The price spread of light to heavy sour crude has tightened in the last several months amid changes in market dynamics on the light crudes and also on the heavy sour crude side.
What are the various factors that have contributed to this and what are the potential lights at the end of the tunnel? Azlin Ahmad, crude markets editor for Asia-Pacific and Middle East based in Singapore, joins The Crude Report to discuss.
Jessica Tran: Hello, and welcome to the Argus Crude Report, a podcast series on global crude oil markets. I'm Jessica Tran for Argus Media.
Another oddity of 2020 has been the spread between light and heavy sour crudes. As we typically see a wider spread in favor of light crude, its heavy sour counterpart is a little bit closer, and to make matters more interesting, heavy sour crude prices have probably increased due to the light crude market dynamics.
Source: Argus Crude
With me today is our crude markets editor for Asia Pacific and Middle East based in Singapore, Azlin Ahmad. Thanks for joining the podcast, Azlin. It's great to have you.
Azlin Ahmad: Thanks for having me, Jessica.
Jessica: So, before we get into the pricing, can you quickly explain the difference between light crude and heavy sour crude? What different refined products do they typically yield?
Azlin: Well, the lighter crudes usually yield more of the lighter products, and mainly that would be things like gasoline and naphtha, and also gas oil or diesel, and jet and kerosene. So, and the heavier crudes would have a higher yield of fuel oil, high sulfur fuel oil or low sulfur fuel, depending on where the crudes come from.
Jessica: Okay. And this spread between the light and heavy sour crudes, that has been quite narrow this year. Why is that?
Azlin: I think the light-heavy sour crude spread has been narrow partly because of the lack of crude exports from Iran and Venezuela as the US sanctions led a lot of refineries globally to stop buying from these two producers on fears that there would be reprisals from the US. Iran and Venezuelan crude are mainly medium to heavier sour crudes. And so, their absence in the international market has tightened the supplies of heavier grades. The Opec+ output cuts have also to some extent heightened supplies because the Middle East Opec producers tend to cut more of their heavier crudes and try and maintain exports of their higher value lighter grades. So, the continued absence of Venezuela and Iran may keep the medium and heavy crude prices supported in the near term. Although in the coming year, the Opec+ groups plan to taper output cuts to about 5.76mn b/d in 2021 from 7.68mn b/d in August to December 2020 will at least help to ease the supply tightness because we could see producers like Saudi Arabia or possibly Kuwait, maybe ease up on their output cuts of their heavier grades.
Jessica: And we can't really have a conversation in 2020 without asking about Covid-19. How has that impacted the light-heavy crude spread?
Azlin: The pandemic has had an impact on the spread mainly because of the impact that it has had on the refined oil products. So, the lockdowns in many countries in Asia, in Europe, even in US, and the travel restrictions globally led to a collapse initially in gasoline and mainly in jet fuel because there was limited airline travel. So, this affected demand for these products, which, as we said before, comes mainly from the lighter crudes. And because of that, the prices of the lighter crudes came down quite a lot. Gasoline demand has started to rise because there has been more travel within countries at least, but the jet fuel demand is still under a lot of pressure because there is still very limited international travel. And so, the airline industry has been really been hit very badly by this Covid-19. So, while the heavier crude, the prices of these grades have strengthened because of the supply tightness, the demand for the lighter crudes, because of the products they yield, has started to come down.
So, these two factors have basically crunched the light-heavy crude spread. For example, if you look at Brent/Dubai EFS, which is the spread of the lighter, sweeter Ice Brent crude futures to medium sour Mideast Gulf Dubai benchmark crude swaps, in March this year, this spread flipped into a discount with Ice Brent prices below Dubai. And this was the first time in a decade that this has happened. And this was because of the weakness in the lighter crudes compared with the heavier crudes. And since March, this EFS spread has remained very narrow. And several times in the last few months, it has again flipped into a discount as the prices of the lighter crudes are struggling still to resume their more normal strength relative to the heavier grades.
Jessica: So, speaking of the lighter crudes, we all know that the US is a major light crude producer, how has US crude production played a part in this narrowing spread?
Azlin: Well, the US production has played a part in the sense that US production or US exports tend to be more of the lighter, sweeter crude like WTI, to a certain extent, back in. And so, although US production did see some declines in this year, US crude exports were still quite high because of lower US refinery runs. And as this lighter US crude, well, mainly WTI, flowed into the market, it kept the international market well supplied with lighter crude, even as the supplies of the heavier grades became tighter. So, in that sense, that aggravated the oversupply in the lighter crudes relative to the heavier crudes and put some pressure on that light-heavy spread.Jessica: Okay. So, looking more at the demand side, I understand that some Chinese refineries are undergoing expansions. Do these expansions change their crude appetite?
Azlin: I think it doesn't change their crude appetite so much, but the new refineries, specifically in China, they are quite sophisticated, and they are geared to refine more of the medium and heavy sour crudes. For example, the refinery Rongcheng is having an expansion capacity by the end of this year. So, presumably, their demand and hence China's demand as a whole for the heavier crudes should be increasing because that's what the refineries are geared to run.
Jessica: Okay. So, that's some good news. When do you think we'll see more normal pre-Covid-19 light-heavy crude spreads?
Azlin: I think it will depend a lot on how quickly global demand for jet fuel recovers, and that will hinge on a rebound in airline travel. So, as we discussed over the last five minutes or so, the supplies of the heavier crudes, we think that that should have some increase in the coming year if the Opec+ group does go forward and relax its output cuts, and this should widen that spread of lighter crudes over heavier crudes. But the actual demand for lighter crudes will only recover when refiners globally can make decent profits from running these lighter crudes. And that will, again, depend on the prices of jet fuel, how much they rebound, and all that could hinge on how quickly the airline sector recovers from the Covid-19 pandemic.
Jessica: Thanks so much for your insight and your time today, Azlin.
Azlin: Thank you, Jessica.
Jessica: For more information on Argus' crude pricing, news, and analysis, both globally and more specifically in Asia Pacific and the Middle East, consider subscribing to our Argus Crude service. You can find more information at www.argusmedia.com. Thanks for tuning in. And we look forward to you joining us on the next episode of The Crude Report.