The oil market maintains a balance that is difficult to square. Since the arrival of the war in Ukraine, the relationship between supply and demand has been blown up. Predictions on raw materials are increasingly complex for experts to make. An example of this are the differences that exist between the price of the different barrels of crude oil. What do they show and how is the market now?
Oil has gone from showing significant bullish strength to doubts about the future that is yet to come. A barrel of Brent crude, a reference in Europe, is trading above 80 dollars, compared to just over 120 dollars a few months ago. This, together with oil production (some 45 million barrels per day from OPEC+, along with the between 3.5 and 5.5 million produced by Libya, Iran and Venezuela) which continues at more adjusted levels compared to the years prior to the pandemic, makes it a real question mark to guess the next moves.
In addition, it must be taken into account that not all barrels produced are the same. Because crude oil pipelines are saturated, barrel-of-crude spreads today depend on product quality (net product benefits) and shipping costs. Both have changed a lot since the start of the energy crisis, aggravated by the war between Ukraine and Russia. The situation clearly shows a tension in the important sector.
Starting with the latter, global tanker rates have doubled since early 2022, as the world embarks on one of the biggest reroutes of raw materials ever seen. “We expected a full redirection of Russian oil flows to be unachievable as rising freight demand – even after the lockdowns – would require freight rates to rise another 50% from early November 2022 levels (… ) However, after an initial rebound in line with our expectations, dirty tanker freight rates have fallen significantly, to the levels of our last update,” the Goldman team says in a report.
That is why the investment bank’s crude research division has revised its freight forecasts downward, placing them around 15% above current levels. “However, taking into account that the order book for new oil tankers is practically empty and that the term to build them is more than two years, we only expect a modest normalization over time,” he analyzed.
Goldman Sachs experts say that followers of the black gold industry underestimated the impact that the reduction in the US SPR had on US crude exports and, therefore, on global demand for crude oil and tankers. “The end of these SPR-driven exports and access to the Iranian dark fleet (after offloading its floating storage) acted to loosen the shackles of the tanker market,” they argue.
Crude quality also remains an important factor, as different barrels from different regions produce very different products. Heavier, more acidic crudes tend to produce fewer light end products (such as gasoline) and more residual streams (such as fuel oil); and vice versa for lighter density crudes.
The Goldam Sachs report details how medium crudes, for their part, tend to have the highest distillate cuts on average (for example, diesel, diesel, jet fuel). “Product differentials have skyrocketed in the last 18 months, driving most of the movements in the Brent-Dubai and WCS-WTI differentials,” highlights the panel of oil specialists from the North American entity.
Thus, the recent fall in natural gas prices has somewhat attenuated some of these output differentials from their historical extremes. However, these spreads remain wide and extremely volatile. “Indeed, commodity prices are now showing higher implied volatility than crude oil prices for the first time since the ‘Golden Age of Refining’ in the mid-2000s, illustrating where the major limitations of the oil markets”, deepens the team of analysts.
The spread signal
Historically, crude oil spreads have been the main driver of US refining tailwinds, where frequent pipeline restrictions experienced by a rapidly growing shale industry have resulted in cheap raw materials. “However, we do not believe that location factors (versus quality) will be the main driver of crude spreads going forward, as US production growth has slowed,” says Goldman Sachs.
On the other hand, a refining sector with little investment and distorted product markets will mean that, in the opinion of the North American bank, the quality of the crude oil is the factor that contributes the most. The ability of complex refineries to turn the least desired products into the most means they win on both sides of the market: by making heavy raw materials cheaper and by increasing premium production.
As such, US refiners are experiencing an unprecedented rising margin environment, with the largest four earning a return of $37 billion in 2022, compared to $64 billion from 2013-2021.
On the other hand, the worst-positioned refineries – which set prices at the margin – are barely making a profit that is in line with the historical average. “This is an interesting contrast to previous phases, where -unlike refining- short-term supply elasticities are very low, and companies further up the cost curve generate leveraged exposure at higher prices. high”, qualifies the team of analysts from Goldman Sachs.
“That is why our forecasts update the crude differential quarterly until 2024 (…) We lower our forecasts for Brent against WTI, expecting a narrower differential in the short term of 5.5 dollars per barrel in the first half of 2023 against to 6.1 dollars a barrel in the short term, and against about 6.8 dollars a barrel in cash, as the price between the MEH and the WTI is compressed, ”he concludes.