Maybe the Quality Problem Isn’t a Problem

Global crude qualities have shifted significantly in recent years. Global demand has shifted towards heavier crude while the makeup of global supply has shifted lighter. This global shift in crude quality supply is already impacting end markets. We are observing a near-term supply glut in gasoline while middle distillates are in deficit.

What has driven the supply changes?

The growth in US crude production has been primarily light, while OPEC cuts have focused on heavy production. OPEC heavy cuts have also been reinforced by large declines from traditional heavy oil producers such as Venezuela. Furthermore, Libya and Nigeria, two OPEC countries that produce primarily light sweet crude, were both exempt from previous cuts and have seen production increase significantly.

What do crude supply changes mean for the refined product market?

The shifting quality of the average global crude barrel is important because different quality barrels produce different end products when refined; processing additional light oil results in a higher yield of gasoline. However, global demand growth for refined products has been concentrated in the middle distillates, not gasoline. Middle distillates are produced from the mid-density crude and are used for freight, aviation, and shipping.

The risk associated with the growing supply of light oil inputs is that it may create a surplus of gasoline. This could reach the point that it distorts refining margins, even in spite of increased global demand for middle distillates. Global gasoline demand has changed significantly though, and the gasoline surplus could be coming at a time when the world is finally ready for it. Excess gasoline has always been better absorbed by consumers, who can respond faster to price changes than industrial users. Emerging market demand has recently shifted towards the consumer, which has increased the negative correlation of product demand to the price of crude. This now puts global consumers in a position to respond to the gasoline surplus, while also allowing the demand for middle distillates to drive growth at the same time. Overall, despite changing crude qualities, the market is well positioned to drive growth in hydrocarbons derived from heavier crudes while responding positively to gasoline surpluses.

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Mark Le Dain