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Want to Understand the Shale Boom? Try a Microscope: Julian Lee


Mar 9, 2019, by Julian Lee
(Bloomberg Opinion)

Look at much of what is written about the oil market and it may be tempting to conclude that crude oil is a homogenous commodity, the same the world over and seamlessly interchangeable. It’s not.

Once you appreciate that all crudes are not created equal, you can see how important it is that long-held expectations for a glut of the heaviest types have turned out to be incredibly wrong. Not a producer or refiner in the world is immune to this development, which is having a growing impact on prices and supplies.

Crude oil consists of a soup of molecules made up of varying numbers of hydrogen and carbon atoms – hence, hydrocarbons. The composition of crudes from different oil fields, and even from different parts of the same oil field, can diverge sharply. Many contain pollutants that have to be removed, with sulfur the most prevalent.

Quality is generally a function of two features. One is sulfur content. Crudes containing lots of sulfur are called sour, those with little are sweet. Sulfur needs to be removed to meet finished-product quality specifications, which adds to the cost of processing and limits the number of refineries that can handle sour grades.

The second is API gravity, a gauge of density. Crudes with a high API gravity are termed light, and those with a lower API gravity are heavy. Light crudes naturally contain lots of the smaller molecules, including those that form gasoline and diesel, while heavy crudes naturally contain lots of larger molecules that require more complex refining processes to break them up into these high-value products. The latter also tend to contain more sulfur than lighter ones, making them doubly costly to refine into useable products. For this reason, heavy, sour oil tends to be cheaper than light, sweet.

When the U.S. shale boom was still just a glint in the eye of George Phydias Mitchell, regarded as the father of the industry, the market’s overriding concern was that the world’s supply of oil would get steadily heavier and sourer in the years ahead. That portended a mismatch with demand, which was expected to be increasingly concentrated in the higher-value light products used to move people and things, rather than the heavy ones used to generate heat or electricity. To add to the difficulty, environmental regulations were stipulating lower and lower levels of sulfur in fuels – a requirement that is to be extended to ships from January 2020.

As a result, refiners around the world, and particularly along the U.S. Gulf coast, invested in expensive equipment to crack big hydrocarbon molecules and remove sulfur. Meanwhile, emerging economies in Asia invested in big new plants to process heavy, sour crude from the Middle East. Those same Middle Eastern producers were also busy building new refineries for their cheaper heavy crudes. These developments are restricting the volume of heavy sour crude available for export to refiners that don’t have a long-term supply deal.

But George and his successors have turned the world on its head. Far from getting heavier, new global supply is now predominantly very light and very sweet. Almost 86 percent of the incremental production between 2015 and 2018 was light, according to recent data from Rystad Energy AS, and nearly three quarters of the additions expected by 2023 are also expected to fall into that category.

Meanwhile, the supply of heavier oils is falling.

Soaring U.S. output has driven OPEC to implement another round of voluntary output cuts in an effort to balance global supply and demand. The combined production of Saudi Arabia, the U.A.E. and Kuwait has fallen by more than 1.2 million barrels a day since November. Off the coast of West Africa, steep decline rates at deepwater fields are cutting into the flow of heavy and medium grades from Angola, where a lack of investment has slowed the development of new fields to replace the losses.

And then there is the recent round of sanctions on Iran, which have cut the Persian Gulf country’s production by a similar amount. Waivers granted to eight buyers of Iranian oil expire in early May and President Donald Trump is yet to decide whether he will renew any of them. If he doesn’t, Iran’s oil production will fall further.

In the Caribbean, mismanagement of oil industries means that heavy oil production from two key countries is also dropping fast. Mexico and Venezuela are both in long-term decline and the sanctions recently imposed on Petroleos de Venezuela will accelerate the fall, particularly if they are extended to target non-U.S. buyers of the country’s crude.

The shortage of heavy crudes is already having a market impact. A useful way to see this is to compare what Saudi Arabia charges buyers of its Arabian Heavy grade to prices for its Arabian Extra Light. The chart above shows how the gap has narrowed. Expect that trend to continue if heavy crudes become even more scarce and an ever-greater proportion of the supply is locked into domestic refineries or long-term supply deals with Asian partners. Too bad for the refiners who have made all the expensive investment to prepare for a heavy-crude world.



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