Crude Market Faces Headwinds as Refiners Cut Processing

(Bloomberg) -- The physical market for crude, buttressed for weeks by supply outages from the Persian Gulf to Latin America, is finally starting to run into headwinds.

Oil prices on Thursday fell the most this year amid demand concerns related to the U.S.-China trade war. On the supply side however, a crunch spanning from the Persian Gulf to Latin America has been chipping away at refineries’ profitability for weeks.

Margins for some plants in the Mediterranean region have slumped to the point where crude processing is being reduced, said Jan-Jacob Verschoor, director of Oil Analytics Ltd., which studies refinery economics. In China, so-called teapot refineries in the Shandong region are losing about $8 for every barrel of oil they process amid a gasoline glut, according to Zhao Jin Futures.

Those losses may spell bad news for the physical market, where barrels of crude are bought and sold. Oil prices in regions from Colombia to Asia were at their strongest levels in five years last week. That’s due to factors including reduced supply from Iran and Venezuela, supply cuts from OPEC and its allies, contaminated oil from Russia and tightness in the North Sea market that prices much of the world’s crude.

The effect has been to push timespreads -- used to gauge market strength -- to the highest level since 2014. However, with refiners curbing their processing, the physical market may finally start to ease.

“Lower refinery runs will act as a temporary relief valve to the acute tightness in crude, allowing differentials to fall back slightly and time spreads perhaps pausing for a breather” said Amrita Sen, chief oil analyst at Energy Aspects Ltd.

Supply Constraints

The situation is complicated by contamination on Europe’s largest oil pipeline. Contaminated Russian flows have seen Total SA limit fuel deliveries from its Leuna refinery in Germany through June after it was forced to shut some units at the plant. However, margins for untainted crude in northwest Europe remain healthy as the supply shortfall supports demand in this region, according to Oil Analytics’ Verschoor.

Still, in the longer-term output of the heaviest types of crude is set to remain crimped. The Organization of Petroleum Exporting Countries has indicated that supply cuts may continue for the rest of the year. The Trump administration continues to threaten to reduce Iran’s oil exports to zero, while U.S. sanctions are also in place on Venezuela. If those supplies continue to ebb, pressure will likely remain in margins for those types of crude.

“Margins based on medium-heavier crude are probably feeling the impact of lower availability of this quality of crude,” says Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA in London. “After all, you have supply curtailment from OPEC Gulf countries, Russia, Venezuela and Iran.”

--With assistance from Serene Cheong and Javier Blas.

To contact the reporters on this story: Alex Longley in London at alongley@bloomberg.net;Bill Lehane in London at blehane@bloomberg.net

To contact the editors responsible for this story: Alaric Nightingale at anightingal1@bloomberg.net, Brian Wingfield, John Deane

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