25 Sep The Saudi Oil Attacks
Saudi Oil Attacks: The Quality Angle
Recent attacks on Saudi Arabia have resulted in significant shifts in global crude qualities. Some of these shifts highlighted quality themes we’ve previously discussed in unexpected ways. The shifts also give us insight into the Kingdom’s situation, and may suggest a tighter market than many have estimated.
The crude grades immediately impacted by the attack were Arab Light and Arab Extra Light. These grades use the word “light” but are more often described as a medium sour grade – grades such as WTI are far too light to serve as a replacement. A more natural substitute is a Bonny Light or comparative grade, but limited volumes of these grades are available globally. Nigerian Bonny Light exports have also recently been under force majeure, further tightening the supply of these comparable grades.
Quality comparison of major crude grades – note Arab Light in the middle of the graph.
After the attacks, Saudi Arabia informed customers that they would still receive their crude deliveries. However, the Kingdom would substitute the impacted crude with heavier grades.
This substitution in the quality of deliveries hints at a few potential root causes:
- Stockpiles are lower than expected and/or production won’t return as quickly as verbalized. Saudi Arabia could be concerned about meeting demand from already reduced stockpiles. Saudi Arabia’s crude stockpile recently dipped below 200 million barrels due to production cuts, from 300 million only a few years ago. Since these crude levels are based on survey results, there is also the chance they are overestimated.
- Stockpiles contain unusable volumes. A 200 million barrel stockpile should be enough to provide contracted crude deliveries. Yet, as we’ve seen before, there are several considerations that limit usable barrels in crude inventories. First, line fill always makes inventories tighter than a headline number would suggest. You can’t run pipelines and tanks dry if you want to keep using them to meet demand. Second, there is also a quality mismatch between what is in storage and what the market needs. Finally, large long-term stored inventories develop quality concerns that limit their usability. These types of issues have already been reported in the US, with tainted SPR releases.
- Saudi Arabia is being prudent ahead of high-profile IPO. While the previous two options hint at a market far tighter than many expect it may also simply be a result of conservative business practices. Switching grades provides the Saudis with a buffer that makes it easier for them to meet customer demand without risking supply shocks in the future. This would be a prudent course of action as they aim to IPO.
Regardless of the root cause, one thing is clear. Switching grades will have significant near-term quality impacts as it adds to the global shortage of medium grades.
Saudi Oil Attacks: Effect on the Shanghai Crude Contract
Note: We discussed the Shanghai crude contact in an insight last year.
Last week, we observed the resilience of the Shanghai crude contract against forces primed to impact Asian crude buyers. The Shanghai crude oil contract launched in March 2018 and is yuan-denominated. The contract has held about 15% market share for the past year, which is an impressive number for a new contract. Its goal is to better meet the needs of Chinese crude purchasers and to help de-dollarize China’s commodity imports. Much of its success is due to its quality spec that well reflects the target grades of Chinese commercial buyers (32 API and 1.5% sulphur). However, this spec also mirrors the quality of Middle East imports affected by the Saudi attacks.
Despite the contract’s success, a key test for any financial instrument is how it reacts to a liquidity crisis like the Saudi attacks. For such a new contract, it wouldn’t have been surprising to see commercial entities return to more standard contracts. However, trading volume on the Shanghai crude contract increased by 54% this past week, along with the major contracts like Brent and WTI. This performance reinforces our view that the Chinese crude contract is here to stay due to its quality focus.