2021 is a fascinating year – in many perspectives. One aspect is that the long-established lead of East
of Suez markets in oil demand growth is temporarily broken, as the Atlantic Basin has established itself as the more dynamic market since spring.
Peak summer road fuel demand glued well with the structural recovery from the pandemic, boosting crude import requirements into North America and Europe. Meanwhile for Asia, optimism has faded, with one COVID 19 outbreak after another weakening final product demand, while crude imports came under even stronger pressure from strategic shifts in China.
Amid the double whammy of strong inflationary pressures and a deepening environmental crisis, Chinese policy makers are step-by-step confirming a drastic U-turn on its domestic refining strategy. Over the last two months, strongly curtailed crude import and product export allowances, closed taxation loopholes on alternative refinery feedstocks and other measures have not only crimped crude processing in China, but also switched the inventory policy from regular strong builds to drawdowns.
The market is at risk of not fully appreciating how big a game changer these developments are for the remainder of this year – on a local and global level. The repercussions of these big picture trends can be seen in Atlantic Basin crude flows, market structure, arbitrage spreads and in implications for storage incentives.
COVID-19 IS STILL A FACTOR
With COVID-19, developments so far appear to cement the better outlook for West of Suez markets. The mixture of a let-it-happen attitude in large parts of the Americas and Europe with a strong vaccination campaign may dent the threat of COVID-19 on the economy. The number of severe cases should be range-bound in spite of concerning developments in the US over recent weeks.
In Asia, much bigger parts of the population are still immunologically susceptible, keeping further waves a
big societal risk, with knock-on effects on the economy and oil demand. More specifically, lockdowns – as the most damaging tool to oil demand – are likely to remain a regular feature in Asia but may already be a thing of the past for the West.
In combination with the policy changes in China, we do not think the East of Suez market, as a whole, has any upside in crude imports for the remainder of the year, relative to year-to-date flows. Vortexa thinks that it is likely that Chinese imports average below the 8 million bpd mark, down nearly 2 million bpd from September-December observations over the last two years. Some key players like India or South Korea may at best make up for some of the losses from China.
At the same time, supply-side growth will be dominated by Middle Eastern exports, as within the OPEC+ group only the biggest producers (such as Saudi Arabia) will be able to boost production and exports meaningfully.
The minor upside possible for Russian crude exports – currently struggling with production outages – will easily be counterbalanced by declines in other West of Suez markets, with US crude production being seen largely stagnant for the rest of 2021.
Historically, about 80% of Middle Eastern crude exports land in Asia, and we see limited reason for a major decline in that share over the coming months, even though we saw some easing established at the margin earlier in 2021.That means that very roughly an additional 1 million bpd of Middle Eastern crude will seek homes in Asia over the coming months, simply crowding out Atlantic Basin grades.
Given better demand economics, these types of stranded Atlantic Basin barrels could well be placed within their home region. Strong refining margins in the US, and the need to restock after an 80 million-barrel draw down from March-August underpin this case. North America as a whole (including Mexico) has seen crude imports rising in five out of the last six months. And the latest Short Term Energy Outlook from the US Energy Information Administration (EIA) sees US crude net-imports 100,000 bpd higher in September-December 2021, as compared to the previous four months around the peak summer driving season.
At the margin, we favour even more growth, with the potential of runs not falling as much as forecast by the EIA through the autumn refinery maintenance period thanks to strong demand for US-sourced products in the Americas as a whole.
Summing up the above trends, crude markets will be fundamentally weaker in key markets for the remainder of 2021, as compared to the tightness observed over previous months, mainly driven by higher Middle Eastern (Opec) supplies at a time of stale Chinese buying. With more Atlantic Basin (specifically US and West African) crude being limited to within the region, a flatter market structure may be required to facilitate some stock building.
As for crude differentials, West Texas Intermediate (WTI) will have to price into export destinations more aggressively undermining its relative value. Of course, the bigger investment mood is a factor here as well, but bullish sentiment has been dented recently on the back of more widespread concerns on
Concluding with a look at storage developments, substantial draws observed over the last 12 months are set to come to an end. While we are far away from a highly conducive storage environment (requiring a contango market structure), difficulties to place crude barrels, could well lead to higher stock levels in Atlantic Basin crude supply areas as well as key refining hubs.
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Fabio Kuhn is the Founder and CEO of Vortexa. www.vortexa.com