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Market Needs More Refined Products, Not Crude

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Governments plan to provide substantial volumes of crude oil to the global market from their strategic stockpiles to boost supplies and lower prices. But it's refined products that are really in short supply. Energy Intelligence takes a look below at the different conditions in the markets for crude oil and refined products.

Is the global market short of oil?

Crude oil futures have been trading at $100 per barrel or more for two months now. But those prices reflect the expectation that insufficient upstream investment will keep supply tight in the coming years. High prices provide an incentive for producers to invest more in upstream capacity. But relative prices are a better indication of the current state of supply. And those have seen a huge shift. Dated Brent — physical cargoes of Brent crude with a defined loading date — is now trading at a discount to the front-month Brent futures contract, having previously traded at a consistent premium since the start of the year. In April the front-month futures contract has been trading at an average premium of around $5.30 per barrel to the contract for oil to be delivered in six months, which is regarded as a geopolitical premium. But that is less than half of the corresponding $13.60/bbl average premium for March, when Russia's invasion of Ukraine dislocated crude flows. So some of the upward pressure on crude prices has abated, although high flat prices continue to draw attention. More importantly, however, prices for refined products are signaling huge shortages. Refiners are experiencing the most lucrative margins in at least a decade and are currently able to make $23/bbl by refining Brent in Europe.

Is this because of Russia's war in Ukraine?

Yes, the contrast between crude and products came into clearer focus after Russia's invasion of Ukraine in late February. During the first three weeks of April, Russia's crude exports from its European ports were actually 450,000 barrels per day higher than in February. The market had been expecting a steep decline. As a result, the spot crude market crude is comfortably supplied, in part because Russia has been selling crude at huge discounts of $20-$40/bbl. The supply outlook has also been boosted by the planned release of more than 300 million bbl from the strategic petroleum reserves of the US and other nations through October. But Russia's exports of refined products have fallen sharply and are down nearly 900,000 b/d from an exceptionally high level in February. Its April products exports are also down about 500,000 b/d from the average for the previous five months. That has had a big impact in Europe, in particular, that had been importing 1.4 million b/d of Russian products. Prices have shot up accordingly.

Wasn't the products market already tight before the war started?

Yes, the products market was already super tight. Going into the winter, demand for diesel and fuel oil had risen as a result of fuel switching triggered by high natural gas prices, especially in Europe and Asia. The market was spooked by the rise of the Omicron variant of Covid-19 in December, but soon shrugged it off. And although demand for products was strong during the winter, refiners in Europe and Asia didn't really ramp up their operations because their margins were not attractive enough at the time. So they continued to draw down their inventories of refined products. Inventory data confirm that the shortage is in products. In March, global commercial crude inventories rose by 15 million bbl but refined product inventories fell by 37 million bbl.

Are all products in short supply, or just some?

Refinery margins indicate that the market for diesel in particular is tight. A refiner making ultra-low-sulfur diesel can earn $38/bbl in Singapore, $50 in Europe and $60 in the US on an incremental barrel of crude throughput. Jet fuel makes even more money for refiners in Europe. Middle distillates have generally been impacted most, but other products are not far behind. Margins for gasoline and ultra-low-sulfur fuel oil are running at $20-$30/bbl and that is also unprecedented.

Where do we go from here? Can Opec-plus help?

The world must either increase the supply of products or slow down consumption. But increasing crude supply will have little impact because there is no shortage of crude — at least not for the time being. The issue is that refiners are not converting crude into refined products quickly enough. So it's understandable that Opec producers like Saudi Arabia and the United Arab Emirates are biding their time and resisting calls to step up their output of crude oil. Demand is already starting to slow down in response to higher prices, Covid-19 lockdowns in China, slower growth of the global economy and the collapse of Russia's GDP. The key question is, how much will demand contract? In the short term, refiners will emerge from spring maintenance closures and ramp up crude runs because they can make a lot of money at current margins. But it's unclear if that will supply the world with enough products for the coming summer. The prospects look better after the summer, when several new refineries are scheduled to come on line. This should alleviate the tightness in the products market by 2023. But that could coincide with the start of an economic recession that really puts a dent in global oil demand.

Topics:
Oil Futures and Derivatives, Oil Supply, Oil Demand, Oil Forecasts, Crude Oil, Oil Products, Refining
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