Saudi crude oil price hike set to collide with recession fears: Russell
(The opinions expressed here are those of the author, a columnist for Reuters.)
By Clyde Russell
LAUNCESTON, Australia, July 7 (Reuters) - Consider the following to show just how weird global crude oil markets are currently.
Saudi Arabia raised the selling price of its crude oil for Asia on July 5 to just below a record high, ostensibly because of strong demand and high refining margins.
In the two days since the hike in the official selling price (OSP) of the world's biggest oil exporter, benchmark Brent futures LCOc1 have slumped 11.3%, ostensibly on weak demand and recession fears.
It may seem a bit of a mission impossible to reconcile these two developments, but in some ways they reflect the difference between the reality of physical oil trading and the perception of the much bigger paper market.
When viewed through the prism of developments in Asia's physical markets for crude and refined products, the decision by Saudi Aramco 2222.SE , the kingdom's state-controlled oil producer, to increase its OSPs for August cargoes makes sense.
The OSP for Aramco's benchmark Arab Light crude for Asian customers for August-loading cargoes was increased by $2.80 a barrel from July's level to a premium of $9.30 a barrel over the regional Oman/Dubai quotes.
This was just shy of the record $9.35 a barrel premium seen in May, and reflects that the Saudis see solid demand for crude from customers in Asia, the top-importing region, as well as extremely strong refining margins.
Certainly refining margins have been high, with the profit from making a barrel of gasoil, the building block of diesel and jet kerosene, at a typical Singapore refinery GOSGCKMc1 hitting a record $68.69 on June 24.
It has since retreated to $41.80 a barrel at the close on Wednesday, but even this level is almost four times higher than the $11.83 at the end of last year, and some 550% above the profit margin at the same time in 2021.
Saudi Aramco doesn't disclose its pricing formula for how it sets its OSPs, but it's generally viewed as a fairly technical process that takes into account the relative price between Oman/Dubai and Brent, refining margins and the actual volumes being sought by refining customers.
The problem for the Saudis in using a technical process is that it can't easily adapt to the highly unusual circumstances in the current global oil market.
Refining margins in Asia have been driven largely by a recovery in demand as economies rebound from the COVID-19 pandemic, but also by the almost complete withdrawal in recent months of Chinese exports of refined fuels, coupled with sanctions, either self-imposed or formal, on Russia's shipments of products.
Raising the OSPs in normal circumstances would allow the Saudis to capture some of what they would most likely view as excess refining margins, and in more normal conditions refiners would have to compete more vigorously for sales in a well-supplied product market.
But these aren't anything close to normal conditions, and it's likely that refiners will try, and perhaps be successful, in passing on the higher OSPs to retail customers.
The question then becomes how quickly high, and in some Asian countries record high, fuel prices translate into weaker demand as consumers cut back on consumption in the face of escalating inflation, rising interest rates and a general loss of confidence.
If past history is any guide, this process takes several months, but it seems that the Saudi decision to raise its OSPs, while justified on a technical basis on current physical market conditions, may result in a faster and more pronounced move downwards as oil demand collides with rising recessionary fears.
Certainly, the paper market is starting to price a global recession as a bigger risk than the loss of supply from Russia in the wake of Moscow's Feb. 24 invasion of Ukraine and the subsequent Western-led moves to sanction Russia's energy exports.
Brent crude dipped below $100 a barrel on Wednesday and was maintaining its weaker path in early Asian trade on Thursday, dropping as low as $99.35, the weakest intraday price since April 11.
A lower price for Brent will encourage those refiners in Asia that can switch crude grades to buy more oil from suppliers that price against the global market, such as West African producers Angola and Nigeria.
Asian refiners that do have flexibility will first buy cheap Russian crude if they can, then they will buy grades priced against Brent, leaving Saudi crude and the Middle East grades that follow the Saudi OSPs as the least desirable oil around.
GRAPHIC-Oil's Volatile State Link
Editing by Kim Coghill
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