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The prompt Brent spread collapsed spectacularly last week, largely driven by a bear play but also due to much-publicised fundamental factors such as the PES closure backing out 20 mb of crude and heavy European refinery maintenance in September and October. But beyond the prompt spread, the backwardation in the Brent curve has steepened just as the physical market has started to perk up again, led by a recovery in East of Suez demand. Apart from an overhang in some Nigerian and North Sea cargoes, the physical market has cleaned up in just three weeks.
Despite deferred Brent spreads strengthening, we still believe they are under-priced. Regardless of the quality issues with Forties and the upcoming Dated Brent contract change, Brent spreads should be more backwardated than Dubai going into IMO 2020 as Middle Eastern crudes contain more sulphur than Forties. Right now, Dubai spreads are possibly benefitting from positioning ahead of the Pemex hedging, as Pemex has allegedly swapped Dubai for fuel oil in its formula.
So, we expect Q4 19 Brent-Dubai spreads to widen. But WTI-Brent may not narrow in Q4 19 given the recent weakening in WTI-Midland differentials amid refinery outages and unsubstantiated rumours about Permian pipeline delays. Cushing stocks may not fall below 30 mb by year-end.
Beyond the micro factors, global demand concerns are the main driver of oil markets right now. Supply losses and the continuing decline in global crude stocks (US, ARA and Japan crude stocks fell by 16.5 mb last week and by 47 mb since early June) will put a floor under prices and spreads, but without a boost in demand, Brent is likely to wallow in relatively shallow backwardation. There are early signs that Chinese demand may be improving but we need more data to know decisively.
|Fig 1: US+Japan+ARA crude stock change, mb||Fig 2: WTI-Cushing - WTI-Midland spread, $/bbl|
|Source: EIA, PAJ, Bloomberg, Energy Aspects||Source: Argus Media Group, Energy Aspects|