Oil Market Update – Venezuela Accelerates Crude’s Quality Problem

In our 2019-2020 Oil Outlook, we asked the question , “does the global market want light sweet shale oil?” On the evidence of the increasing volumes exported from the Gulf Coast to Europe (up 0.2mn b/d yoy in Dec18) and Asia (up 0.6mn b/d yoy over the same period) the answer would be a resounding yes. However, we argue that imports have increased due to a lack of alternatives, with medium-heavy sour production curtailed by a combination of planned (Alberta, OPEC) and unplanned (Venezuela, Iran) outages. The replacement of medium-heavy sour barrels with light sweets has had numerous impacts through the first quarter of 2019, including: -Dubai trading flat to premium vs Brent -Weak WTI structure compared to Brent -Urals strength in European markets, parity to Brent -Very weak light ends cracks in most refining markets With refinery upgrades biased towards medium-heavy sours and consumption trends favouring diesel over gasoline, US shale is increasingly out of place despite becoming the market’s go-to “replacement barrel.” IMO 2020 will turn these trends on their head, with low-sulphur US crudes likely bid as the market penalises the sulphur content of refinery inputs and finished products. We consider this a short-term trend however with the market likely finding equilibrium at above consensus scrubber penetration and incentivised HSFO upgrading, both of which will put a floor under HSFO cracks and diminish the sulphur penalty (and consequently the low-sulphur advantage). In the longer term, US grades will need to remain discount to price into global markets, with these discounts eventually reaching shut-in levels if consumption trends remain the same ( implying stagnant light-ends demand ) . The long-term beneficiary will be OPEC . The cartel’s medium-sour production (and abundant reserves) fits well with both current consumer trends and increasing refinery complexity.