Growing glut of high-quality crude signals danger for oil market
NEW YORK and LONDON (Bloomberg) -- The physical oil market -- where traders buy and sell bbl on their journey from the well-head into the global refining system -- is looking increasingly fragile.
When Saudi Arabia and Russia agreed to boost oil production in late June, they assured traders high output wouldn’t flood the market. Less than two months later and the market doesn’t appear so certain as a small but steadily growing glut emerges of light, sweet crude, high-quality oil prized for its yield of valuable gasoline and lack of polluting sulfur molecules.
"The market is feeling soggy," said Andrew Dodson, chief investment officer at the recently launched energy hedge fund Philipp Oil in London.
The market only has a few weeks to clear the glut before the summer season of peak demand ends and refiners start turning down units for seasonal maintenance, significantly reducing crude intake.
The overhang is best reflected in time spreads for Brent, the North Sea benchmark that underpins the global market.
Barrels available for delivery within weeks have started trading at a discount to cargoes for further in the future, a market situation known as contango that suggests a near-term surplus of oil. The price difference between Brent futures nearest delivery and the contract a month later moved from a premium of $0.53 in late June to a discount of $0.63 in late July.
Oil refiners have plenty of crude at hand right now with unsold cargoes of light, sweet crude in northwest Europe, the Mediterranean, China, and West Africa, traders said. While U.S. sanctions on Tehran could quickly tighten the physical market later this year, supplies are currently plentiful as the Saudis and Russians boost production before the market loses significant Iranian supply.
"The increase in supply from OPEC seems to be real and it’s already translating into an overhang in supplies of Brent," Marwan Younes, chief investment officer at commodities fund Massar Capital Management, said.
Although many traders still expect the light, sweet crude market to tighten toward the end of the year, investors increasingly seem less convinced. The price difference between Brent crude for delivery in December 2018 and December 2019 -- a popular trade known in the industry as Dec-Red-Dec -- has narrowed to $2.48/bbl, down from a peak of $6.16/bbl three months ago, suggesting a looser market.
The weakness in light, sweet crude is such that its premium over lower-quality heavy, sour crude has narrowed dramatically since May. The Brent-Dubai exchange of futures for swaps, a measure of the difference in prices between the two benchmark crudes, fell to $1.10/bbl in late July, down from more than $4.50/bbl three months earlier.
The overhang in light, sweet crude is compounded by a surge in U.S. exports into Europe as Washington’s trade war with Beijing prompts traders to divert cargoes they once hoped to sell to China. That’s putting further pressure on Brent, one of the world’s two main crude benchmarks. Total U.S. crude exports have surged to 2.2 MMbpd on average over the last four weeks, compared to 893,000 bpd in July 2017.
Adding to the problem, Riyadh is offering additional bbl of Arab Extra Light, which is adding to the glut in light crude, traders said. And Kazakhstan is also boosting output of its main export grade, known as CPC Blend, a similar grade. Libyan production, which briefly plunged in early July, has also now recovered.
"The prompt crude oversupply has taken on a life of its own," said Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. in London.
Beyond trade disputes, China is making things worse on the demand side as so-called teapot refineries scale down purchases in the North Sea, traders said. They estimated that less than 7 MMbbl left the region heading to Asia in July, down from 15 MMbbl in May.
The weakness, traders say, is likely to extend in the next few weeks into the domestic U.S. oil market, which has been largely isolated from the waterborne glut. West Texas Intermediate, the U.S. benchmark crude, has been trading in a relatively healthy backwardation -- the opposite structure to contango -- suggesting a tight market.
The price has been supported by falling inventories at the storage and pipelines hub of Cushing. The Oklahoma town serves as the delivery point for the WTI oil futures contract.
Cushing crude stocks fell last week to a near four-year low of 22.4 MMbbl, putting inventories perilously close to what some consider tank bottoms at around 16 MMbbl. In June and July, American refiners tapped Cushing stocks heavily to replace the loss of 350,000 bpd from the Syncrude facility in Canada. But, with the plant, which upgrades Canadian oil sands into a synthetic light crude, returning to full operations in September, just as refineries enter maintenance season, Cushing is set to build again.
Once the Oklahoman storage hub starts to fill again, that could spell more pressure for Brent and Brent-related crude.
