Column: Saudi jawboning up crude oil prices contrasts with soft physical market

Saudi Arabia appears to have been largely successful in talking up the price of crude oil by publicly mulling output cuts, but the risk is that the disconnect between paper and physical markets could widen even further.

Global benchmark Brent crude futures were trading around $104.28 a barrel early in Asia on Tuesday, up almost 9% from the close on Aug. 22, prior to the latest Saudi intervention.

Saudi Energy Minister Prince Abdulaziz bin Salman said the world’s largest crude exporter was prepared to cut production to shore up prices. He told Bloomberg News that the drop to around $95 a barrel was based on “unsubstantiated” information on demand destruction and a “a self-perpetuating vicious circle of very thin liquidity and extreme volatility.”

Other key members of the OPEC+ group, including the United Arab Emirates, subsequently indicated that they were in line with the Saudi view of the market. That raised the possibility that the group would move to reverse its recent increase in output quotas.

The paper market response to the jawboning by OPEC+ has been predictable, with prices rising.

But the physical crude market is telling a somewhat different story, with demand in Asia, the top-importing region, flat at best as China’s imports maintain their recent soft trajectory.

It’s also worth noting that any OPEC+ move to cut output quotas may have very little impact on actual oil supply, given that the group is already failing to pump anything close to its current targets.

OPEC+, which consists of the Organization of the Petroleum Exporting Countries and allies including Russia, produced 2.892 million barrels per day (bpd) below their target in July, two sources within the group told Reuters on Aug. 22.

That means that any cut to output targets announced at the group’s next meeting would have to be absolutely massive to exceed what those producers are already failing to deliver.

While the Saudi energy minister is talking about new production curbs as a way to bolster prices, it also seems that Saudi Aramco, the state-controlled oil producer, may reduce its selling prices for October-loading cargoes to refiners in Asia, the main buyers of its crude.

Aramco may cut the official selling price (OSP) for its flagship Arab Light grade by about $4.50 a barrel in October, according to an Aug. 29 Reuters survey of five refiners.

This would be the first Saudi price cut in four months and would follow the kingdom’s raising of September OSPs for Arab Light to record high levels of $9.80 a barrel above the regional benchmark Oman/Dubai average.

If Aramco does meet the refiners’ expectations for a steep cut in the OSP, it would reflect the reality that crude demand is lukewarm and Asian customers have increasingly been seeking cargoes from outside the OPEC+ group, including from the United States.

CHINA WEAKNESS

China, the world’s top importer, is expected to land just 8.69 million bpd in August, slightly higher than July’s 8.41 million bpd, according to data compiled by Refinitiv Oil Research.

The small uptick in August still leaves China’s imports well short of the 2021 average of 10.26 million bpd, and the level of imports in June, July and August has been about 1.5 million bpd below the average for last year.

China’s refinery processing has been weak so far in 2022 amid softer domestic demand caused by strict COVID-19 lockdowns and falling product exports as Beijing cut quotas to ship out refined fuels.

It’s likely to remain that way for the rest of 2022 as well, with Sinopec, the world’s largest refining company, saying on Aug. 29 that it would process 6% less oil in 2022 than it did last year.

The company said it planned to process 240 million tonnes of crude in 2022, equivalent to 4.8 million bpd. Given that its processing was 120.76 million tonnes in the first half, this implies no pick-up in the run rates in the second half.

Asia’s other major importers are also showing flat demand profiles, with India’s arrivals estimated at 3.99 million bpd in August, down from July’s 4.63 million bpd, while Japan’s imports are pegged at 2.74 million bpd, slightly up from July’s 2.62 million.

Overall, Asia’s August imports are expected by Refinitiv to be 23.87 million bpd, down from 24.55 million bpd in July and in line with June’s 23.83 million bpd.

This is hardly a picture of strong demand, meaning prices can only hold at elevated levels on constrained supply, which is what OPEC+ appears to be talking about.

Whether OPEC+ can actually restrain output by enough to tighten the market remains to be seen, especially since Russia’s crude exports are holding up as Moscow sends more oil to Asia.

Demand may also be entering a tricky period. Economies in Europe and much of the developing world are likely to be hit hard by sky-high natural gas and electricity prices, leading to an erosion of manufacturing and consumer confidence. Moreover, that will be exacerbated by rampant inflation and associated rises in interest rates.