Surge in light crude trade altering market for Atlantic basin refiners

N. Foster Mellen
Petroleum Economics Ltd.
Sugar Land, Tex.

• Changes in Atlantic Basin Oil Output [54,512 bytes]

World crude oil production currently is booming. It increased by more than 2 million b/d in 1996 and was likely to grow by a similar amount in 1997 and possibly even more in 1998.

By the year 2005, world crude and condensate production may be as much as 15 million b/d higher than the 1996 level.

A study recently completed by Petroleum Economics Ltd. (PEL) looked in detail at the expected changes in crude oil supply in relation to changes in refinery demand, with particular emphasis on the quality distinctions, particularly in the Atlantic basin markets.

In the early 1990s, almost all the net change in oil supply was of heavy crudes. However, the quality of new oil production changed significantly in 1994, with a substantial increase in light (and principally sweet) crude becoming available.

During this period, there was also a slowdown in additional heavy crude production, largely due to virtually no growth in Middle East heavy crude production, as total output from individual countries remained largely unchanged and, for the Organization of Petroleum Exporting Countries, close to quota.

This turning point in 1994 was almost entirely due to the sharp rise in North Sea production, which amounted to 900,000 b/d and was almost all light, sweet crude.

As a result, about 60% of the increase in world oil production in 1994 was of light crude, compared with an average of less than 10% in the early 1990s.

This trend was maintained through 1995, when, again, more than half of the increase in supply was light, sweet crude.

However, this increase in light production was more broadly based than in 1994, with increases in light crude production in Colombia (with the start-up of Cusiana field), the Middle East (with the start-up of the Arab "super light" stream), as well as in the North Sea.

In 1996, further sustained growth in light production fell short of expectations and the output of heavier crudes increased sharply and substantially in excess of incremental light production.

The slowdown in growth in light crude production was partly attributable to delays in new field developments in the U.K. North Sea sector; but more importantly, there was a sharp upturn in heavier crude production, not seen since 1993.

New production

During 1997-98, light crude production is expected to increase as a result of:

• The start-up of delayed and currently scheduled North Sea fields.
• New light production from Colombia.
• New production coming on stream in Algeria, Libya, and Nigeria.
• Resumption of exports from Iraq, which are predominantly light, sour crude.
• New, light output in the Middle East.
• The large-scale increases in condensate production, particularly in the Middle East (Abu Dhabi and Qatar) but also in the North Sea and Asia-Pacific (Thailand and Malaysia).

Despite the fact that production in Saudi Arabia, Kuwait, and the United Arab Emirates is expected to increase, reflecting the new OPEC quotas, incremental light crude production is still likely to dominate the changes in world oil supply during 1997-98.

Beyond 1998, however, it is likely that changes in oil supply will be dominated by heavier crude production.

Light production in the North Sea is expected to reach close to peak levels around 2000 and possibly begin to decline during the first half of the next decade.

Also, new, heavier crude developments, particularly in the Western Hemisphere, are expected to be the focus of new crude production.

Sweet crude production increases account for more than half of the total increase in production in 1995-96 and, in 1997-98, are expected to account for two thirds of the total.

In the late 1990s, sour crude increases are expected to dominate, and in the first half of the next decade, almost all the net increase in supply is expected to be sour.

Whereas, in the early 1990s, light, sweet crude accounted for around 10% of the total increase in oil production, during 1994-96, it accounted for about 40%.

Moreover, the increases in light, sweet production anticipated during 1997-98 are expected to amount to 50% of the overall increase, although these increases are concentrated in a few countries, namely Colombia, the U.K., Norway, Algeria, Libya, and Nigeria.

However, these trends are expected to be reversed in the late-1990s and the early part of the next decade, and the overall net increase in light sweet production is predicted to account for less than 10% of all new supplies during this latter period, similar to the situation in the very early 1990s.

Output climbs

These shifts are being driven by developments in the Atlantic basin.

The strongest growth in production has been, and is expected to be, in this region.

During 1990-94, spurred largely by developments in the North Sea, Atlantic basin crude and condensate production increased by about 2.3 million b/d (a rate of just under 600,000 b/d/year).

In this period, North Sea production alone accounted for more than 70% of the total increase in production in the region.

During 1994-96, the region's annual rate of increase in production more than doubled, with production in- creasing another 2.6 million b/d in only 2 years.

But while North Sea production continued to show large increases, this was overshadowed by growth in production from Latin America.

