Physical oil and futures align to tell story of a tighter market

New marine fuel regulations from 2020 are encouraging refiners to switch to crude grades that produce smaller quantities of high-sulfur fuel oil. (AFP)
Updated 23 November 2019

Physical oil and futures align to tell story of a tighter market

  • Premiums for heavier grades continue to rally because of the continuing US sanctions on Iran and Venezuela

LONDON: The physical crude oil market and the structure of the oil futures curve have rarely been more aligned over the past few years than in recent weeks, and they tell a counter-intuitive story of a tight oil market next year. 

While OPEC and the International Energy Agency point to a swelling oil glut next year due to booming non-OPEC supplies including in the US, the physical market offers a different story. Traders are prepared to pay near-record premiums for sweeter barrels as new marine fuel regulations from 2020 encourage refiners to switch to crude grades that produce smaller quantities of high-sulfur fuel oil. 

However, premiums for heavier grades, which produce more fuel oil, also continue to rally due to a deficit created by US sanctions on Iran and Venezuela. In addition, the structure of the oil futures market shows that premiums of front months to later dates – known as backwardation – have narrowed in recent weeks, also suggesting the market’s expectations of a glut are diminishing somewhat. 

To be sure, benchmark oil futures do not necessarily follow the physical market and could still decline next year if global oil demand falls because of the US-China trade dispute or if US oil output surprises again on the upside. Soaring physical crude prices are also negatively impacting refining margins, often prompting refiners to cut processing. New marine fuel rules have created a rally in certain crude oil grades. 

From January 2020, the United Nations’ International Maritime Organization (IMO) will ban ships from using fuels with a sulfur content above 0.5 percent, compared with 3.5 percent now, unless they have sulfur-cleaning kits called scrubbers. 

Nigeria’s biggest crude stream, Qua Iboe, is valued at a premium of $3.30 a barrel, the highest since 2013, Refinitiv Eikon data shows. Azeri Light, or BTC, has a premium of $5.10 to the benchmark, its highest since 2013. 

Both crudes are valued especially highly by simple refineries as they are ideal for producing IMO-compliant bunker fuel oil, said Eugene Lindell, an analyst at JBC Energy in Vienna. “The focus now is on not producing high-sulfur fuel oil at all costs. If you are a simple refinery, it comes down to choosing the right crude,” he said. “The end result is a lot of people are going to be seeking these grades and that boosts the price. They will remain strong and may increase further.” 

While the rally in those two light, sweet grades stands out, sour crudes such as Russian Urals have been supported by other factors. Urals in northwest Europe is trading at a premium of $1 a barrel to dated Brent, a record high. “The strength in sour crudes, despite IMO 2020, is due to the loss of sour crude supplies from Venezuela and Iran and high demand for heavy molecules to feed the conversion units of more complex refineries,” analysts at Energy Aspects wrote. 

US sanctions on Iran and Venezuela have forced the two OPEC members to cut oil exports sharply, tightening the market for sour crude. Voluntary OPEC cuts due to a supply pact that producers are expected to renew in December have also curbed output. Expectations of a growth slowdown in US shale could also tighten the market further. North Sea crude grades, which underpin the Brent futures contract, are also rallying. Ekofisk, one of the five grades that can set the value of dated Brent, jumped to its highest since 2013 on Tuesday.

The rally in physical crude is being reflected in strengthening time spreads in the Brent futures market, even though the outright price at $62 a barrel is well below this year’s high of $75. The first-month Brent contract is trading at a premium to the second month, indicating current tight supply. 

Backwardation persists for future months, although it becomes shallower next year. 

“We expect Brent oil prices to continue trading around our $60-a-barrel forecast with backwardation likely to persist as the ongoing OPEC cuts and slowing shale activity offset rising other non-OPEC supply and moderate demand growth,” Goldman Sachs said in a report this month.


China Pakistan Economic Corridor is a game-changer

Updated 14 August 2020

China Pakistan Economic Corridor is a game-changer

  • Project will strengthen bond between two countries who share history of good strategic relations

The China Pakistan Economic Corridor (CPEC), presently under construction at a cost of $46 billion, aims to improve Pakistani infrastructure and deepen the economic and political ties between China and Pakistan.

