Quality matters, not quantity.
That was the message from the International Energy Agency (IEA) in its latest Oil Market Report. The world has plenty of oil, but perhaps not the right type of oil.
A series of events have caused the market for light oil to diverge from that of medium and heavier blends. This trend has been underway for some time, but the deviation has magnified recently, and could cause havoc as 2019 wears on.
The backdrop is the surge in U.S. shale production. The multi-year boom in light sweet oil from Texas and North Dakota, among other places, has added huge volumes of light oil to global supply. The U.S. Gulf Coast, where much of this oil is heading, has not been able to keep up. Refiners are churning out as much as possible, which has led to a glut of gasoline. But excess barrels have been increasingly exported, adding huge volumes of light oil onto the global market.
To accommodate steadily rising barrels of light oil, OPEC and its non-OPEC partners have backed out their own supplies in order to prevent a crash in prices. But many OPEC members produce medium and heavier blends. The quantity of global supply may not be vastly different, but the quality of the crude slate has changed dramatically.
Refiners cannot easily swap out one type for another. The upshot is that the world is seeing a glut of light oil at a time when supply of medium and heavier barrels are relatively tight. Related: Looming Elections Could Exacerbate Alberta’s Pipeline Problems
But this trickles over into the product markets as well. Because light sweet oil from Texas produces relatively more gasoline, prices for gasoline around the world have dropped relative to diesel. Meanwhile, the lack of medium and heavier barrels, which produce relatively more diesel and other distillates, means that margins for diesel have shot up.
As such, there is a two-speed market for both crude oil and for refined products.
U.S. sanctions against Venezuela and Iran are magnifying this trend, knocking even more medium and heavier barrels off of the market. Sure, U.S. shale will ramp up supply to offset the supply losses, as many analysts and shale-boosters like to point out, but that only makes the divergence between light/heavy oils and gasoline/distillates even more pronounced.
The IEA said that these quality differences could cause some problems this year. “In quantity terms, in 2019 the US alone will grow its crude oil production by more than Venezuela’s current output,” the agency wrote in its Oil Market Report published Wednesday. “In quality terms, it is more complicated. Quality matters.”
Bloomberg reports that prices for heavier crudes in Asia are already gyrating after U.S. sanctions on Venezuela. Bitumen prices have soared in China.
The IEA also highlighted this rather bizarre pricing movements. “With heavy barrels being removed from the market, refiners have to pay more. The premium of Light Louisiana Sweet crude over Mars crude has fallen to below $1/bbl from more than $4/bbl in November,” the IEA noted in its Oil Market Report. “Since the US sanctions against Venezuela were announced, the premium of Mars over WTI has soared from $4.50/bbl to over $7.50/bbl.” Related: Venezuelan Opposition Could Soon Take Over Citgo
Meanwhile, OPEC+ production cuts could erase the supply surplus in the near future. Saudi Arabia has promised to cut more than required, lowering output in January by 350,000 bpd while also promising another 500,000 bpd cut by March. “[C]ore-OPEC producers are adopting a ‘shock and awe’ strategy and exceeding their cut commitment,” Goldman Sachs said in a note, predicting that Brent oil prices will average $67.50 per barrel in the second quarter.
At the same time, the U.S. EIA just published its Short-term Energy Outlook, in which it revised up its forecast for U.S. shale growth by an additional 300,000 bpd. The agency believes the U.S. will average 12.4 mb/d in 2019, up sharply from last month’s forecast of 12.1 mb/d. The revision suggests that the U.S. shale industry may not slow down as much as previously thought, at least according to the EIA.
To reiterate, the OPEC+ cuts will take medium and heavy barrels off of the market at a time when U.S. shale continues to rise. The divergence in both the crude oil and refined product markets will only grow over the course of this year.
By Nick Cunningham of Oilprice.com
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