Just days after Brent crossed $85, demand concerns have resurfaced, especially as EM currencies continue to weaken against the US dollar. Significantly weaker refining margins have not helped matters, but we see this as being about the need to ration crude rather than a sign of weak demand. Asian margins are still healthy, but Europe is being forced to trim runs at the margins. Forward margins are still holding up, so widespread run cuts are not yet occurring.
Still, weak margins are weighing on Brent spreads, despite physical crude markets in Asia still on fire. Weaker Urals due to refinery works is making matters worse for Brent. But the biggest drag on spreads is freight, where rates have surged to the highest since January 2017, caused by Iran’s fleet being taken out of service and used to store its own crude as Iranian exports drop sharply.
So, prices and spreads may stall for a bit. But given the US administration has limited appetite for a US SPR release (even though Trump changing his mind can never be ruled out) or to issue blanket waivers (India and perhaps China and Korea may receive very small and specific waivers), the options to cap the upside in oil prices this quarter are limited. Iran is not keen on a deal either.
The only way to balance the near-term market is for prices to go up sharply to ration demand, as price elasticity of Asian demand is positive, even when lagging prices to account for delayed consumers responses. It is income elasticity that matters. Undoubtedly, with higher oil prices and rising rates globally, a slowdown in growth is coming but with China embarking on a stimulus policy to support growth, market concerns about demand are premature. Similarly, worries about Q1 19 builds are unnecessary—stocks always rise in Q1. That won’t change the Q4 18 tightness.
|Freight rates, world scale||Asian demand growth vs price change, %|
|Source: Reuters, Energy Aspects||Source: Energy Aspects|