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Micro-balances will drive crude movements in the months ahead, even as weaker refinery margins, demand uncertainties from the trade war, and the upcoming IMO 2020 implementation will be in the driver’s seat for now. The key change in H2 19 will be the expected surge in US production at a time when local refinery kits have reached maximum light processing capacity. The US will have to deal with an oversupplied market and further boost exports. With Europe’s maximum appetite for US light crude imports somewhere around 1.4 mb/d, the US will need to bolster flows to Asia to ensure that exports over 3.2 mb/d for the nation can be sustained. Korea, India, Thailand and Taiwan have already stepped up US takes and even China has shown interest in USGC grades lately despite the trade conflict. US crudes to Canada will hit record highs and even movements into Latin America will have to increase.
According to our calculations, despite the steep backwardation in Brent, the US export arb is open to Europe and the Mediterranean, but the arb is borderline to Asia after the recent drop in prices there. Maya, Basrah and Castilla have all been attractive into the USGC as an alternative to Mars, especially with lower supplies of Venezuelan, Mexican and Brazilian crude due to sanctions, unforgiving field declines and unit maintenance, respectively.
The Russian organic chloride contamination issue in Europe has been underestimated by many and it has significantly affected flows into and out of the region. As on-specification Urals supplies plummeted, European refiners turned to clean Urals via ship and North Sea grades as the nearest substitutes, boosting local differentials and opening the arbitrage for US crude into the region. At least three VLCCs of Forties will leave for Asia in June but even with the renewal of the Free Trade Agreement with South Korea, the North Sea arb to Asia is shut given the strength in Dated Brent. However, unplanned refinery issues at Grangemouth and at Fos, partial relief on the Druzhba pipeline and the growing overhang of West African barrels should weigh on the North Sea price complex and potentially reopen the arbitrage east, especially if weaker Middle Eastern OSPs into Europe entices refiners to switch away from local grades.
Indeed, Angolan grades have recently fallen by $0.60 per barrel to $1 per barrel over Dated Brent as Chinese demand has waned, with 10-12 July loading cargoes currently unsold even as the August programme has just been released. Similarly, while Nigerian differentials were strong earlier in the cycle, a growing overhang of 30-35 unsold cargoes across the June and July programmes are weighing on differentials. Once differentials have adjusted lower, we expect to see more West African barrels swing to Europe unless Chinese buying picks up.
Middle Eastern OSPs into Asia are stronger across Saudi Arabia, Iraq and Kuwait. A pause in Chinese buying—after procuring a large volume of Iranian crude in April before sanctions expiry—alongside refinery run cuts in Asia are also weighing on differentials there. Yet sour grades such as Maya and Castilla are still attractive in the east. Even Mars is borderline open as Iranian exports have effectively plummeted to less than 0.1 mb/d.