After five weeks of being whiplashed by financial market fears, crude reconnected with its own fundamentals over March 12-16, only to become locked in a narrow price band, with WTI anchored at $60/barrel and Brent at $65. Predictions of ballooning non-OPEC oil supplies were counter-balanced by reiterations of confidence in strong global oil demand growth this year, depriving the market of any incentive to either go long or short.
The limbo could prove to be short-lived. As the week came to a close, Iran and the fate of its nuclear deal had moved to the top of news headlines. The sudden departure of Rex Tillerson, a moderate on Iran, and his replacement as US secretary of state by the more hawkish CIA director Mike Pompeo, could precipitate a clash between the two countries over the 2015 multilateral nuclear deal. The fate of the Iran nuclear deal is now a cliffhanger and likely to inject a fear premium in crude over the coming weeks.
Meanwhile, anxiety over the possible outbreak of trade wars, especially between the US and China, as well as the US and its partners in the precarious North American Free Trade Agreement — Canada and Mexico — could continue to rattle the financial markets. The fears come on top of lingering uncertainty over the course of US inflation rates and monetary policy. The Federal Reserve is widely expected to raise interest rates by a quarter of a percentage point at its next meeting March 20-21.
Myriad concerns rippling through the financial markets since the start of February ultimately converge to hang a question-mark over the presumed strong and synchronous global economic growth this year. They have rattled equity markets across the world and are likely to continue buffeting crude as well. A deceleration in the global economic growth would not bode well for the health of oil demand.
The oil market’s focus this week was primarily on OECD inventory data and outlook for global oil supply and demand balances. The closely-watched monthly oil market reports from OPEC and the International Energy Agency released on Wednesday and Thursday respectively were remarkably similar in tone and almost evenly split between the bullish and bearish elements on the horizon. The weekly US stocks data also pulled market sentiment in opposite directions, showing a major build in crude inventories and a plunge in gasoline and distillate stocks for the week ended March 9.
The OPEC and IEA reports lent further credence to expectations of a shale renaissance in 2018, given their projections of US crude production vaulting by 1 million b/d or more this year, way higher than the growth recorded in 2017. The market is once again paying attention to the weekly US rig count data after mostly ignoring it through the latter half of last year, once the shale growth trajectory had become clear. The rig numbers are not a good proxy for US crude production rates, but a useful input for market participants continuously trying to assess or validate their assessment of shale’s growth.
Unfortunately, the rig count is also not telling a coherent story yet. Baker Hughes reported a drop of four in the number of oil rigs operating in the US in the week ended March 9 to a total of 796, reversing six successive weeks of increases, and leaving the market guessing on what the trend might be.
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Less than two weeks ago, the VLCC Navarin arrived at Tanjung Pengerang, at the southern end of Peninsular Malaysia. It was carrying two million barrels of crude oil, split equally between Saudi Arab Medium and Iraqi Basra Light grades.
The RAPID refinery in Johor. An equal joint partnership between Malaysia’s Petronas and Saudi Aramco whose 300 kb/d mega refinery is nearing completion. Once questioned for its economic viability, RAPID is now scheduled to start up in early 2019, entering a market that is still booming and in demand of the higher quality, Euro IV and Euro V level fuels RAPID will produce.
Beyond fuel products, RAPID will also have massive petrochemical capacity. Meant to come on online at a later date, RAPID will have a collective capacity of some 7.7 million tons per annum of differentiated and specialty chemicals, including 3 mtpa of propylene. To be completed in stages, Petronas nonetheless projects that it will add some 3.3 million tons of petrochemicals to the Asia market by the end of next year. That’s blockbuster numbers, and it will elevate Petronas’ stature in downstream, bringing more international appeal to a refining network previously focused mainly on Malaysia. For its partner Saudi Aramco, RAPID is part of a multi-pronged strategy of investing mega refineries in key parts of the world, to diversify its business and ensure demand for its crude flows as it edges towards an IPO.
