The great disruptor that is US shale oil is coming to Asia, as refiners in the energy-hungry region look to expand and diversify their sources of crude, and the consequences will likely go well beyond a shift in oil trade flows.
It should come as no surprise that rising oil output in the United States would find its way to the region that is the world’s fastest-growing consumer of the fuel, but perhaps the rapid pace of the shift has caught some in the market off-guard.
Crude oil exports to Asia from the United States are still relatively small-scale, with Thomson Reuters Oil Research and Forecasts estimating flows of around 261,000 barrels per day (bpd) in the first eight months of the year.
However, this is about 10 times what they were in the same period last year.
Major buyer China has gone from taking just one cargo of under 1 million barrels in the January-August period in 2016 to buying about 115,000 bpd from the United States so far this year.
It’s also likely that US shale oil exports will rise sharply in the next couple of years as production grows rapidly.
In one of the major U.S. shale plays, the Permian Basin, output is expected to surge to 2.9 million bpd by next year from the current 2.4 million, Ryan Krogmeier, vice president of crude supply and trading at Chevron, told the S&P Global Platts Asia Pacific Petroleum Conference in Singapore on Monday.
Much of this production will be exported as US refiners along the Gulf Coast aren’t capable of processing more light crude, having been set up to deal more with heavier and sour grades from offshore Gulf of Mexico platforms and imports from the Middle East.
That leaves Asia as the clearing house for US crude. But there are several factors that have to work together to ensure that U.S. crude does actually flow east.
The first, and most important, is that US crude has to remain at a significant discount to similar grades, given the higher loading and shipping costs.
US shale crude is largely priced against West Texas Intermediate (WTI), while the other light grades that typically move to Asia, such as crude from Angola and Nigeria, are priced against Brent, often described as the global benchmark.
The spread between the two grades has widened recently, with Brent closing at $59.02 a barrel on Monday, a premium of $6.80 to the closing trade for WTI.
Effectively investors are taking the view that there is still surplus crude in the United States, home of WTI, while the market for Brent is starting to tighten as efforts by the Organization of the Petroleum Exporting Countries and allied producers start to drain global inventories.
WTI DISCOUNT TO REMAIN
The current discount of WTI certainly makes it profitable for traders to ship U.S. crude to Asia. If enough cargoes are booked, it should in theory boost the price of WTI relative to Brent.
However, there is a limit to how much WTI can rise relative to Brent before sending US crude to the East is no longer economically viable.
Estimating that level is obviously an inexact science, but its worth noting that the two biggest months for US crude arrivals in Asia this year were April and June.
In both cases, the discount of WTI to Brent was wider about six to eight weeks ahead of those months, suggesting that traders need a gap of around $5 a barrel to make the trade profitable.
This implies that WTI will have to remain in a structural discount to Brent is order to clear rising US crude supplies.
Of course, this level is far from fixed or permanent.
It could easily be lower in coming years as the United States builds out infrastructure that would allow for crude exports to be loaded directly onto the largest oil tankers, rather than medium-sized carriers as is currently the case at many export ports.
The other major implication is that WTI is going to become considerably more important in pricing decisions among Asia crude buyers.
If Asian refiners seeking light crudes can buy at prices linked to WTI, that may be far more attractive than looking at crudes priced against Brent.
This could mean that producers who use Brent as a benchmark will have to offer greater discounts in order to compete in Asia against US crudes.
While WTI would have a long way to go before supplanting Brent as the global benchmark, it may well make inroads in Asia and become more attractive to market participants in the region as a tool for hedging and price discovery.