Despite expected increases in production of about 1 million b/d from the North Sea during 1996-2000, the future growth in Atlantic basin production is expected to be led by developments in Latin America.

In Venezuela, Brazil, Colombia, and Mexico, output is expected to rise by more than 2 million b/d during 1996-2000.

Developments in Africa (Algeria, Nigeria, Angola, Congo, Libya, and Chad), are expected to add more than 1.2 million b/d to the region's output over the same period.

Also, an upturn in crude exports is anticipated during the late 1990s from developments in Azerbaijan and Kazakhstan.

New crudes

From a quality perspective, in the early 1990s, with the North Sea playing the dominant role in the region's growth in production, the incremental barrel produced was typically light and sweet.

However, with the rapid growth in output from Latin America, the region's incremental barrel has become progressively heavier.

Although the majority of this increase in heavy crude production is sour, it is noteworthy that there are a number of developments that are likely to bring on stream heavy, sweet supplies.

Much of the new production in Brazil and Africa will be heavy sweet, as will a number of the new North Sea crudes.

The increases in light sweet production during 1997-98 are led by developments in the North Sea, with some of the large increase in 1997 reflecting new production that was originally scheduled to come on stream in 1996.

In the late 1990s, most of the Atlantic basin region's incremental light, sweet crude is expected to come from Africa, with also some notable increases in light sweet supplies from the former Soviet Union (FSU) and Caspian region.

On the other side of the quality spectrum, it is important not to overlook the continuing substantial increases in heavy sour production in the Atlantic basin region.

It is further particularly important to note that, during 1996-2000, out of the total increase in heavy sour production of more than 2 million b/d, more than 70% of that increase is expected to be 20-28° gravity or below 20° gravity.

The chart on p. 17 illustrates the average annual changes in Atlantic basin oil production, split by quality category.

Demand factors

Global and regional demand for crude is essentially determined by developments in oil product demand and refinery capacity.

Outside the Atlantic basin, the expected substantial increase in throughput in the Middle East is primarily the result of significant refinery capacity increases in the region, with much of that capacity geared to providing product to the growing Asian markets, as well as to satisfy growing product demand within the Middle East.

Throughput is assumed to remain essentially "local" sour crude. The rather limited light, sweet crude production in the region is all assumed to move into the export markets, primarily into the Asia-Pacific region.

The tremendous growth in refining capacity in Asia is expected to continue, albeit at a somewhat slower rate than has occurred over the last few years, and regional throughput is expected to increase by more than 3 million b/d during 1996-2000.

Almost all Asian crude production is expected to remain in the region, but the bulk of Asian throughput will be Middle Eastern sour crudes, predominantly heavy sour.

However, tightening environmental requirements in much of the region will draw increasing volumes of light sweet and heavy sweet crude from the Atlantic basin into Asia.

Flows from West Africa and the North Sea into Asia were estimated at 700,000 b/d in 1996 and are expected to reach 1.2-1.5 million b/d by 2000.

Because the Atlantic basin is a large net importer of crude oil, refinery throughput does not mirror production in the region, neither in terms of volume nor in quality.

In very broad terms, driven by buoyant demand growth throughout most of the region, Atlantic basin refinery crude demand is expected to increase by 2.7 million b/d during 1996-2000.

With generally greater environmental pressures, demand growth essentially in light and middle distillates, and somewhat limited increases in upgrading capacity, the quality mix of Atlantic basin throughput is expected to shift slightly towards the use of lighter and more low-sulfur crude inputs.

Western Hemisphere

During 1996-2000, U.S. Petroleum Administration for Defense Districts 1-4 refinery crude demand is expected to increase by just over 500,000 b/d, while crude distillation unit (CDU) capacity will increase by almost as much.

U.S. refinery utilization rates will rise slightly over the period, and with the completion of several upgrading units (primarily cokers), slightly more than one half of the incremental throughput is expected to be heavy sour crude, which can be readily met by increasing Gulf of Mexico production.

In Canada, refinery crude demand is expected to grow only slightly, as utilization rates increase slightly. Roughly half of the incremental demand will be heavy sour crude, reflecting increased domestic production.

While light sweet production in Canada is expected to decline in 1996-2000, the expected reversal of the Interprovincial Pipeline Line 9 from Montreal to Sarnia in 1998 will enable more imported crude to move into central Canadian refineries, with much of that incremental crude expected to be light sweet.

