European crude buyers bring fresh issues to term talks

European refiners have entered negotiations for next year's term contracts for Saudi and Iraqi crude with a new set of concerns over official formula prices, availability and the allocation process. But the reliability of supplies from Opec's two biggest producers combined with a lack of sour crude alternatives is likely to see intake unchanged from this year.

The deadline for European and Mediterranean refiners to submit their 2021 requirements to Iraq's state-owned marketer Somo was 15 October, while state-controlled Saudi Aramco has a later deadline of 30 October, according to traders. Buyers operate "evergreen" contracts that are automatically renewed each year and are difficult to regain if they are dissolved. Some opt for talks ahead of submitting their requirements.

Contracts usually specify buyers' total yearly volume, preferred grades, any fixed monthly requirements and the exact refinery or regional destination. Refiners make monthly nominations within the yearly contract specifications, paying the official Saudi or Iraqi formula price for each loading month. Traders expect Aramco and Somo to review plans for yearly term supplies by late November.

Fresh concerns have surfaced among European customers for this year's term negotiations. Refiners say the overall margin of running sour crude remains slim when factoring in the cracks of all product yields — particularly weak gasoline and diesel. This is despite an improvement in margins of high-sulphur fuel oil (HSFO) which sour crudes are rich in. HSFO crack spreads averaged a $9.94/bl discount to front-month Ice Brent futures in January-September, compared with a $12.83/bl discount across the whole of 2019.

Another concern is the allocation process. Some Iraqi term buyers have had their monthly allocations cut this year as Baghdad strives to compensate for producing above its Opec+ quota in the first few months of the latest output restraint deal. Argus tracking shows exports of Iraqi Basrah Light and Heavy to Europe and the Mediterranean averaged 554,000 b/d in January-May, but fell to 345,000 b/d in June-September. Opec+ cuts have also weighed on Saudi Arabia's westbound crude exports, which dropped to 1.05mn b/d in May-September from 1.92mn b/d in January-April. Saudi contracts include a clause that allows Aramco to tighten allocations under certain circumstances such as Opec+ production restraints, according to a Saudi source.

As of April, Aramco and Somo have also limited freight subsidies for their western clients to at most 10pc of the cargo value. The subsidy is designed to increase the appeal of picking up crude from Saudi Arabia's Ras Tanura port or Iraq's Basrah Oil Terminal to refiners outside the two producers' core Asian markets. Somo's clients have been more impacted by this as Aramco's European customers primarily load from Sidi Kerir in Egypt or from storage in Rotterdam.

Sour power

Still, market sources do not expect these issues to prompt any significant changes in European buyers' 2021 term contracts, partly because of the lack of sour crude alternatives. Even if Democratic candidate Joe Biden wins the US presidential election in November and softens sanctions against Tehran, Iranian supplies may not return to the market until the fourth quarter of next year, according to some traders. Iranian marketer NIOC is understood to have crude available in floating storage but getting it to market will not be straightforward. Banks may delay issuing letters of credit — which will be required if NIOC does not offer open credit or deferred payment — until they are fully acquainted with post-sanctions legislation, while buyers could struggle to broker freight or insurance arrangements.

Regional sour crude is also scarce. Exports of Russian Urals and Siberian Light are on course to average just 1.21mn b/d in May-October, compared with 2.08mn b/d in January-April. Shipments of Iraqi Kirkuk blend marketed by the Kurdistan Regional Government dropped by 4pc on the year to 417,000 b/d in January-September. And while new North Sea grade Johan Sverdrup has gained favour with Mediterranean refiners — particularly in Turkey — it is too too light and sweet for some buyers in the region.

By Ruxandra Iordache