Barely had Saudi Arabia and Russia managed to rein in crude’s rally with a hard-earned OPEC/non-OPEC deal to increase output by up to 1 million b/d, that US President Donald Trump upped the ante again.
The US would press its allies to cut their crude imports from Iran to zero by November 4 (when US sanctions against Iran’s oil sector take effect), a senior State Department official told reporters in a “background briefing” in Washington on June 26, bringing crude bulls back into play.
Though there was some back-pedalling by US officials subsequently, the market was left rattled, once again. The surprising US declaration raised fears that the few OPEC/non-OPEC producers that do have meaningful spare capacity, would run out of steam if called upon to compensate, in theory, 2.4 million b/d of Iranian crude disappearing from the market.
The suggestion that the US was not inclined to waive sanctions against buyers in exchange for them paring their purchase of Iranian crude, as it did during the 2012-2015 sanctions era, prompted the market to factor in a much bigger potential loss of Iranian barrels than the 0.5-1.0 million b/d range estimated in recent weeks.
The June 26 State Department posturing could turn out to be a classic bargaining tactic — get an upper hand by starting out with an extreme demand — as the US dispatches its envoys to Iran’s crude customers China, India and Turkey.
A State Department official Thursday softened the original message, saying that the US was “prepared to work with the countries that are reducing their imports on a case-by-case basis.”
Comments on the same day by Nikki Haley, US ambassador to the UN on a visit to India, also suggested a moderation in stance. In an interview with a local TV channel, Haley acknowledged that India “can’t change its relationship with Iran in a day,” but nonetheless, said the US was encouraging it to re-evaluate that relationship.
Discussions between the US and China over Iran sanctions are bound to be more complicated, given that the two economic powers are locked in an increasingly fierce trade battle, having announced tit-for-tat import tariffs against each other. Besides, Beĳing continues to stand by the 2015 Iran nuclear deal as one of its signatories.
China has another lever to pull — its substantial and rising purchases of US crude. The country, which is now neck and neck with Canada as the largest importer of US crude, has threatened a 25% import tariff on the product. That would effectively stem the flow of US crude into China by making it economically unviable.
Russia is also under US sanctions, but both China and India have continued their trade relations with that country.
While neither Chinese nor Indian refiners would want to risk secondary US sanctions, the Iran crude imports issue could get stuck in protracted diplomatic wrangling. That would keep the oil market on tenterhooks and the Iran fear premium intact in crude prices through the third quarter.
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.