In Latin America, refinery crude demand is expected to increase by more than 1.1 million b/d, with strong growth driven by new CDU capacity, as well as by increased utilization rates throughout most of the region.

These higher utilization rates are driven by expected strong growth in product demand in the region, as well as by the growth in U.S. product import requirements.

While the Latin American region will show strong growth in light, sweet crude production (primarily from Colombia) during 1996-2000, almost all of that increase is expected to be exported from the region, principally to the U.S.

Heavy sweet production in the region is also expected to increase sharply, particularly in Brazil.

However, despite substantial growth in refining capacity and capabilities, as well as increased utilization over the period, configuration constraints will force some of the incremental heavy sweet production into the export market.

In order to continue to process substantial volumes of the region's predominantly heavy crude, the Latin American region is investing in almost one-half of the Atlantic basin region's new cracking/upgrading capacity.

Nevertheless, imports of light sweet and light sour crude, primarily from West Africa and the Middle East, respectively, are expected to rise in Latin America, as regional refiners seek to balance the predominantly heavy "local" crudes.

Europe

In Europe, it is likely that there will be a decline in crude distillation capacity during 1996-2000.

There is only a limited amount of planned investment in new capacity, and it is likely that this will be outweighed by the planned/probable shutdown of some capacity.

Nevertheless, refinery throughput in Western Europe is projected to rise by about 500,000 b/d during 1996-2000 through higher utilization of existing crude distillation capacity.

Against this rise in demand for crude, there are far more substantial increases in "local" crude production, from the North Sea (light sweet and heavy sweet supplies) and North Africa (light sweet supplies).

Thus, most, if not all, of these incremental crude runs are likely to be met by short-haul supplies from the North Sea into Northwest Europe and from North Africa into Mediterranean Europe.

During the first half of the 1990s, essentially all incremental crude runs in western Europe were sweet and came almost exclusively from the North Sea and North Africa.

Where possible, European refiners are likely to continue to run more local, sweet crudes. The reason for this is the increased availability of these supplies, combined with upwards price pressure on the light ends/middle distillate part of the barrel, weakness in the residual fuel oil market, and only limited planned investment in upgrading capacity.

As a result, a far greater proportion of crude run in the European refining system is likely to come from these "local" sweet sources.

It is also the case that any increase in crude exports from the FSU during the next 3-5 years is likely to come from Azerbaijan/Kazakhstan and will probably be light sweet.

These volumes will be moved via the Black Sea, and the closest market will be in the Mediterranean.

Taking into account this substantial increase in short-haul crude supplies (almost all of which is sweet) and the likely preference for these volumes, it is possible that not only will the net increase in refinery throughput be for sweet (predominantly light) crudes, but sour crude processing could be reduced.

Consequently, longer-haul crude movements of heavy, sour supplies from the Middle East into Europe could fall during 1996-2000.

Thus, the European refining system is already running significantly higher volumes of sweet crude than in the early 1990s, and this trend could be extended through the latter part of this decade.

Other regions

In Africa, refinery crude demand is expected to increase by almost 300,000 b/d in 1996-2000, with increases in throughput generally reflecting the quality of local production (i.e., light sweet in particular, but also some heavy sweet).

In eastern Europe, refinery crude demand is also expected to increase by almost 300,000 b/d during 1996-2000, with the incremental throughput expected to be predominantly light sweet, primarily from North Africa into southern areas and from the North Sea into northern markets.

In addition, some increased light, sweet supply is expected to come from the FSU/Caspian area via the Black Sea into the southern European markets.

In comparing regional crude and condensate production with regional throughput, it is important to note that, over the next 3 years, regional production is expected to increase substantially faster than refinery throughput, thereby reducing the net import requirement for the region.

Thus, the net imports into the Atlantic basin, which have already fallen from 7.8 million b/d in 1994 to 4.3 million b/d in 1996, are expected to be more than halved during 1996-2000, to 1.7 million b/d.

The significant factor with regard to this production and demand outlook is the implication for future trading patterns and to what extent existing Middle East trade to the Atlantic basin is backed out and moves to the Asia-Pacific market.

Alternatively, substantially greater Atlantic basin volumes could move to the Asia-Pacific.

Imbalances

More importantly, by 2000, more than 2.2 million b/d of Middle East heavy, sour crude (theoretically, at least, the marginal supply into the region) could potentially be "backed out" of the Atlantic basin market.

