Last month, OPEC and its non-OPEC allies, known as OPEC+, agreed to extend their deep production cuts through July in an effort to rebalance oversupplied markets in the face of pandemic-hit demand. The cuts were supposed to take ~10% off the markets with July’s cut clocking in at 9.6 million bpd.
But now there are signs that the pendulum could have swung a bit too far, with the markets beginning to experience shortages of key crude grades.
There are growing signs that the markets are undersupplied with Urals and Arab Light thanks to continuing deep production cuts as well as a rebound in demand by key customers such as China and Northern Asia.
The price of Urals, Russia’s flagship grade, has flipped to record premiums to the Brent crude benchmark, briefly changing hands at $2.40 a barrel above Dated Brent last week to reflect the undersupply.
That marks a sharp turnaround compared to a discount of more than $4.50 a barrel recorded in April. Urals for delivery to Rotterdam, the main oil refinery hub in northwest Europe, were selling at a premium of $1.90 by the end of June, matching a prior record high. This, in effect, means that Rotterdam Urals were selling at ~$45 a barrel, a far cry from the $15 a barrel they commanded in early April.
Oil markets in backwardation
A similar pattern is being observed for other sour crude grades, which are commanding premium prices even with global oil demand still 10% below normal levels.
Under ordinary circumstances, medium-sour crude that Saudi Arabia and its OPEC partners pump is usually cheaper than light sweet crude with a lower sulfur content. However, OPEC, which mostly pumps medium-sour crude, has dramatically cut output to its lowest level since 1991. Further, Iran and Venezuela, which also supply medium and heavy sour crude, have both seen production severely curtailed due to U.S. sanctions as well as a lack of investment.
Consequently, Saudi Aramco has been able to raise the price of the crude it sells to refiners for three months in a row. And now for the first time ever, Aramco is selling its most dense crude, known as Arab Heavy, at the same price as its flagship Arab Light, a clear indication of strong demand for medium-heavy sour grades. Under normal circumstances, Arab Heavy sells at a discount of $2-to-$6/barrel to Arab Light. Related: Big Oil’s Investment Risk Is Spiking
To make matters even more interesting, medium-heavy sour crude for immediate delivery is commanding premiums to forward contracts, a situation known as backwardation. That’s a 180-degree turn from the situation just two and a half months ago when oil markets were in deep contango, meaning forward contracts were selling at a big premium to near-term contracts.
Production cuts working
CME data shows that oil futures in general are beginning to flirt with backwardation— a positive sign for oil markets. Back in May, the markets were in super-contango with futures for June delivery trading at just half the value of January 2021 futures; the situation is far less dramatic with futures for August delivery trading…