Physical oil market warns price rout might not be over

Concerns come from less transparent trading activity in crude oil and other product markets

As Opec watches a near 15 per cent drop in the oil price in three weeks, important indicators in the physical crude market are flashing worrying signals that the decline might be far from over.

The concerns come not from the heavily traded futures market, but from less transparent trading activity in crude oil and other products markets, where key US, European and Russian crude prices have fallen of late, suggesting less robust demand.

Benchmark oil futures have plunged in recent days together with global stock markets due to concerns over inflation as well as renewed fears that rapid output increases out of United States will flood the market with more crude this year. Opec, including its Secretary General Mohammad Barkindo, argue the decline is just a blip because demand is exceeding supply and will guarantee prices won’t plunge again to $30 (Dh110) per barrel as they did in 2015 and 2016.

Traditionally, when oil futures decline, prices in the physical markets tend to rise because crude is becoming cheaper and hence more attractive to refiners.

But in the past weeks, differentials in key European and US markets such as North Sea Forties, Russia’s Urals, West Texas Intermediate in Midland, Saudi Arabia will restrain its oil exports in March despite lower domestic need for crude as Opec’s leader is pushing to eliminate fully the global oil glut and combat worries about a new cycle of oil price weakness.

The Saudi energy ministry said production by state oil company Aramco in March will be 100,000 barrels per day (bpd) below February’s level. Crude exports will be kept below 7 million bpd in March, despite a shutdown for maintenance of the 400,000 bpd SAMREF refinery, the ministry said.

“Saudi Arabia remains focused on working down excess oil inventories,” a ministry spokesman said in a statement.

“Market volatility is a common concern for producers and consumers, and the Kingdom is committed to mitigating this volatility and moderating its negative impacts by responsibly meeting its pledges” under the Opec-led deal.

The Organisation of Petroleum Exporting Countries is reducing output by 1.8 million barrels per day until the end of 2018 as part of a deal with Russia and other non-members to get rid of a supply glut. Texas, or the Atlantic diesel market have all fallen to multimonth lows.

The reasons tend to be different for most physical grades but overall the trend paints a bearish picture.

“Physical markets do not lie. If regional areas of oversupply cannot find pockets of demand, prices will decline,” said Michael Tran from RBC Capital Markets.

Looser fundamentals

“Atlantic Basin crudes are the barometer for the health of the global oil market since the region is the first to reflect looser fundamentals. Struggling North Sea physical crudes like Brent, Forties, and Ekofisk suggest that barrels are having difficulty finding buyers,” he added.

This follows the run-up in US production to daily output of 10.04 million bpd as of November, highest since 1970, pushing it into second place among crude producers, ahead of Saudi Arabia and trailing only Russia, according to the US Department of Energy.

On Tuesday, the Paris-based International Energy Agency said increased US supply could cause output to exceed demand globally in 2018.

Forties crude differentials to dated Brent have fallen to minus 70 cents, down from a premium of 75 cents at the start of the year as the Forties pipeline returned to normal operation.

The Forties differentials are now not far off their lowest since the middle of 2017, when the benchmark Brent crude price was trading at around $45 per barrel compared to $62 per barrel now and $71 per barrel just a few weeks ago.

In the United States, key grades traded in Texas and Louisiana have fallen to their lowest in several months.