Clyde Russell, Reuters
The great disruptor that is U.S. shale oil is coming to Asia as refiners in the energy-hungry region look to expand and diversify their sources of crude, and the consequences will likely go well beyond a shift in oil trade flows.
It should come as no surprise that rising oil output in the U.S. would find its way to the region that is the world’s fastest-growing consumer of the fuel, but perhaps the rapid pace of the shift has caught some in the market off-guard.
Crude oil exports to Asia from the U.S are still relatively small-scale, with Thomson Reuters Oil Research and Forecasts estimating flows of about 261,000 barrels per day (bbl/d) in the first eight months of the year.
However, this is about 10 times what they were in the same period last year. Major buyer China has gone from taking just one cargo of under 1 million barrels (MMbbl) in the January-August period in 2016 to buying about 115,000 bbl/d from the U.S. so far this year.
It’s also likely that U.S. shale oil exports will rise sharply in the next couple of years as production grows rapidly.
In one of the major U.S. shale plays, the Permian Basin, output is expected to surge to 2.9 MMbbl/d by next year from the current 2.4 MMbbl/d, Ryan Krogmeier, vice president of crude supply and trading at Chevron, told the S&P Global Platts Asia Pacific Petroleum Conference in Singapore on Sept. 25.
Much of this production will be exported as U.S. refiners along the Gulf Coast aren’t capable of processing more light crude, having been set up to deal more with heavier and sour grades from offshore Gulf of Mexico platforms and imports from the Middle East.
That leaves Asia as the clearing house for U.S. crude; however, there are several factors that must work together to ensure that U.S. crude does actually flow east.
The first, and most important, is that U.S. crude has to remain at a significant discount to similar grades, given the higher loading and shipping costs.
U.S. shale crude is largely priced against West Texas Intermediate (WTI), while the other light grades that typically move to Asia, such as crude from Angola and Nigeria, are priced against Brent, often described as the global benchmark.
The spread between the two grades has widened recently, with Brent closing at $59.02 a barrel on Sept. 25, a premium of $6.80 to the closing trade for WTI.
Effectively investors are taking the view that there is still surplus crude in the U.S., home of WTI, while the market for Brent is starting to tighten as efforts by OPEC and allied producers start to drain global inventories.
WTI Discount To Remain
The current discount of WTI certainly makes it profitable for traders to ship U.S. crude to Asia. If enough cargoes are booked, it should in theory boost the price of WTI relative to Brent. However, there is a limit to how much WTI can rise relative to Brent before sending U.S. crude to the East is no longer economically viable.
Estimating that level is obviously an inexact science, but it’s worth noting that the two biggest months for U.S. crude arrivals in Asia this year were April and June. In both cases, the discount of WTI to Brent was wider about six to eight weeks ahead of those months, suggesting that traders need a gap of about $5/bbl to make the trade profitable. This implies that WTI will have to remain in a structural discount to Brent is order to clear rising U.S. crude supplies.
Of course, this level is far from fixed or permanent. It could easily be lower in coming years as the U.S. builds out infrastructure that would allow for crude exports to be loaded directly onto the largest oil tankers, rather than medium-sized carriers as is currently the case at many export ports.
The other major implication is that WTI is going to become considerably more important in pricing decisions among Asia crude buyers.
If Asian refiners seeking light crudes can buy at prices linked to WTI, this may be far more attractive than looking at crudes priced against Brent. This could mean that producers who use Brent as a benchmark will have to offer greater discounts to compete in Asia against U.S. crudes.
While WTI would have a long way to go before supplanting Brent as the global benchmark, it may well make inroads in Asia and become more attractive to market participants in the region as a tool for hedging and price discovery.
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