Saudi oil supply increase widens sour price gap

Saudi Arabia's solo move to boost output is widening the price gap between undersupplied light crude and abundant lower-quality oil, and will force producers to offer their heavy grades to customers at deeper discounts. Lower relative values for high-sulphur crude hurt most members of the Organisation of Petroleum Exporting Countries (Opec) and benefit refiners that have the upgrading capacity to process heavy oil into light fuels. Brent, a light sweet crude benchmark, touched a five-week high above $120 a barrel yesterday. The discount for Dubai crude, the Middle East heavy sour oil marker, widened to $7.67 a barrel, the biggest since hitting an almost six-year peak near $8 in April. "The sweet-sour spread is going to widen because we are going to have to cope with more heavy crude in a market that needs light sweet grades," said Tony Nunan, a risk manager with Tokyo-based Mitsubishi Corp. "The Saudis are not going to force additional barrels into the market. The best thing for them is to just say it's available, hoping that [futures] prices don't rise too much." Saudi grades are similar to those pumped by the kingdom's Gulf Opec allies and by members that blocked an output increase at the group's meeting in Vienna last week. Those include Saudi rival Iran and its ally Venezuela. Top exporter Saudi Arabia will boost production in July to 10 million barrels per day (bpd), Al Hayat newspaper reported yesterday. The kingdom's oil minister, Ali Al Naimi, made it clear when he left Wednesday's meeting that requirements would be met despite the lack of an Opec accord to raise output. Capacity Saudi Arabia's spare capacity is mostly of sulphurous crude, of little use for simple refiners who need lighter grades to substitute Libya's high-quality output. To prevent a further collapse of sour crude differentials, Saudi oil giant Aramco must reallocate sweeter supplies for export and earmark incremental output of heavy grades for domestic power generation as summer demand peaks. "There is too much Arab Heavy," said a trader with a refiner that buys Saudi crude in northeast Asia. "Even before the Opec meeting, I have been hearing that they had been offering more barrels to some end-users." Confirmation that additional Saudi supplies are on the way came yesterday, when industry sources said it had offered extra crude of all grades to Asian refiners in July. A few refiners were interested in buying more, and India's MRPL has bought a small cargo of about 600,000 barrels of extra Saudi oil for July from Aramco. But most refiners had already covered their needs and declined the Saudi offer. "The question when they talk to customers is that there is no shortage of oil in the market, and even if they tell them more is available, the additional volume they may take is small," said an industry source familiar with Saudi oil policy. MRPL's cargo was of Arab Super Light crude, the source said. While the kingdom has plentiful supply of heavier crude, some traders said Saudi Arabia is also trying to sell additional supplies of its higher-quality crude by making exports of lighter grades cheaper, while raising heavier crude prices. On Sunday, Aramco slashed the official selling price (OSP) of Arab Light to Asian customers by 70 cents for July, down from the second-highest premium on record in June. It raised the price of Arab Heavy by 85 cents a barrel. Differentials Next month would likely see a fall in differentials across the board if Saudi was serious about supplying more oil, traders said. "OSPs will likely drop further now to help entice buyers," said a crude trader with a European trading firm. In another sign of the weakening prices for heavy sour grades, the price of the principal crude stream from the UAE has also fallen. The differential for Abu Dhabi Murban crude has slumped to around parity with the OSP from a premium of about 40 cents last month. The absorption of the Arab Heavy output by the domestic power sector would allow the Saudis to flag their determination to ensure oil markets remain well supplied and their commitment to rein in futures prices, while at the same time safeguarding the relative value of their sulphurous crude exports. Arab Heavy may be used for power generation To minimise the market impact of additional Saudi output of heavy crude, "there may be some flexibility to burn Arab Heavy for power generation", the source with knowledge of Saudi policy said, adding until now the state-owned utility has preferred Arab Light, of which output stands at 5-6 million bpd. Arab Heavy production of about 1 million bpd is mostly committed to term buyers, and any additional output of that grade is likely to go into power generation to replace Arab Light or fuel oil. "The Saudis have already come out to say that the bulk of that is going to domestic consumption," said Barclays Capital London-based analyst Amrita Sen. "All of that extra stuff coming on line is heavy. The light-heavy spread will continue to come under pressure."