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Last Updated: June 21, 2018
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Market Watch

Headline crude prices for the week beginning 18 June 2018 – Brent: US$75/b; WTI: US$65/b

  • As OPEC prepares for its meeting in Vienna on June 22, oil prices are also facing a new challenge – the growing trade spat between the US and China
  • After China retaliated to the US’ imposition of tariffs on US$50 billion worth of imports last week, and the US mulls action on another US$200 billion, there is worry that China will reply with targets on US crude and LNG.
  • On the OPEC side, there is an emerging consensus that some form of output increase will be on the cards – supported by Saudi Arabia and Russia – though the size may be ‘modest’ to appease opposition from Iran and Iraq.
  • The figure being bandied about is some 300-600,000 b/d – smaller than Russia’s favoured increase of 1.5 mmb/d and far smaller than the 1.8 mmb/d cut agreed in November 2016.
  • Rosneft has expressed ‘comfort’ with the current price range of US$70-80/b, an indication that OPEC will aim to keep crude at this level even with an agreement on an output hike.
  • Beyond the June meeting, Saudi Arabia is said to be planning a leaders’ summit for the OPEC and NOPEC countries later this year, a step in formally institutionalising co-operation between the two oil blocks.
  • In the US, oil has seen some inventory drops, but the US active oil rig count continues to grow by one site last week, which was offset by the loss of three gas rigs, bringing the total active count to 1,059.
  • The standoff between the US and China over trade issues is uncharted territory. If the trade war continues to escalate, crude prices will continue to be affected by the vortex, placing additional pressure on prices and prompting investors to seek safe havens.
  • Crude price outlook: An output rise at OPEC is expected, and with trade issues dominating headlines, we expect some downward pressure on prices. Brent should stay at US$74-75/b while WTI may widen its discount to US$63-64/b as the infrastructure crunch persists in the Permian.

Headlines of the week

Upstream

  • Encouraged by mega-test finds in Guyana, ExxonMobil has begun developing drilling at three of its projects in Guyana, which should start producing some 500,000 b/d of oil by 2020.
  • As upstream in East Africa slowly but surely heats up, Kenya has approved a new petroleum law defining oil revenue sharing, with 75% going to the state.
  • Petrobras has sold 25% of the Roncador oil field in Brazil’s Campos basin to Equinor for US$2 billion, bringing Equinor’s equity output to 100,000 b/d.
  • ExxonMobil is reportedly taking ‘baby steps’ to create an in-house crude and fuels trading unit, though current plans call for an operation size that pales in comparison to the trading units of Shell, BP and Total.

Downstream

  • Fresh from mega-refinery deals in China, India and Malaysia, Saudi Aramco states that it will continue downstream investment with the goal of ‘8-10 mmb/d of participated refinery capacity and significant chemicals by 2040’
  • As the Chinese city of Tianjin gears up to be the pilot city in introducing an ethanol-gasoline fuel mix by September – part of a wider biofuels initiative by Beijing using local corn stock to reduce pollution – Sinopec’s Tianjin refinery says it is ready to produce some 120,000 tons of the biofuel by October.
  • New tax rules have clipped the wings of China’s independent oil refiners – the teapots – moving from a profit bonanza to shrinking margins and losses.
  • A massive blockade by farmers’ unions of refineries and depots in France has left some fuel stations dry, as the protest of imported biofuels continues.
  • Venezuela may refine foreign crude for the first time ever for domestic fuel demand and to fulfil exports, as the upstream sector buckles under pressure.
  • In a sign that China is looking to diversify its crude diet away from Russia and Saudi Arabia, chemical producer Hengli has purchased crude from Brazil to fuel startup at its new 400,000 b/d refinery in Dalian.

Natural Gas/LNG

  • Chevron has started up the second train of Wheatstone LNG, as it plays catch up with other Australian LNG projects after severe cost-blowouts and delays.  
  • Total, along with Sonatrach, Repsol and Alnaft, has signed a new concession contract for the Tin Fouyé Tabankort gas and condensate field in Algeria, extending the life of the current contract by 25 years.
  • Shell has sold its entire stake in the Petronas-operated MLNG Tiga LNG plant in Malaysia to the Sarawak state government for US$750 million.
  • Phillips 66 is planning a US$1.5 billion expansion of its NGL project in Sweeny, Texas, including two new 150,000 b/d fractionators.
  • Centrica and Tokyo Gas have signed non-binding agreements to purchase some 2.6 mtpa LNG from Anadarko’s Mozambique project, which should support the project’s upcoming FID.
  • The planned gas pipeline linking Israel to Egypt is one step closer to fruition, as Delek Drilling, Noble Energy and an Egyptian company agree to purchase 37% of East Mediterranean Gas, giving the partners control over the pipeline.

Corporate

  • Oasis Management has taken stakes in Japan’s Idemitsu Kosan and Show Shell Sekiyu, reviving the possibility of a merger between the two refiners that has been scuppered by Idemitsu’s founding family.

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Saudi Aramco Moves Into Russia’s Backyard

International expansions for Saudi Aramco – the largest oil company in the world – are not uncommon. But up to this point, those expansions have followed a certain logic: to create entrenched demand for Saudi crude in the world’s largest consuming markets. But Saudi champion’s latest expansion move defies, or perhaps, changes that logic, as Aramco returns to Europe. And not just any part of Europe, but Eastern Europe – an area of the world dominated by Russia – as Saudi Aramco acquires downstream assets from Poland’s PKN Orlen and signs quite a significant crude supply deal. How is this important? Let us examine.

