Saudi Arabia is favoring Asian customers over those in US and Europe, with pricing of Arab Light crude becoming more favorable for Asia, Bank of America Merrill Lynch said in a report on Sunday.
Following the deal between OPEC and non-OPEC members to trim production in December last year, Saudi Arabia “made it clear to its customers that it would cut supply of medium/heavy barrels but would continue to sell its light grades,” the report said.
“As such, it comes as no surprise that US imports from the Kingdom, which are typically medium to heavy grades, have slowed substantially over the past five months,” the lender added.
Meanwhile, the top oil exporter’s pricing of Arab Light has favored Asia over the US and Europe. Since January, the discount on the crude grade to Europe has narrowed, while the Arab Light premium to US has widened.
The price differential to Asia, on the other hand, has gone from +0.45$/bbl last December (pre-deal) to -0.45$/bbl for the upcoming month.
“It seems relatively clear that Saudi views Asia as the short, medium and long-term source of growing demand for oil. As such, when oil enters a bear market, the Kingdom tries to maintain or even increase its Asian market share by reducing its Arab light grade premium to regional benchmarks,” BofAML said.
On the other hand, in a higher price environment, Saudi Arabia upgrades its pricing to Asian benchmarks as fundamentals in the region are usually tight, the report said, adding that the Arab light crude differential to Asia and crude oil prices are well correlated.
“Perhaps more interestingly, we find that most of the impact of a change in Saudi pricing on WTI or Brent price level occurs two months later,” the lender said.
OPEC and non-OPEC oil producers’ December deal to cut output by a combined 1.8 million barrels per day (bpd) has failed to cut global inventories so far, but has had a meaningful impact on crude grade differentials across the world, with light-heavy crude spreads tightening substantially over H1 2017.
The narrowing spread came as countries in the agreement favored cutting medium to heavy grades over light, in order to maximize revenues in a low oil price environment.
Meanwhile, production from US shale oil – one of the world’s lightest crude grades – started to rise again, partly driven by the gradual recovery in crude prices post the OPEC deal.
BofAML sees the spread eventually widening again, driven by two possible scenarios: the first is if OPEC manages to convince Libya and Nigeria to comply with output cuts, and the second is when output from the two countries reaches a ceiling later this year.
A third scenario would be another geopolitical crisis in Libya or Nigeria, forcing major disruptions of light sweet output again.
In all three cases, the outcome would be the Saudi heavy/light grade price ration widening again, eventually reaching averages seen in 2015-16.
Moreover, after the OPEC/non-OPEC deal expires in March next year, Saudi and Russian production of mostly medium grades is expected to pick up gradually again throughout the rest of 2018.
“The Brent-Dubai spread could widen structurally as early as the end of the year as Saudi and Russian output increases and US shale output stabilization looms,” BofAML concluded.
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