Warning to Opec: Rout might not be over

As Opec watches a near 15 per cent drop in the oil price in three weeks, important indicators in the physical crude market are flashing worrying signals that the decline might be far from over. The concerns come not from the heavily traded futures market, but from less transparent trading activity in crude oil and other products markets, where key US, European and Russian crude prices have fallen of late, suggesting less robust demand.
Benchmark oil futures have plunged in recent days together with global stock markets due to concerns over inflation as well as renewed fears that rapid output increases out of United States will flood the market with more crude this year.
Opec, including its Secretary General Mohammad Barkindo, argue the decline is just a blip because demand is exceeding supply and will guarantee prices won’t plunge again to $30 per barrel as they did in 2015 and 2016.
Traditionally, when oil futures decline, prices in the physical markets tend to rise because crude is becoming cheaper and hence more attractive to refiners.
But in the past weeks, differentials in key European and US markets such as North Sea Forties, Russia’s Urals, West Texas Intermediate in Midland, Texas, or the Atlantic diesel market have all fallen to multi-month lows.
The reasons tend to be different for most physical grades but overall the trend paints a bearish picture.
“Physical markets do not lie. If regional areas of oversupply cannot find pockets of demand, prices will decline,” said Michael Tran from RBC Capital Markets.
“Atlantic Basin crudes are the barometer for the health of the global oil market since the region is the first to reflect looser fundamentals.
Struggling North Sea physical crudes like Brent, Forties, and Ekofisk suggest that barrels are having difficulty finding buyers,” he added.
This follows the run-up in US production to daily output of 10.04 million bpd as of November, highest since 1970, pushing it into second place among crude producers, ahead of Saudi Arabia and trailing only Russia, according to the US Department of Energy.
On Tuesday, the Paris-based International Energy Agency said increased US supply could cause output to exceed demand globally in 2018.
Forties crude differentials to dated Brent have fallen to minus 70 cents, down from a premium of 75 cents at the start of the year as the Forties pipeline returned to normal operation.
The Forties differentials are now not far off their lowest since the middle of 2017, when the benchmark Brent crude price was trading at around $45 per barrel compared to $62 per barrel now and $71 per barrel just a few weeks ago.
In the United States, key grades traded in Texas and Louisiana have fallen to their lowest in several months. A similar pattern is observed in the Russian Urals market, one of the biggest by volumes in Europe.
At a discount of $2.15 to dated Brent, Urals’ differentials in the Mediterranean are now at their lowest since September 2016, when Brent futures were hovering near $40-$45 per barrel.
“Sour grades are not in a good shape worldwide, so is Urals,” said a European crude oil trader, who asked not to be named because he is not allowed to speak publicly. That sharply contrasts with a situation from the start of 2017 when Opec cuts of predominantly sour grades made them attractive to buyers.
“Supply is more than ample in Europe, Urals faces strong competition from the Middle Eastern grades,” said another trader on the Russian crude oil market adding that supplies of Urals to Asia were uneconomic due to a wide Brent-Dubai spread.
Adding pressure on Urals, traders expect loadings of the grade to rise in the coming months due to seasonal maintenance at Russian refineries.
A decline in physical crude values generally means better margins for refiners. But it is also not happening this time. The profit margin refiners make on processing crude into diesel collapsed in Europe and the United States by over 18 per cent over the past week.
Europe, where nearly half of the vehicles are fuelled by diesel, is the home to the global benchmark for diesel prices and the biggest storage hub for the road fuel as regional refineries are unable to meet local demand. — Reuters

Dmitry Zhdannikov, Olga Yagova and Ron Bousso