First, the deal itself and its history. As part of the current Polish government’s plan to strengthen its national ‘crown jewels’ in line with its more nationalistic stance, state energy firm PKN Orlen announced plans to purchase its fellow Polish rival (and also state-owned) Grupa Lotos. The outright purchase fell afoul of EU anti-competition rules, which meant that PKN Orlen had to divest some Lotos assets in order to win approval of the deal. Some of the Lotos assets – including 417 fuel stations – are being sold to Hungary’s MOL, which will also sign a long-term fuel supply agreement with PKN Orlen for the newly-acquired sites, while PKN Orlen will gain fuel retail assets in Hungary and Slovakia as part of the deal. But, more interestingly, PKN Orlen has chosen to sell a 30% stake in the Lotos Gdansk refinery in Poland (with a crude processing capacity of 210,000 bd) to Saudi Aramco, alongside a stake in a fuel logistic subsidiary and jet fuel joint venture supply arrangement between Lotos and BP. In return, PKN Orlen will also sign a long-term contract to purchase between 200,000-337,000 b/d of crude from Aramco, which is an addition to the current contract for 100,000 b/d of Saudi crude that already exists. At a maximum, that figure will cover more than half of Poland’s crude oil requirements, but PKN Orlen has also said that it plans to direct some of that new supply to several of its other refineries elsewhere in Lithuania and the Czech Republic.

For Saudi Aramco, this is very interesting. While Aramco has always been a presence in Europe as a major crude supplier, its expansion plans over the past decade have been focused elsewhere. In the US, where it acquired full ownership of the Motiva joint venture from Shell in 2017. In doing so, it acquired control of Port Arthur, the largest refinery in North America, and has been on a petrochemicals-focused expansion since. In Asia, where Aramco has been busy creating significant nodes for its crude – in China, in India and in Malaysia (to serve the Southeast Asia and facilitate trade). And at home, where the focus has on expanding refining and petrochemical capacity, and strengthen its natural gas position. So this expansion in Europe – a mature market with a low ceiling for growth, even in Eastern Europe, is interesting. Why Poland, and not East or southern Africa? The answer seems fairly obvious: Russia.

The current era of relatively peaceful cooperation between Saudi Arabia and Russia in the oil sphere is recent. Very recent. It was not too long ago that Saudi Arabia and Russia were locked in a crude price war, which had devastating consequences, and ultimately led to the détente through OPEC+ that presaged an unprecedented supply control deal. That was through necessity, as the world faced the far ranging impact of the Covid-19 pandemic. But remove that lens of cooperation, and Saudi Arabia and Russia are actual rivals. With the current supply easing strategy through OPEC+ gradually coming to an end, this could remove the need for the that club (by say 2H 2022). And with Russia not being part of OPEC itself – where Saudi Arabia is the kingpin – cooperation is no longer necessary once the world returns to normality.

So the Polish deal is canny. In a statement, Aramco stated that ‘the investments will widen (our) presence in the European downstream sector and further expand (our) crude imports into Poland, which aligns with PKN Orlen’s strategy of diversifying its energy supplies’. Which hints at the other geopolitical aspect in play. Europe’s major reliance on Russia for its crude and natural gas has been a minefield – see the recent price chaos in the European natural gas markets – and countries that were formally under the Soviet sphere of influence have been trying to wean themselves off reliance from a politically unpredictable neighbour. Poland’s current disillusion with EU membership (at least from the ruling party) are well-documented, but its entanglement with Russia is existential. The Cold War is not more than 30 years gone.

For Saudi Aramco, the move aligns with its desire to optimise export sales from its Red Sea-facing terminals Yanbu, Jeddah, Shuqaiq and Rabigh, which have closer access to Europe through the Suez Canal. It is for the same reason that Aramco’s trading subsidiary ATC recently signed a deal with German refiner/trader Klesch Group for a 3-year supply of 110,000 b/d crude. It would seem that Saudi Arabia is anticipating an eventual end to the OPEC+ era of cooperative and a return to rivalry. And in a rivalry, that means having to make power moves. The PKN Orlen deal is a power move, since it brings Aramco squarely in Russia’s backyard, directly displacing Russian market share. Not just in Poland, but in other markets as well. And with a geopolitical situation that is fragile – see the recent tensions about Russian military build-up at the Ukrainian borders – that plays into Aramco’s hands. European sales make up only a fraction of the daily flotilla of Saudi crude to enters international markets, but even though European consumption is in structural decline, there are still volumes required.

How will Russia react? Politically, it is on the backfoot, but its entrenched positions in Europe allows it to hold plenty of sway. European reservations about the Putin administration and climate change goals do not detract from commercial reality that Europe needs energy now. The debate of the Nord Stream 2 pipeline is proof of that. Russian crude freed up from being directed to Eastern Europe means a surplus to sell elsewhere. Which means that Russia will be looking at deals with other countries and refiners, possibly in markets with Aramco is dominant. That level of tension won’t be seen for a while – these deals takes months and years to complete – but we can certainly expect that agitation to be reflected in upcoming OPEC+ discussions. The club recently endorsed another expected 400,000 b/d of supply easing for January. Reading the tea leaves – of which the PKN Orlen is one – makes it sound like there will not be much more cooperation beyond April, once the supply deal is anticipated to end.

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Market Outlook:

-       Crude price trading range: Brent – US$86-88/b, WTI – US$84-86/b

-       Crude oil benchmarks globally continue their gain streak for a fifth week, as the market bounces back from the lows seen in early December as the threat of the Omicron virus variant fades and signs point to tightening balances on strong consumption

-       This could set the stage for US$100/b oil by midyear – as predicted by several key analysts – as consumption rebounds ahead of summer travel and OPEC+ remains locked into its gradual consumption easing schedule 

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