November 22, 2019 / 7:03 AM / 3 months ago

Physical oil and futures align to tell story of a tighter market

    * IMO 2020 boosts demand for certain sweet crudes
    * Sour crudes supported by Venezuela, Iran supply loss
    * Goldman says Brent futures backwardation likely to persist

    By Dmitry Zhdannikov and Alex Lawler
    LONDON, Nov 22 (Reuters) - The physical crude oil market and
the structure of the oil futures curve have rarely been more
aligned over the past few years than in recent weeks, and they
tell a counterintuitive story of a tight oil market next year.  
    While OPEC and the International Energy Agency point to a
swelling oil glut next year due to booming non-OPEC supplies
including in the United States, the physical market offers a
different story.
    Traders are prepared to pay near-record premiums for sweeter
barrels as new marine fuel regulations from 2020 encourage
refiners to switch to crude grades that produce smaller
quantities of high-sulphur fuel oil.
    However, premiums for heavier grades, which produce more
fuel oil, also continue to rally due to a deficit created by
U.S. sanctions on Iran and Venezuela.
    In addition, the structure of the oil futures market shows
that premiums of front months to later dates – known as
backwardation – have narrowed in recent weeks, also suggesting
the market's expectations of a glut are diminishing somewhat.
    To be sure, benchmark oil futures do not necessarily follow
the physical market and could still decline next year if global
oil demand falls because of the U.S.-China trade dispute or if
U.S. oil output surprises again on the upside.
    Soaring physical crude prices are also negatively impacting
refining margins, often prompting refiners to cut processing.
    New marine fuel rules have created a rally in certain crude
oil grades. From January 2020, the United Nations' International
Maritime Organization (IMO) will ban ships from using fuels with
a sulphur content above 0.5%, compared with 3.5% now, unless
they have sulphur-cleaning kits called scrubbers. 
    Nigeria's biggest crude stream, Qua Iboe BFO-QUA, is
valued at a premium of $3.30 a barrel, the highest since 2013,
Refinitiv Eikon data shows. Azeri Light, or BTC BFO-AZR, has a
premium of $5.10 to the benchmark, its highest since 2013.
    Both crudes are valued especially highly by simple
refineries as they are ideal for producing IMO-compliant bunker
fuel oil, said Eugene Lindell, an analyst at JBC Energy in
    "The focus now is on not producing high-sulphur fuel oil at
all costs. If you are a simple refinery, it comes down to
choosing the right crude," he said.
    "The end result is a lot of people are going to be seeking
these grades and that boosts the price. They will remain strong
and may increase further."
    While the rally in those two light, sweet grades stands out,
sour crudes such as Russian Urals have been supported by other
factors. Urals in northwest Europe BFO-URL-NWE is trading at a
premium of $1 a barrel to dated Brent, a record high. 
    "The strength in sour crudes, despite IMO 2020, is due to
the loss of sour crude supplies from Venezuela and Iran and high
demand for heavy molecules to feed the conversion units of more
complex refineries," analysts at Energy Aspects wrote.
    U.S. sanctions on Iran and Venezuela have forced the two
OPEC members to cut oil exports sharply, tightening the market
for sour crude. 
    Voluntary OPEC cuts due to a supply pact that producers are
expected to renew in December have also curbed output.
Expectations of a growth slowdown in U.S. shale could also
tighten the market further.             
    North Sea crude grades, which underpin the Brent futures
contract, are also rallying. Ekofisk, one of the five grades
that can set the value of dated Brent, jumped to its highest
since 2013 on Tuesday. 
    The rally in physical crude is being reflected in
strengthening time spreads in the Brent futures market, even
though the outright price at $62 a barrel         is well below
this year's high of $75. 
    The first-month Brent contract is trading at a premium to
the second month LCOc1-LCOc2, indicating current tight supply.
Backwardation persists for future months, although it becomes
shallower next year.
    "We expect Brent oil prices to continue trading around our
$60-a-barrel forecast with backwardation likely to persist as
the ongoing OPEC cuts and slowing shale activity offset rising
other non-OPEC supply and moderate demand growth," Goldman Sachs
 said in a report this month.

 (Editing by Dale Hudson)
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