The Light Sweet-Medium Sour Crude Imbalance and the Dynamics of Price Differentials
The current sweet-sour crude oil imbalance is creating challenges for producers and refineries alike. While OPEC+ is striving to balance the market by the first half of 2019, unplanned outages from countries such as Venezuela, Iran and Canada and OPEC+ cuts have contributed to a large deficit in medium/heavy sour crudes. This is having a big impact on key market outcomes including trade flows, the dynamics of crude price differentials, and refining margins. The crude imbalance is also complicating planning and risk management decisions, especially at times when the International Maritime Organization (IMO) will enforce a new 0.5% global sulphur cap on bunker fuel from the 1st of January 2020.
This Energy Comment examines the dynamics of the sweet-sour crude price differentials, represented by the Brent-Dubai (BD) price spread and assesses how supply factors can impact the crude quality imbalance between light/heavy oil and sweet/sour crude and hence the crude price spreads in 2019. The results show that the current supply outages and OPEC+ cuts do not only impact price levels, but also the price differentials between the key sweet-sour benchmarks. Since most of the recent supply losses are concentrated in the medium/heavy sour category, while most of the supply gains are concentrated in the light sweet category in big part due to the strong growth in US shale, the light sweet-medium sour crude spread has collapsed and at certain instances was trading at negative values. Looking ahead, our paper predicts that, other things being equal, the downward pressure on light sweet – medium sour crude spreads will persist throughout this year as losses from countries like Iran and Venezuela due to sanctions may accelerate and as Saudi Arabia and its partners are expected to maintain the cuts until the end of 2019.
This may have come as a surprise to some market analysts. A few months ago, the conventional wisdom was that the Brent-Dubai spread would widen as IMO rules start taking effect and the shipping industry shifts towards consuming cleaner fuels including Marine Gasoil (MGO) and compliant low sulphur fuel oils. This should have the impact of increasing demand for light sweet crudes while lowering demand for sour crudes. What our results show is that the IMO is only one of the many factors impacting spreads and supply factors are as important (if not more important) in determining movements in price differentials. In other words, the widening of the sweet-sour spreads may still occur, but this is far from a forgone conclusion. Our results also show that the current sweet-sour imbalance presents a challenge for OPEC+ and may complicate its efforts to balance the market. On the one hand, OPEC+ cuts are contributing to balancing the market in terms of volumes; on the other hand, the surplus in light sweet crude persists. By cutting output, OPEC+ is tightening an already very tight medium/heavy sour market with potential implications on refining margins and eventually on global oil demand if complex refining margins weaken significantly. The key question facing OPEC+ producers is whether they should or can take any measures to resolve this quality imbalance or should they just leave it to the market mechanisms to resolve it.