Alternatively, given that Middle Eastern suppliers might not be willing to concede the Atlantic basin markets, substantial volumes of Atlantic basin heavy, sour crude oil could be forced to find a market outside the region, in the Asia-Pacific.

The table on p. 19 [112,263 bytes] summarizes the development of these imbalances.

During 1996-98 and 1998-2000, the net requirement for heavy sour crude is expected to fall by around 1.1 million b/d for each forecast period.

The pressure is thus more or less chronic.

However, in the first of the two periods, there is also a marked reduction in the net requirement for sweet crudes. If light, sweet and heavy, sweet are combined, it can be seen that the net reduction in 1996-98 is more than 800,000 b/d. This, however, does not continue in 1998-2000.

Light, sweet crude is estimated to have been in a net export position in the Atlantic basin in 1996 of about 950,000 b/d, up from about 62,000 b/d in 1994.

By 2000, the net export position is expected to increase further to 1.24 million b/d, as a surplus of Atlantic basin material pushes and/or is pulled into Asian markets. Very much the same can be said for heavy, sweet crudes, which are also expected to show substantially increased movements to Asia.

Imports of light, sour crude are expected to increase during 1996-2000 largely because there were essentially no Iraq exports in the 1990s prior to late 1996, but at least limited exports have been assumed to be in place in the outlook period.

It is in the heavy, sour category that the reduction in net imports is expected to make itself felt the most. From more than 8 million b/d in 1994, these are projected to fall to only 2.7 million b/d by 2000.

If Russian and Iraqi export volumes are considered as Atlantic basin supplies, the Atlantic basin's need for Persian Gulf crude could be reduced to almost nonexistent levels.

However, it is strongly expected that at least some Persian Gulf crudes will be priced at sufficiently competitive levels to ensure sales to the Atlantic basin.

While this would result almost certainly in a reduction in oil sales revenues, it is likely that such sales will be seen as having a high strategic value.

If it is assumed that Persian Gulf exports to the Atlantic basin are maintained at an appreciable level, the production and refinery throughput projections used here imply that Atlantic basin heavy, sour crudes will either be forced to move to Asia or be priced at a low enough level relative to lighter and sweeter crudes to change the choice of crudes.

Either way implies high levels of competition between heavy, sour crude oil producers and relatively weak heavy, sour crude oil prices. The major focus of this competition is strongly expected to be in trade to the U.S. Gulf Coast.

PEL's study projects no increase in U.S. import demand for heavy, sour crude, but it foresees strong growth in supplies in the Western Hemisphere, which look to the U.S. as their main market-indeed, in the case of some crudes, most especially Canadian crude, as their only market.

Conclusions

A number of responses can be expected.

First, some producers may attempt to ensure markets for their own crudes by integrating forward, and there has been ample evidence of this already.

Second, however, it can be expected that imaginative pricing approaches will be considered with the initial intent of locking in markets, a form of "soft" integration.

However, a second intent of such pricing may well be to attempt to defend the price of the existing baseload of crude sales.

If Western Hemisphere producers are forced to look much further afield than the U.S. Gulf Coast for markets, they can be expected to try to prevent the marginal market, setting the price for all their sales.

There are also a number of price implications of the Atlantic basin production developments.

The relationship between Persian Gulf prices and Atlantic basin prices has been shifting as increasing volumes of Atlantic basin oil moves east and decreasing volumes of Persian Gulf oil move west.

This trend is expected to continue and, indeed, become more entrenched. Essentially, PEL believes that the differential between Atlantic basin and Persian Gulf crudes will be formed in the East, not in the West.

Thus, at any given price for crude in the Persian Gulf, the price of a similar crude in the Atlantic basin can be expected to be significantly lower than several years ago; the freight-rate element of pricing has been reversed.

In addition, product price differentials are expected to widen in the next few years, and light/heavy crude price differentials will follow. The same is believed to be true for the sweet/sour spread.

The specific relationship between product values and crude prices is contentious and almost certainly changeable, but a widening in price differentials can be expected.

However, additional weakness in heavy crude prices is expected as buyers will want and probably will achieve a greater price discount than value differentials would imply.

In conclusion, it would seem that the technical successes of the oil industry in producing significantly more oil in the Atlantic basin will be tempered by the fact that the relative price that some of this oil can achieve will be lower than anticipated.

The Author