Asia's physical crude oil isn't as tight as Brent pricing suggests: Russell

The case for higher prices is largely built around a return of demand as the global coronavirus pandemic eases

  
Oil rigs in a storage facility wait to be transported to the oil field in Midland, Texas U.S. August 22, 2018.

Oil rigs in a storage facility wait to be transported to the oil field in Midland, Texas U.S. August 22, 2018.

REUTERS/Nick Oxford

LAUNCESTON, Australia- When a market gets behind a narrative it's tempting to discount factors that challenge the prevailing discourse, and this may be the case with the current bullish view on crude oil.

The case for higher prices is largely built around a return of demand as the global coronavirus pandemic eases, and ongoing supply restrictions by leading producer body, the Organization of the Petroleum Exporting Countries, and its allies in the group known as OPEC+.

But there are some factors, particularly in the world's top oil consuming and importing region of Asia, that might not be so bullish, especially for the second quarter.

There also seems to be something of a disconnect emerging between the strong pricing in the paper oil futures market, and the somewhat more subdued pricing in the physical crude market, especially for east of Suez cargoes.

Brent crude futures LCOc1 have rallied strongly in recent weeks, ending at $66.13 a barrel on Feb. 26, down slightly from a 13-month closing high of $67.04 on Feb. 24.

Bulls are happy to point to Brent futures' massive 247% rally from the 2020 closing low of $19.33, hit at the height of the pandemic lockdowns, but in doing so fail to contextualise the figures.

A huge rally in percentage terms was always likely after the equally massive 72% slump in prices between the 2020 high of $68.91 a barrel on Jan. 6 of that year, and the closing low of $19.33 on April 21.

What is fairer to say is that paper Brent is almost back to where it was before the pandemic struck, wiping out some 20% of global oil demand in a matter of weeks.

Much of the oil market analysis tends to focus on supply and inventory levels, particularly those in the United States, largely because in the past those have been the main factors that drove prices.

This dynamic was on display with the recent winter storms in Texas, where the market chose to focus on the loss of production as onshore wells were shut in by the weather, rather than the loss of demand as refineries also closed.

It will take a little while to sort out the real impact of the cold weather, but it's generally safe to assume that output may be quicker to return than refinery throughput, meaning crude stocks may build while product stocks decline.

The crude market is now focused on whether OPEC+ will ease its production cuts at a meeting on March 4, boosting supply to ease what is said to be a tight market.

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But is the market really that tight, especially for Asia

Certainly, the region's imports seem to be robust enough, with Refinitiv Oil Research estimating Asia's imports in February at the equivalent of 26.4 million barrels per day (bpd), up from an estimated 24.5 million bpd in January.

The start of 2021 has seen stronger demand from the end of last year, with Refinitiv figures showing Asia imported 23.2 million bpd in December and 24.0 million bpd in November.

However, delve a bit deeper into the numbers and it becomes clear that Chinese buying for delivery in the first two months of the year is a major factor.

Chinese refiners, especially independents, snapped up cargoes in November and December in anticipation of the (duly granted) crude import quotas for the new year, leading to strong arrivals at the start of 2021.

However, the question is whether this will be repeated in coming months, and there are several factors mitigating against ongoing strength in China's imports.

Firstly, peak refinery maintenance season is in March and April, to coincide with the historically softer demand in the shoulder period between winter and summer peaks.

Secondly, the strong arrivals for the first two months were secured at a time when global crude prices were still relatively weak, with Brent ranging between just below $40 to around $48 in October and November period.

Higher prices since then may discourage Chinese buying, especially since its also likely that both commercial and strategic crude stockpiles are near capacity, given the massive buying spree last year when crude prices dropped to the lowest in more than two decades.

Chinese refiners are already saying they aren't buying as much crude, with one source, quoted by Reuters, saying "demand is very slow and there are many available cargoes to choose from." 

This tallies with reports that some cargoes of Middle East crude grades for April- and May-loading are trading at discounts to official selling prices, and also that cargoes from West African producers are going unsold.

High crude prices will also work to suppress demand in price-sensitive markets such as India, Asia's second-biggest importer, which may cause an easing in imports just as they were recovering to pre-pandemic levels.

Overall, there appears to be a gap between the current bullish pricing of paper crude, and the somewhat more bearish signals of demand from Asia for physical crude for loading in the second quarter.

Clyde Russell

(Editing by Sam Holmes) ((clyde.russell@thomsonreuters.com)(+61 437 622 448)(Reuters Messaging: clyde.russell.thomsonreuters.com@reuters.net))