IP week(ly): Paradoxical inversion

Published at 12:12 4 Mar 2019 by . Last edited 11:18 22 Aug 2019.

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IP week was dominated by talk about crude quality, specifically the dearth of heavy, medium sour crudes and the deluge of naphtha-rich light crudes. The tightness has been exacerbated by Venezuelan output declines, as well as sharply lower Mexican and Brazilian heavy output. And with Saudi Arabia tying up its heavy crudes in new joint venture refineries, no incremental heavy crude is available until the Neutral Zone returns, which may not be till year-end.

Heavy sour crude market tightness is unlikely to get a respite anytime soon, and even though heavies have already risen sharply (so they are likely to consolidate), structurally, we remain constructive through the summer after which the effects of IMO 2020 should weigh on their values. So, while we believe Brent-Dubai has narrowed enough for now, the spread is likely to invert in Q2 19 as refineries return from works and new sour crude refineries ramp up.

Overall, we believe that there is perhaps a month or two of softness in the physical market ahead as China slows its buying having overbought and global refinery maintenance is underway, but we see the market tightening once we start trading June barrels. Once inventories of sour crudes have been exhausted, that will pull light crude stocks lower too, supporting Brent spreads.

Fears from Q4 18 linger on and there is still uncertainty over US supply, whether Saudi will truly stand up to Trump, and what the demand trajectories will be. Without clarity on these, conviction may be absent for now. But the supply side this year is going to be much more challenging, with plenty of downside risks. With inventories failing to build materially in Q1 19, the enormous crude quality mismatch and constructive diesel markets, the H2 19 set up for crude is appealing.

Mexican oil output, mb/d Asia refinery runs ex China, y/y, mb/d
Mexican oil output Asia refinery runs ex China
Source: Pemex, Energy Aspects Source: Energy Aspects

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