Viewpoint: Med sour crude availabilities to dwindle

Supply of Mediterranean sour crude to Europe will remain tight in the first half of 2019, as a result of the renewed Opec and non-Opec production deal, lower Iraqi allocations and US sanctions against Iran.

Opec and non-Opec producers in early December agreed to remove 1.2mn b/d of output in the first half of 2019 to curtail global inventories. Opec producers will lower total production by 800,000 b/d, with most members assigned cuts of 2-3pc from an October 2018 baseline, as assessed by secondary sources, including Argus.

Iran — along with Libya and Venezuela — received an exemption from the output cut deal, but supplies from the country are likely to dwindle further in 2019, as its oil sector has to contend with unilateral US commercial sanctions that came into effect on 5 November.

Iranian crude loadings bound for northwest Europe and the Mediterranean averaged 619,000 b/d in the first nine months of the year, down from 749,000 b/d in full-year 2017. The White House granted waivers to eight countries — including Italy, Greece and Turkey — allowing them to continue buying Iranian oil for six months ending in early May. European buyers are typically drawn to Iranian supplies because of their more favourable official price formulas, compared with rival volumes from Saudi Arabia, Iraq and Kuwait. But the pricing appeal may well fail to offset the effect of US sanctions on Tehran, which will leave Mediterranean buyers struggling to strike the shipping and financing arrangements to import supplies.

And, further down the line, it is unclear whether the White House will be amenable to extending its waivers past their initial expiry in early May, or whether the same countries will be exempted. The US administration has vowed to take Iranian exports to zero, but simultaneously seeks to avoid a drive-up in US gasoline prices that a shortage of crude could prompt. External market conditions could weigh more firmly on the White House's final decision on additional waivers than its political position against Tehran.

Saudi and Iraqi supplies are unlikely to offer much relief for Mediterranean sour crude requirements in the first half of next year. Saudi Arabia shouldered the lion's share of output cuts under the November 2016 production deal and championed the new deal in December. The kingdom's oil minister Khalid al-Falih said Saudi production would drop to 10.2mn b/d in January, implying a fall of 400,000 b/d from the 10.62mn b/d October baseline.

In addition to reducing supplies, Saudi Arabia has also shifted its marketing focus towards the Asia-Pacific region. It seeks to become China's main crude supplier and boost sales to the country by 500,000-600,000 b/d next year, although market participants indicate that most of this additional volume could be compensated by lower supplies to the Americas. This would leave European allocations for 2019 at a lighter risk of cuts.

Mediterranean-bound volumes from Iraq are likely to be limited in the first half of 2019, as cuts in Basrah term allocations are set to exceed prospectively higher Kirkuk exports. At least four European buyers of Iraqi crude were not extended term supplies in 2019, while eight regional customers had their allocations reduced by up to 50pc. A minimum of six European buyers had the volumes of their 2018 contracts left unchanged, and just two Mediterranean buyers of Iraqi crude havee so far benefited from hikes in their Basrah allocations for next year. But Iraq Petroleum Trading (IPT) — previously known as Lima, a joint venture between Iraqi state marketer Somo and Russia's Litasco — might be designated higher destination-free Basrah volumes in 2019, which could make their way into the Mediterranean.

Somo's decision to reduce European allocations comes after the company said it will send 67pc of its export availabilities to the Asia-Pacific region next year, with 20pc assigned to Europe and the remaining 13pc to the US. Combined Basrah loadings that sailed to northwest Europe and the Mediterranean averaged 22pc in January-November of this year, according to Argus tracking data.

The call to cut European allocations may be a result of Somo's recent campaign to crack down on contractually-banned resales of its Basrah crude. The company in October notified some European and Asia-Pacific clients regarding crude that had been allegedly re-traded. A firmer enforcement of the ban against resales could see the Basrah spot trade dwindle in the Mediterranean market, barring free-destination or equity barrels. Volumes that are free-destination can be sold to any location on a spot basis.

Iraq could increase exports of Kirkuk crude, after Somo and the Kurdistan Regional Government (KRG) in November struck a deal that led Somo to resume flows through the Iraq-Ceyhan pipeline and receive a weekly 600,000 bl of Kirkuk in its storage tanks at the Turkish port of Ceyhan.

Somo had sent four 260,000 bl lots of Kirkuk to Turkish refiner Tupras' 113,400 b/d Kirikkale refinery by pipeline by mid-December with another scheduled, and on 11 December exported its first seaborne cargo of Kirkuk in two years, with two more scheduled.

It is not yet clear whether Somo will consistently allocate Kirkuk to its contractual buyers in 2019, or whether it will tender out its availabilities, as it did with the three cargoes loading in December. Some European buyers could turn to Somo-marketed Kirkuk, after shying from KRG volumes of the grade in the past to avoid putting their Basrah contracts at risk. Somo has in the past frowned on its clients buying KRG supplies.

While Somo issues official formula prices for both European and US destinations, Kirkuk crude — whether sold by the Iraqi state marketer or by the KRG — has overwhelmingly stayed in the Mediterranean.

Meanwhile, regional light-sweet supplies are likely to hold steady or record a slight increase, despite potential output outages. Libya has retained its exemption from production cuts as part of the renegotiated Opec and non-Opec deal, but its output remains curbed by frequent disruptions as a result of armed clashes and infrastructural collapse.

Libyan production drops are often sharp but short-lived, and the country has succeeded in raising its production to 960,000 b/d over January-November this year, from 810,000 b/d last year amid volatility, according to Argus data. Libyan output — which primarily stays in the Mediterranean — is likely to continue adding to regional light-sweet availabilities in the first half of next year, particularly as the country's state-owned NOC remains committed to raising Libya's production capacity to 2mn b/d within four years.

Fellow Opec member Algeria is likely to carry on providing a more stable alternative of light-sweet crude to the Mediterranean market. Much of Algeria's flagship grade Saharan Blend stays in Europe, with a combined 312,000 b/d bound for the region over January-November this year — accounting for an average of 56pc of Algerian exports.

Algeria's state-owned Sonatrach's recent steps to set up a marketing joint venture could reshape its approach to its crude sales, which have so far largely taken place on a term basis.

Algeria's production is unlikely to pick up significantly in the first half of the year. The country has once again stalled until the end of next July a critical legislative revision that could broaden foreign investment interest into Algeria. The law will likely still include a mandatory 51:49pc shareholding split between Sonatrach and foreign partners, which has in the past has deterred some investors.