Weak product cracks, arb barrels to cap extent of Middle East crude OSP hikes: sources
Middle East crude producers, including regional leader Saudi Arabia, are expected to raise slightly the official selling prices of their respective crude grades, as a persistently wide Brent/Dubai structure and backwardation in Dubai create some room for upward adjustments to prices, trade sources told S&P Global Platts.
However, the sour crude complex continues to face headwinds from an oversupply of affordable arbitrage cargoes from other regions, such as West Africa, as well as flailing refined product cracks for all but gasoline, which may cap the hike in OSPs, they said.
“Based on the market structure alone, lighter crudes such as Arab Light should see a hike of 50 cents/b. However, I expect they will not increase all the way… [we could see] increases [of] about 30-40 cents for lighter grades, and the same or more for heavier grades,” said a trader with a North Asian refinery.
The cash Dubai premium over same-month Dubai futures spread — understood to be a key element in OSP calculations — rose to an average of $1.19/b in March, up from a 69 cents/b average in February, Platts data showed.
OSP decisions will also rely on the outcome of the OPEC+ alliance’s upcoming April 1 meeting, as production quota decisions made in the meeting will shape the supply fundamentals for sour crude, sources said.
A rollover of production cuts, including Saudi Arabia’s voluntary cuts, is generally expected by the market, amid a resurgence of COVID-19 in some countries, which highlights the fragility of demand recovery, as well as a softening of flat prices in the second half of March.
Market participants surveyed by Platts expect OSPs to be raised by an average of around 30 cents/b, though they have mixed expectations about the extent of the hike for different grades.
Some expect lighter grades to see a relatively smaller increment as floundering naphtha cracks have pressured lighter crudes grades and condensates in the broader market.
Second-month naphtha cracks versus Dubai swap cracks averaged minus 53 cents/b in March, the lowest since December 2020, when they averaged minus $1.71/b, Platts data showed.
“There is more support for heavier grades in the OSP hike, as lighter grades are supported by middle distillate and naphtha cracks, and naphtha cracks have been falling,” said a crude oil trader based in Singapore.
Still, others expect the OSP hike for lighter grades to exceed that of medium and heavy grades.
“Jet [fuel] demand will become better, so lighter grades will see a bigger hike to restore the pre-pandemic differential between light and medium grades,” said another crude oil trader in Singapore, adding that loosening travel restrictions within China may boost air travel demand.
Weak product margins, arbitrage supply glut
Market participants anticipate that the poor performance of most product cracks may place a lid on the extent of the hike.
“The demand side is not seeing improvement and refinery margins are not so well. If they increase the OSP too much, it will eat into refinery margins,” said another trader with a North Asian refinery.
The wider Brent/Dubai spread seen in March gives Middle East producers some scope to increase OSPs, but weak product cracks could restrict the upward movement of OSPs, echoed a trader with an Indian refinery.
Front-month Brent/Dubai Exchange of Futures for Swaps averaged $2.60/b in March, compared to $1.93/b in February, Platts data showed.
While a wider Brent/Dubai spread typically shields the Middle East sour crude market from arbitrage crudes, as Dubai-linked sour crude becomes economically more attractive to buyers, arbitrage barrels have continued to flow into Asia due to excess supply, especially for West African crudes, which have put pressure on the cash differentials of these grades.
“Arb [is] is getting cheaper than AG grades, AG is too expensive now,” said another trader with a North Asian refinery.
Sellers of arbitrage have been adjusting offers lower on a delivered basis to remain competitive, as the they are eager to clear distressed overhang barrels in a backwardated market, sources said.
“There are a lot of West African crudes available, and Mediterranean crude grades are also available at a good discount as Europe is not able to absorb,” said the trader at the Indian refinery.
Chinese buyers have also diverted some of their demand to Iranian crude, resulting in weaker buying interest for other Middle Eastern crude grades, some traders said.
Although some buyers, such as Japanese refineries, will likely continue to show inelastic demand for sour crudes, others may diversify away if OSPs are increased too much, they added.