Fundamentals September 2018

Published at 09:59 25 Sep 2018 by . Last edited 15:12 5 Nov 2018.

According to our crude balances, Q4 18 is set to be the tightest quarter we have seen in over a decade and tighter than any quarter we are currently predicting for 2019. This is due to a combination of the steep decline in Iranian exports, a lack of any near term spare capacity and the resurgence of Chinese teapot buying.

Near term spare capacity is effectively maxed out. Saudi Arabia is likely to produce close to 10.9 mb/d through Q4 18, aided by the ramp-up of the 0.3 mb/d Khurais expansion that started up in August. We understand the spat between Sinopec and Saudi Aramco over high OSPs has been resolved, and China has even exercised operational tolerance clauses to nominate for 10% more than its contractual term volumes. This implies exports from the Kingdom will likely rise towards 7.6-7.8 mb/d from next month, which they should be able to sustain over the winter now that summer crude burn requirements are finished. With Russian output already at 11.3 mb/d, there will be barely any spare capacity left in the short term.

Looking into 2019, the picture improves somewhat. At the start of next year, we expect the 0.3 mb/d Khafji field in the Neutral Zone to gradually return to production alongside several large offshore projects in the UAE and elsewhere. With barely three months left in the year, many of the projects scheduled for 2018 have yet to come online and will slip into 2019. Saudi Aramco has started to add rigs and drill more over Q3 18, so it should also be able to raise sustain production above 11 mb/d even without the restart of the Neutral Zone.

Russia has a few new projects that could add 0.2-0.3 mb/d of average production through the year, while a breakthrough between Baghdad and the Kurdistan Regional Government could see Iraqi volumes rise by an additional 0.2 mb/d over and above the increases we foresee from the south due to debottlenecking and small field expansions. These projects are the reason why we expect combined OPEC and Russian output next year to rise y/y by almost 0.3 mb/d, even with Iranian production set to be 1.0 mb/d lower y/y and Venezuela by almost 0.4 mb/d.

Importantly, we have factored these into our balances for months and still see draws in 2019 of around 0.3 mb/d. But no quarter gets as tight as Q4 18, with the highest draws predicted in Q3 19 at 0.8 mb/d. Of course, with inventories so low, any draw is a further tightening and supportive of prices, but the point here is that we are staring at an imminent crude supply crunch in Q4 18.

Despite such a tight physical crude market, the market is focussing on the collapse in refining margins. Margins across the world have fallen below year-ago and five-year average levels, although y/y comparisons are distorted by Hurricane Harvey. In the Med, where margins have crunched in even more to the lowest point since 2014, some refiners are trimming runs, though deep cuts are yet to occur. Brent cracking margins are at a six-month low, USGC margins are at their weakest since 2015, and FCC margins are now negative. Only margins in Asia are holding up well despite the region being the strongest crude market globally, helped by more robust products fundamentals and aided by a wide Brent-Dubai differential.

While weak refining margins during or just ahead of autumn refinery maintenance is usually a cause for concern, one can hardly call these normal times. The market must realise that crude is genuinely tight, and we will not have enough crude around in Q4 18 to sustain post-maintenance refinery runs and feed the tanks of the new refineries starting up in the east of Suez. In a market with hardly any near term spare capacity, the only way to balance in the short run is through a significant compression in refining margins that reduces crude demand.

In short, this is an upward spiral and a highly synchronised one at that. We should see timespreads across all three benchmarks—Dubai, Brent and WTI—rise in tandem, pulled higher by a complete lack of crude availability in the east. The physical side does not get better than this; it’s only a matter of time that flat price follows.

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