Eighteen months after OPEC’s momentous decision in November 2016 to slash production in concert with a group of major non-OPEC producers to drain the world’s bloated inventories and shore up crude prices, the group is at a crossroads again.
Commercial oil inventories in the OECD countries are estimated to have finally come in line with or fallen slightly below their five-year average over the past two months, achieving OPEC’s target nearly nine months before its production restraint agreement is set to expire.
Disciplined OPEC/non-OPEC cuts, aided by strong global oil demand growth, have finally managed to reverse the persistent build in global oil stocks since early 2014 to a near-continuous draw-down from mid-2017.
Brent, which tanked to a 13-year-low of $27.88/barrel on 20 January 2016, repeatedly flirted with the $80 key psychological level this week.
The world is now bracing for more spikes, anticipating protracted supply issues in OPEC producers Iran and Venezuela, combined with intermittent disruptions in Libya and Nigeria against a thinning cushion of stocks and spare production capacity while consumption growth remains robust.
Alarm bells are going off among consumers and OPEC will need to respond. Neither the threat of declining Iranian supplies nor the downward spiral in Venezuelan production are problems of OPEC’s making. But if crude continues its march above $80, the group will be hard-put to justify its curbs — especially now that OECD stocks have fallen to five-year average levels.
The pressure is already on. Saudi energy minister Khalid al-Falih this week had phone conversations with his counterparts in the US, South Korea, India, the UAE and Russia as well as the International Energy Agency’s Executive Director Fatih Birol. In a call with the Indian oil minister Dharmendra Pradhan on Thursday, Al-Falih said Saudi Arabia will ensure market stability and adequate oil supplies. Pradhan expressed concern over the impact of high crude prices on the Indian consumer and economy.
UAE energy minister Suhail al-Mazrouei and Al-Falih were said to have concluded in their conversation that the oil market remained well-supplied and the recent price surge was driven by geopolitics rather than fundamentals.
That might well be the case. There appears to be enough prompt supply. The big worry is over an accelerated tightening in the coming months. The recent sharp narrowing of the backwardation at the front end of the Brent futures curve and the return of contango in the front two months of WTI futures contracts supports that view. It reflects active buying in forward contract months, lifting their prices relative to the prompt barrels.
Anxiety over a crimp in Iranian supply as US sanctions kick in on November 4, combined with a tailspin in Venezuelan production, especially if the US imposes sanctions against its oil sector, is real.
OPEC has to take a view beyond the spot market and factor in the fears. When it meets on June 22 in Vienna to decide on its supply policy for the next six months, it needs to have a strategy in place to address sudden supply shocks. If the group takes its role as a market balancing agent seriously, the time has come to walk the talk.
Something interesting to share?
Join NrgEdge and create your own NrgBuzz today
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.