Saudi Arabia faces a pricing dilemma between supporting prices in line with the Opec+ historical deal to cut output and ensuring there is enough buying interest for the kingdom’s crude oil in an environment of dismal demand.
Aramco’s latest official selling prices suggest it has chosen to prioritise market share in the key Asia-Pacific region, entrenching the price war that emerged after the collapse of last month’s Opec+ meeting.
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Transcript
Hello everyone, I am Alejandro Barbajosa, VP for crude in Asia-Pacific and the Middle East at Argus, and I would like to welcome you all to the fifth episode of our coronavirus podcast series, where we discuss the impact of the pandemic on Asian oil markets. Today, we will address how Saudi Arabia is intensifying efforts to ensure its crude remains the most competitive in Asia-Pacific.
President Trump, President Putin and King Salman all had something to boast about after the 12 April Opec+ agreement to withdraw close to 10mn b/d from the global oil market. But the slump in demand triggered by the coronavirus pandemic dwarfs any supply management efforts and the accord masks a crude reality: physical prices of the commodity remain under immense pressure and the so-called price war kicked off by Saudi Arabia and Russia last month is returning with a vengeance.
Saudi Arabia and other Middle Eastern and west African oil producers use official selling prices, also known by their acronym of OSPs, as a tool to regulate how attractive they want to make their crude supplies to term buyers across different regions each month. These are typically premiums or discounts relative to widely-used benchmark prices, which national oil companies (NOCs) fine-tune based on the prevailing balance between supply and demand for individual crude streams. This market-based approach is usually devoid of political influence. NOCs routinely follow well-known methodologies to set the differentials, based on the degree of urgency for prompt supplies, changes in refining margins and variations in spot differentials for competing grades. But at times of crisis, such as today’s unprecedented global decline in transport fuel consumption, new dynamics are at play.
Refiners of Middle Eastern crude across Asia are desperately seeking ways to defer term purchasing commitments as they cut processing rates. This has raised a widespread concern among producers about security of demand. In order to ensure that there is a market for their crude, NOCs are scrambling to adapt their pricing mechanisms to dismal demand in times of pandemic. A good example is how Abu Dhabi’s Adnoc in a matter of days swapped a decades-old retrospective OSP system that had been under review for several years, for a prospective approach to give clients better visibility of how Abu Dhabi crude compares in value with competing Middle Eastern grades. And the marker they adopted wasn’t their yet-to-be-launched and preferred Murban futures contract, scheduled for listing on the Ice exchange later this year. It was the Dubai benchmark, used by Saudi Arabia, Iraq, Kuwait, Iran and Qatar in conjunction with the Oman benchmark for crude sales to Asia.
And it was last week’s unexpected Opec+ agreement that set in motion one of the most challenging oil pricing choices ever faced by any producer: a potential rollover or pullback in record OSP discounts Saudi Aramco offered for cargoes loading in April, following the spirit of the Opec+ pact seeking a rebound in futures prices, or yet another dramatic slashing of differentials for May-loading cargoes to ensure Asian buyers would reconsider any opportunities and available capacity to push crude into storage, commercial or strategic.
The difference between one loading period and the next: an expected decline of almost 4mn b/d in Saudi crude output from April to May that under normal circumstances would have all but guaranteed stronger OSPs, or at least little change, in line with the signal sent by the Dubai market structure. Front-month Dubai swaps averaged a discount of about $3/bl relative to third-month swaps in March, similar to the $3.10/bl discount that Aramco offered to Asian clients for April-loading cargoes.
Despite the abrupt about-face in Saudi oil production policy, the kingdom doubled down on its market-share strategy, deepening the discount for Arab Light to $7.30/bl for May-loading cargoes, and potentially pre-empting Middle Eastern crude markets into a downward spiral in the absence of a long-lasting demand recovery. More than actively waging a price war, the world’s largest oil producers are fighting for survival, just a month after Opec+ failed to agree on output cuts in their previous ordinary meeting.
In a symbolic move, Aramco marginally increased the OSPs for Saudi grades to the US market for May, a token of appreciation for President Trump’s personal involvement in concluding the Opec+ agreement. But in fact, that may also have been a market-based decision to stave off the flow of US Mars crude to China, which directly competes with Saudi grades across Asia. By raising prices to the US and sharply reducing them to Asia, Aramco aims to redirect Saudi supplies away from a locally oversupplied market at the US Gulf coast to the only market where there is hope for a speedier demand recovery led by China. While the Saudis welcomed the Trump administration’s initiative for renewed Opec+ cooperation, Aramco’s aggressive pricing strategy makes it clear that Atlantic basin barrels are unwelcome in Asia.
As I have mentioned before, you can access more timely news and analysis on this topic through our Argus Crude market services and we also have a special page dedicated to the effects of the Covid-19 outbreak across all commodity markets on our Argus website at www.argusmedia.com/coronavirus. We will also be holding a webinar next week where we will discuss these topics for further information. Thank you for listening and goodbye.