The horrendous attack in the Golan Heights over the weekend together with the Ukrainian drone strike on an oil depot in Russia’s Kursk region only provided a brief price support as the new week kicked off. The plausibly rigged Venezuelan election where the incumbent was declared winner leading to security forces clashing with opposition supporters, and which probably will entail renewed US sanctions on the country’s oil exports also failed to provide substantial upside push and so did the planned US Department of Energy purchase of 4.65 million bbls of crude oil in the fourth quarter of the year to replenish SPR.

Instead, macroeconomic considerations keep shaping investors’ sentiment and oil slid through technical supports like hot knife through butter. Chinese economic turmoil, including sluggish growth and falling crude oil imports, is still a major driving force for our market. But grim prospects have spread to the wider commodity sector. The S&P GSCI Commodity Index matched the performance of October Brent with a return of -6.1% month-to-date. Crude oil backwardation, both WTI and Brent narrowed considerably, Brent CFDs have also come under pressure of late and Nigerian crude has had difficulties of finding buyers, partly because the newly launched Dangote refinery is reportedly reselling US and domestic crude due to technical issues.

In the face of general economic resilience investors are keenly watching the meetings of the BoJ, the BoE and the Fed this week. Anxiety is growing that lowering borrowing costs will re-ignite inflationary pressure and would push global and regional economies a step closer to recession. It is, however, worth remembering that even in case major central banks cut rates in coming months, they will be still restrictive enough to guarantee soft landing. It is entirely plausible that any downward revision in Chinese oil demand due to ongoing turbulence will be countered by OPEC+ mitigating or completely halting plans to gradually unwind the 2.2 mbpd voluntary cuts starting 4Q 2024 causing global oil inventories to slim towards the year end, particularly if the compensation pledge for overproduction from the three laggards is implemented in a credible fashion. The current weakness precipitated by unease about the Chinese economy and recession worries is fundamentally justified, its longevity, however, is dubious.

Tightness is Building Up in the US Sour Market

It is an economic axiom that there are gains to be made from international trade. A manufacturer or producer would calculate her opportunity cost (how much it costs to halt the making of one product in order to produce more of the other), compare it with that of her international competitors and concentrate on the one that cost comparatively little to produce. In practice it is more complex than it sounds due to protectionism, trade wars and several other factors. The picture is even more nuanced in our market. Some countries have abundance of the black gold. They satisfy their domestic needs from it and sell the surplus to those who don’t have enough of it. Global oil trade is further complicated by the consumption of fuels refined from crude oil, the composition of which varies from country to country.

The US is the perfect example of the elaborate landscape of crude oil trading. Domestic production is just above 13 mbpd. About 80% of the refinery input comes from crude oil with the rest made up by other liquids, fuel ethanol, HGL and blending components. The end result is roughly 50% finished motor gasoline, 25% distillate fuel, 9% kerosene type jet fuel with other assorted products completing the picture. (Throughout the report we use 2023 data from the EIA.) The US, especially after the emergence of the shale industry, chiefly produces light and sweet crude oil but its refiners rely on heavier and sourer grade. Consequently, refiners are forced to look for alternative supply from abroad whilst producers will happily send their sweeter grades overseas. Last year, average net crude oil imports of 2.3 mbpd was composed of gross imports of 6.5 mbpd and exports of 4.2 mbpd. Given their geographical proximity, the US’s northern and southern neighbours, Canada and Mexico, are the main sellers of crude oil into the US. In 2023 their combined volume of just over 4.6 mbpd (3.87 mbpd from the north and 733,000 bpd from the south), 71% of the total crude oil import volume. These shipments are predominantly sour crudes. Because of recent developments both in Canada and Mexico, the availability of crude oil might be becoming scarcer in the future.

In Canada, the Trans Mountain pipeline expansion should have a palpable effect on Canadian crude oil flows to the US Gulf Coast. It is essentially a twinning of the existing pipeline that stretches from near Edmonton, Alberta to the Westridge Marine Terminal and a Chevron refinery in Burnaby, British Columbia by the Pacific Ocean. The nominal capacity has tripled from 300,000 bpd to 890,000 bpd. The primary goal of the project is to provide new outlets for Canadian crude oil. The first cargo from the expansion loaded 550,000 bbls of Access Western Bend to China. The expansion is designed to reshape the Pacific crude oil market with Aframax shipments destined to the US West Coast all the way to the Far East. It then naturally entails reduced flows from Canada to the main refining hub of the US, the Gulf of Mexico. Two weeks ago, the US imported a record 4.42 mbpd of Canadian crude oil, but again, most of it found homes at refiners in PADD 5, which is isolated from the rest of the US by the Rocky Mountains.
USGC refiners will need to look for replacement and this substitute will unlikely originate from Mexico. The country is in the process of starting up its 340,000 bpd Dos Bocas or Olmeca refinery. The ultimate goal of this long-needed project is the reduce the dependence on foreign, namely US, gasoline shipments by using domestic crude oil as feedstock. Considering that just over 730,000 bpd of Mexican crude found its way to the US last year and around 500,000 bpd US gasoline flowed the opposite direction it is blatantly obvious that USGC gasoline cracks will suffer whilst the region will become structurally shorter on sourer crude when the Mexican refiner becomes fully operational – around the first quarter of 2025, according to latest estimates. The Mexican state-owned company intends to reduce fuel imports to 20,000 bpd in 1Q 2025, down from 498,000 bpd in 1H 2024, although delays in the startup of the refiners could make this target somewhat ambitious. The collective impact of the Canadian pipeline expansion and the Mexican refinery startup should support US sour grades against their lighter and sweeter peers and the discounts observed in the past might narrow and even turn into premium.
 

Overnight Pricing

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