Market Disruptions and Quality Shifts

As crude quality becomes increasingly important, key risks to reliable product supply are market events that affect quality, rather than simply volume. Changes in crude quality supply expectations are happening more and more regularly due to heightened regulatory and social shifts, along with the ever-present geological surprises. These frictions across the global supply chain create economic, social and environmental risks. 

Maintaining supply of the same end products to consumers while upstream quality is in flux can mean more transportation and blending. This can lead to significant price impacts on grades and products to incentivize supply and demand shifts. In the last several weeks there have been multiple events, with an array of causes, that have impacted the supply of several specific qualities. We felt an end of year review of a few examples of these events would be valuable.  

California Drilling Ban (Regulatory):

In California, Gov. Gavin Newsom halted the approval of hydraulic fracturing in the state until the permits can be reviewed by an independent panel. A moratorium was also introduced on new permits for steam-injected oil drilling. While some production approaches are exempt from both of the new regulations, a significant amount of future production will be impacted. The California regulations are especially impactful due to the uniquely heavy crude quality in the State. For example, at the Kern field in California, the API gravity is ~13º and sulfur content is 1.02%. The supply shift caused by these regulations will require refineries to import crudes to replace the missing qualities in their desired crude slate.

Guyana Field Quality Risks (Geological):

Guyana has long remained a bright spot in global crude supply with expectations of significant supply growth. However, this changed in November when it was reported that key fields in the country contain heavier grades with high sulphur content. This type of finding can signal a gap in expected light oil supply. Moreover, the presence of high sulphur heavies can also signal a reduction in supply in general. It is often more difficult to produce and transport heavy sour grades, and the negative economic impact of these challenges can reduce the total volumes developed. This impact could easily be isolated to some of the smaller fields, but it is a good reminder of quality risks associated with new discoveries (and the advantage of being prepared to respond to them quickly).

Upheaval in South America (Social):

Heavy crude supplies from South America continue to plummet due to unrest in Venezuela. Canadian heavy crudes have not replaced these crudes to the extent possible due to pipeline delays out of the country. To fill this gap, US refiners significantly increased the imports of Colombian crudes, particularly unique heavy sweet grades which are a good fit for IMO 2020 product requirements (credit to Anas Alhaji who flagged this). However, recently marches have begun in Colombia in opposition to the government. These marches need to be closely monitored as Columbia represents a key wedge of remaining heavy supply that could now be at risk. These protests have continued for several days but have yet to impact oil production. However, in an effort to combat the protests, the president of Colombia has offered costly reforms to appeal to the protestors (particularly tax breaks on the lowest incomes). To raise these funds, the government is planning to issue a special dividend of $1.1 billion from state-controlled Ecopetrol. While the dividend shouldn’t impair the company financially, it is important to note that when governments have to put significant financial pressure on state-controlled oil companies, it will typically have a negative impact on production projections in the future. 

Mark Le Dain

Mark Le Dain currently runs strategy for Validere and previously worked as an energy investment banker. Mark has significant experience advising energy and infrastructure companies, successfully completing over $18 billion of M&A transactions and $5 billion of capital markets transactions.
Mark Le Dain