Saudi OSP Hike May be Self-Harming

 

Saudi Aramco, the state-owned oil company, lifted the official selling price (OSP) for its benchmark Arab Light grade to Asian refiners by 60 cents a barrel for July shipments, according to a statement released on Sunday.

 

Arab Light cargoes for July will now be sold at a discount of 25 cents a barrel to the Oman-Dubai crude price, up from a discount of 85 cents for June shipments.

 

The increase in the OSP had been expected by the market, although it was by a wider margin than forecast in a Reuters survey of six Asian refiners and traders, with the increase of 60 cents beating even the top estimate of 50 cents in the poll.

 

Saudi Aramco sets the OSP based on recommendations from customers and after calculating the change in the value of its oil over the past month, based on yields and product prices.

 

It also takes into account the market structure, and some narrowing of the Oman-Dubai contango at times in May from April was also a pointer to an increase in the price.

 

A contango market refers to prompt prices that are lower than those in future months, while a narrowing contango signals increased demand or tightening supply.

 

The difference between front-month Dubai crude and third-month stood at 54 cents a barrel on June 2, which is down from 62 cents on May 29 but is actually wider than the 44 cents that prevailed on the last trading day in April.

 

What this means is that part of the Saudi price hike for July was attributable to technical factors and was an expected response.

 

But it's worth noting that the change in the contango is actually very small, and certainly not enough to justify a larger-than-expected increase in the OSP for July.

 

A further sign that the hike for July was higher than expected is shown by the relative lack of movement in the premium of Brent crude to Dubai, known as the exchange for swaps <DUB-EFS-1M>.

 

Over time the Saudi OSP tends to track the premium quite closely, but in recent months the Saudis have kept the OSP in a fairly narrow range while the Brent-Dubai spread has narrowed considerably, from $2.07 a barrel in December to just 65 cents by June 2.

 

Normally this would result in the Saudis lowering the OSPs, and while they did do this for May and June cargoes, the increase for July reverses the earlier price cuts.

 

It does seem that the Saudis are using pricing to try to tighten supply to Asia, which buys about two-thirds of the kingdom's exports.

 

This would fit alongside with the kingdom's stated aim of boosting prices by cutting output, along with other members of the Organization of the Petroleum Countries (OPEC) and allied producers such as Russia.

 

The Saudis are leading the efforts to lower output by a combined 1.8 million barrels per day (bpd), a move that aims to drain inventories by enough to lift prices over the longer run.

 

But while it's relatively easy for the Saudis to increase their OSP by more than their customers expected, it's less easy to fight off competitors from outside the agreement to restrict production.

 

China, the world's biggest crude importer, is a case in point.

 

Saudi Arabia supplied 3.956 million tonnes of crude to China in April, according to customs figures released on May 23, taking their year-to-date total to 18.314 million.

 

This gave the Saudis a share of Chinese imports of 11.5 percent in April, lower than their January-April share of 13.2 percent.

 

What is probably more worrying for the Saudis is that their market share in China is heading in the wrong direction, given it was 13.4 percent for the whole of 2016.

 

In contrast, the share of Chinese imports enjoyed by Brazil, a producer outside the OPEC and allies agreement, is rising.

 

Brazil's share in the first four months of the year was 5.4 percent, up from 5 percent for the whole of the 2016.

 

And in a further sign that the Chinese are broadening their base of crude suppliers, the United States gained a 0.9 percent share of imports in the first four months of 2017, up from a negligible 0.13 percent in 2016.

 

While it's true that suppliers such as Brazil and the United States are minnows compared to Saudi Arabia and Russia when it comes to meeting China's oil needs, the point is that they seem able to take up the slack of any lower shipments from producers that may be restricting output.

 

And it's not only volumes that make disturbing reading for the Saudis and their allies, it's pricing as well.

 

Chinese data shows that the average price paid per tonne of crude oil in April was $379.81, or about $52.03 a barrel.

 

The average price of Saudi imports was higher, at $388.52 a tonne, as was those from fellow output cutters Russia, at $390.09.

 

In contrast, supplies from Brazil were below the Chinese average at $363.25 a tonne, as were those from the United States at $368.20.

 

Of course, this is a bit of an apples and pears comparison, given the Chinese customs data doesn't break down imports by grade, with lighter crudes tending to fetch a premium over heavier types.

 

But there has also been movement in the relative pricing since December, the month before the output cuts agreements took effect.

 

In December the average price of Saudi crude was 2.4 percent below the overall average paid by China, by April it was at a premium of 2.3 percent.

 

Brazil's crude was at a discount of 2.3 percent to the Chinese average in December, and this had widened to 4.4 percent by April.

 

In other words, not only is Saudi Arabia losing market share in China, it's crude is now more expensive relative to those from some competitors outside the OPEC and allies agreement.