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Last Updated: May 25, 2017
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Last week in the world oil:

Prices

  • As confidence grows that the world’s top oil exporters will agree to extend the OPEC supply cuts, crude oil prices have hit their highest point in a month. Brent started the week at nearly US$54/b, while WTI managed to break past the US$50/b level to settled at almost US$51/b.

Upstream & Midstream

  • First oil has begun to flow at Quad 204’s, BP’s new upstream project in the west of Shetland region in the UK. The Schiehallion and Loyal fields in the area were originally developed in the mid-1990s and are now part of the Quad 204 redevelopment project led by BP with co-venturers Shell and Siccar Point Energy. Some additional 450 million barrels of resources are expected to be unlocked, with production lasting to 2035, and highlights the potential of the UK to develop its Atlantic energy resources.
  • Even as crude prices see-saw, US oil production as proxied by rig activity shows no sign of stopping. Sixteen new oil and gas rigs started up last week – 8 apiece – including 2 offshore rigs to bring the US active rig count above 900 for the first time in almost two years.

Downstream

  • In the footsteps of BP and Glencore, ExxonMobil is now the latest firm to target Mexico’s downstream market. The US supermajor announced that it would be investing US$300 million to established a network of Mobil fuel station in the recently opened Mexican sector. BP was the first to stake a claim in Mexico, and has reported that its plan to open some 1,500 service stations has been more promising than expected, leading to an increase in investment. Trader Glencore has established a deal with Mexico’s Corporacion G500 SAPI to establish some 1,400 G500 Network-branded sites, creating even more competition.

Natural Gas and LNG

  • As upstream action in the eastern Mediterranean heats up, Greece is making another attempt to strike gas. With Israel’s Leviathan and Egypt’s Zohar giant gas discoveries establishing the Levant Basin as a natural gas powerhouse, Greece has invited ExxonMobil and Total to test for natural gas in areas south of Crete island and western Greece. Previous attempts to elicit interest in the blocks failed, but the recent gas discoveries have changed the upstream outlook for the area.
  • South Africa will be looking to issue its first shale gas exploration licences this September, with Shell, Falcon Oil and Gas and Bundu Gas & Oil likely to receive permission to drill for shale in the onshore Karoo basin. South Africa has historically dependent on offshore production for its gas, but is now turning to onshore opportunities as production dwindles and the country attempts to wean itself off coal as a power plant fuel.

Corporate

  • Saudi Aramco will be setting up a petrochemicals subsidiary, putting it in direct competition with Saudi chemicals giant SABIC. The potential change comes as Saudi Aramco attempts to diversify and strengthen its downstream operations ahead of its planned IPO, to create more broad-based operations to be palatable to investors. Aramco has plans to triple its current chemicals production to 34 million tons by 2030.

Last week in Asian oil

Downstream

  • Fresh off its tie-ups in Malaysia and India, Saudi Aramco has announced another mega refining project, this time in China. The joint venture between Aramco and state-owned China North Industries Group (Norinco) will see the world’s largest crude seller and world’s largest crude importer build a 300 kb/d oil refinery with a 1 million ton/year ethylene cracker in Liaoning. The move will deepen the ties between the two nations, as Saudi Aramco looks to lock up long-term supply for its crude through strategic downstream investments. The project is unusual, as Norinco is primarily a defence manufacturer, and could be a signal that China is serious about opening up competition in its energy industry.
  • To the surprise of no one, Vietnam’s second refinery has been delayed. The US$7.5 billion Nghi Son site has been delayed to 2018 from 3Q17, as the refinery faced some mechanical troubles in test runs. The delay means that Vietnam will remain heavily dependent on oil product imports, which Nghi Son was expected to ease.
  • China’s section of the East Siberia Pacific Ocean (ESPO) pipeline will be completed by 2018. As China expands its crude import options, the pipeline connecting the city of Mohe at the Russian border to the city of Daqing will pump some 15 million tons/year of Russian crude to China.

Natural Gas & LNG

  • Italy’s Eni has started gas production at Indonesia’s Jangkrik ahead of schedule. Ten offshore deepwater subsea wells have been connected to the new Jangkrik Floating Production Unit (FPU), with production expected to scale up to 450 million cubic feet per day. Processed gas will be delivered onshore via a 79km pipeline, connecting to the Kalimantan Transportation System to the Bontang LNG plant.
  • Malaysia’s Petronas has signed a MoU with Gas4Sea to collaborate and promote LNG as a cleaner maritime fuel. The move is in line with Petronas’ aim of diversifying its LNG business, with the deal signed through its shipping affiliate MISC. Gas4Sea comprises French natural gas company Engie, and Japanese shippers Mitsubishi and Nippon Yusen Kabushiki Kaisha. Bunker fuels have traditionally been heavy fuel oil, but efforts to promote cleaner fuels have led the shipping industry to consider gasoil and LNG as alternate fuels.
  • Another month and another shutdown at Chevron’s Gorgon LNG plant. The eighth outage since the project began in early 2016, Train 1 has been shut down for at least a month to replace to a faulty flow-measurement device. Outages have plagued the project but Gorgon is slowly finding its footing, starting up Train 3 in March 2017. Chevron will also be boosting capacity on Train 2 of its other Australian project, Wheatstone, as partner Woodside targets production growth of 15% per year through 2020.
  • China has successfully extracted natural gas from methane hydrate deposits mined deepwater. Trapped in ice-like chunks, gas is extracted and processed in a floating platform unit platform in the Shenhu area of the South China Sea. The successful extraction paves the way for a new revolution in energy that would help boost Chinese domestic gas production over the long run. Commercial development of the resource is still far away, with 2030 named as a target date.

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High Oil Prices and Indonesia’s Ban on Oil Palm Exports

Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.  

A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.

Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.

Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.

And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.

That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.

Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.

End of Article

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Market Outlook:

  • Crude price trading range: Brent – US$110-1113/b, WTI – US$105-110/b
  • As the war in Ukraine becomes increasingly entrenched, the pressure on global crude prices as Russian energy exports remain curtailed; OPEC+ is offering little hope to consumers of displaced Russian crude, with no indication that it is ready to drastically increase supply beyond its current gentle approach
  • In the US, the so-called NOPEC bill is moving ahead, paving the way for the US to sue the OPEC+ group under antitrust rules for market manipulation, setting up a tense next few months as international geopolitics and trade relations are re-evaluated

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