RAPID won’t be alone. Vietnam’s second refinery – the 200 kb/d Nghi Son – has finally started up this year after multiple delays. And in the same timeframe as RAPID, the Zhejiang refinery by Rongsheng Petro Chemical and the Dalian refinery by Hengli Petrochemical in China are both due to start up. At 400 kb/d each, that could add 1.1 mmb/d of new refining capacity in Asia within 1H19. And there’s more coming. Hengli’s Pulau Muara Besar project in Brunei is also aiming for a 2019 start, potentially adding another 175 kb/d of capacity. And just like RAPID, each of these new or recent projects has substantial petrochemical capacity planned.
That’s okay for now, since demand remains strong. But the danger is that this could all unravel. With American sanctions on Iran due to kick in November, even existing refineries are fleeing from contributing to Tehran in favour of other crude grades. The new refineries will be entering a tight market that could become even tighter. RAPID can rely on Saudi Arabia and Nghi Son can depend on Kuwait, both the Chinese projects are having to scramble to find alternate supplies for their designed diet of heavy sour crude. This race to find supplies has already sent Brent prices to four-year highs, and most in the industry are already predicting that crude oil prices will rise to US$100/b by the year’s end. At prices like this, demand destruction begins and the current massive growth – fuelled by cheap oil prices – could come to an end. The market can rapidly change again, and by the end of this decade, Asia could be swirling with far more oil products that it can handle.
Upcoming and recent Asia refineries:
Headline crude prices for the week beginning 8 October 2018 – Brent: US$84/b; WTI: US$74/b
Headlines of the week
Source: U.S. Energy Information Administration, Monthly Crude Oil and Natural Gas Production
As domestic production continues to increase, the average density of crude oil produced in the United States continues to become lighter. The average API gravity—a measure of a crude oil’s density where higher numbers mean lower density—of U.S. crude oil increased in 2017 and through the first six months of 2018. Crude oil production with an API gravity greater than 40 degrees grew by 310,000 barrels per day (b/d) to more than 4.6 million b/d in 2017. This increase represents 53% of total Lower 48 production in 2017, an increase from 50% in 2015, the earliest year for which EIA has oil production data by API gravity.
API gravity is measured as the inverse of the density of a petroleum liquid relative to water. The higher the API gravity, the lower the density of the petroleum liquid, meaning lighter oils have higher API gravities. The increase in light crude oil production is the result of the growth in crude oil production from tight formations enabled by improvements in horizontal drilling and hydraulic fracturing.
Along with sulfur content, API gravity determines the type of processing needed to refine crude oil into fuel and other petroleum products, all of which factor into refineries’ profits. Overall U.S. refining capacity is geared toward a diverse range of crude oil inputs, so it can be uneconomic to run some refineries solely on light crude oil. Conversely, it is impossible to run some refineries on heavy crude oil without producing significant quantities of low-valued heavy products such as residual fuel.
Source: U.S. Energy Information Administration, Monthly Crude Oil and Natural Gas Production
API gravity can differ greatly by production area. For example, oil produced in Texas—the largest crude oil-producing state—has a relatively broad distribution of API gravities with most production ranging from 30 to 50 degrees API. However, crude oil with API gravity of 40 to 50 degrees accounted for the largest share of Texas production, at 55%, in 2017. This category was also the fastest growing, reaching 1.9 million b/d, driven by increasing production in the tight oil plays of the Permian and Eagle Ford.
Oil produced in North Dakota’s Bakken formation also tends to be less dense and lighter. About 90% of North Dakota’s 2017 crude oil production had an API gravity of 40 to 50 degrees. The oil coming from the Federal Gulf of Mexico (GOM) tends to be more dense and heavier. More than 34% of the crude oil produced in the GOM in 2017 had an API gravity of lower than 30 degrees and 65% had an API gravity of 30 to 40 degrees.
In contrast to the increasing production of light crude oil in the United States, imported crude oil continues to be heavier. In 2017, 7.6 million b/d (96%) of imported crude oil had an API gravity of 40 or below, compared with 4.2 million b/d (48%) of domestic production.
EIA collects API gravity production data by state in the monthly crude oil and natural gas production report as well as crude oil quality by company level imports to better inform analysis of refinery inputs and utilization, crude oil trade, and regional crude oil pricing. API gravity is also projected to continue changing: EIA’s Annual Energy Outlook 2018 Reference case projects that U.S. oil production from tight formations will continue to increase in the coming decades.