CPEC is advantageous to Pakistan but also carries substantial economic and strategic benefits for China.

Its importance for China is evident from the fact that it is part of China’s 13th five-year development plan.

CPEC will boost ties between China and Pakistan, which share a history of congenial strategic relations, over a versatile canvass of mutual interest extending over six decades.

In the past 65 years, both countries have developed strong bilateral trade and economic collaboration.

China is Pakistan’s largest trading partner in imports and exports. And CPEC is going further to enhance the lucrative economic cooperation between the two countries.

If realized, the plan will be China’s biggest splurge on economic development in another country to date.

Consul Syed Hamzah Saleem Gilani

It aims over 15 years to create an economic corridor between Gwadar Port to China’s northwestern region of Xinjiang through the 2,700 km long highway from Kashgar to Gwadar, railway links for freight trains, oil and gas pipelines and an optical fiber link.

The project will create nearly 700,000 new jobs and add up to 2.5 percent to Pakistan’s annual growth rate.

CPEC has undeniable economic and strategic importance for Pakistan and China. It has been called a game-changer for Pakistan because it will link China with markets in Central Asia and South Asia. Presently China is some 13,000 km from the Arabian Gulf with a shipping time of about 45 days.

CPEC will shrink this distance to merely 2,500 km (an 80 percent reduction).

The shipping time will reduce to 10 days (a 78 percent reduction). The bulk of China’s trade is through the narrow sea channel of the Strait of Malacca.

Top security analysts say that in the event of a future war in Asia, the US Navy could block the Strait of Malacca, which would suffocate China’s trade route. CPEC, besides providing an alternate route, will reduce the shipping time from China to Europe.

The largest part of the project would provide electricity to energy-thirsty Pakistan, badly affected by hours of daily scheduled power cuts because of electricity-shortages, based mostly on building new coal-fired power plants.

The plans envisages adding 10,400 megawatts of electricity at a cost of $15.5 billion by 2018. And after 2018 a further 6,600 megawatts, at an additional cost of $18.3 billion, will be added, doubling Pakistan’s current electricity output.

The CPEC brings many benefits for China and Pakistan, but it is also challenged by security-related and political threats.

There are two major sources of threat: Indian involvement, and the separatist rebellion in Baluchistan where the port of Gwadar is situated.

Both dimensions of threat are interconnected because recent arrests of Indian spies by Pakistan reveal that the Indian government is spending a huge amount of money and resources on sabotaging the CPEC project.

Apart from espionage activities, India is also supporting the Baloch rebels. Nevertheless, Pakistan is well-equipped, with adequate security and infrastructure support to effectively deal with such challenges. Operation “Zarb-e-Azb,” which has received international recognition, has flushed out the major chunk of extremists from Pakistan’s soil.

The political side of the project for Pakistan is also not rosy.

It is always difficult to achieve political consensus on an issue. The Kalabagh dam project, for example, which is considered to be extremely important in addressing Pakistan’s water-shortage problems, has been subjected to political controversy and still awaits construction.

Similar formulas are being applied to CPEC. Drums of provincialism are being beaten loudly to make CPEC another Kalabagh dam.

However, this time sanity has prevailed in the political leadership and controversies were nipped in the bud at an early stage. Besides the efforts of political leaders, the contribution of the Army chief should not go unappreciated.

He took a special interest in this project and provided — and ensured for the future — the Pakistan Army’s full support for the mega-economic project.

CPEC has the potential to carry huge economic benefits for the people of Pakistan and the region. According to a recent estimate, CPEC will serve three billion people, nearly half of the global population. Thus a huge economic bloc is about to emerge from this region.

On completion of the CPEC, Pakistan will become a connecting bridge to three engines of growth: China, Central Asia, and South Asia.

It will create many jobs and elevate Pakistan to high growth rates, which will ensure Pakistan’s stability and serve as a deterrent to extremism and violence.

The completion of CPEC is not going to be an easy task because it has attracted international conspiracies, against which it must be protected.

The economic dividends of this project, by connecting all the economies of the region, are going to be so high that once this project is in full-operation even our neighbor India might ultimately join the club for greater economic benefits.

 

The author is Pakistan’s press counselor in Jeddah