below the five-year average. Overall, total inventories (crude + gasoline + distillate) showed a marginal increase of 0.1 million barrels, coupled with a 1% improvement in refinery utilization to 88.5% last week (see pages 11 and 18 attached).

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The substantial draw in commercial crude inventories, particularly compared to the typical seasonal build, has emerged as a key price driver (see page 12 attached).

Secondly, the third consecutive day of oil price gains can be attributed to renewed optimism regarding US rate cuts, supported by positive US jobs data suggesting potential Federal Reserve rate cuts this year. This optimism has boosted risk assets and weakened the dollar, rendering commodities more appealing to buyers.

In a broader context, crude oil prices have been moderating since early last month amidst easing tensions in the Middle East. Attention is also focused on OPEC+, with Russia, a key member, exceeding production targets ahead of the cartel’s upcoming meeting. Expectations are widespread for an extension of output cuts during the next meeting.

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Conversely, providing support to global crude prices is the Biden administration’s intention to increase the price ceiling for refilling US strategic petroleum reserves to as much as USD 79.99 per barrel.

With geopolitical tensions relatively subdued, but lingering, the market remains vigilant in analyzing data and fundamentals. Our outlook for oil prices at USD 85 per barrel for 2024 remains firm and attainable for the foreseeable future.

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