Saudi snub and statistically significant spreads

Deep Dive Summary:

• Medium grades should remain bid.
• CL spreads pricing in severe nervousness.
• WTI exports in October may not be as robust as we had hoped.

Last week’s multi-layered attack on Saudi Arabia sent both physical and financial markets ripping higher.

As the week wore on, the financial markets pulled back from the highs on profit-taking and news that partial flows could be restored on the East-West pipeline. Physical European diffs, however, looked quite firm.

With the late-week confirmation that Saudi Arabia would not sell October barrels to Europe, the region was faced with a difficult situation. As a result, Johan Sverdrup differentials catapulted to record-setting levels in the North Sea window and there was chatter of even higher diffs trading hands outside the window.

(Medium grade Johan Svredrup FOBs surpassing April’s highs)

We estimate the loss of flows to be in the 0.6 to 0.8 mb/d range. From a value perspective, WAF and Central + South American grades represent the best replacement barrels.

According to data from Signal, over the past six months a little more than a third of WAF exports already go to NWE and Med destinations while nearly 45% head to Asian markets.

Conversely, about 40% of the exports from the Americas (ex US and Canada) stay within the Americas, a third headed to Asia, and only about 22% headed to NWE and Med. Using Egina and Payara Gold as representative grades for WAF and South America (respectively), we can see NWE should be the ideal region to maximise complex margins. Mid-October loadings of either grade wouldn’t land until the end of the month.

Perhaps more importantly, if Europe bids away barrels that would have otherwise gone to Asian markets, that disruption will not be apparent until late November/early December due to longer transit times.

Only time will tell, but market consensus expects the US/Iran war to drag on into early 2027 with a high likelihood of restricted flows through Hormuz and Bab-al-Mandeb. Late November and into December is also when we expect refinery activity to return to very strong levels before going back into maintenance season in January.

For non-Russian Europe, we are hearing forecasts in the 750 kb/d range for October CDU maintenance. As strongly as Johan Sverdrup and other local grades have reacted now that we know Saudi has cancelled October barrels, we can only imagine the price reaction would be worse if Saudi cancels November or December volumes as well.

(Strong margins should help attract WAF and LATAM grades to backfill missing Saudi barrels)

October CL futures expire this week, and the front spread is poised to price out within striking range of the highest penultimate settlement value of the last 15 years.

Back in May, the Jun/Jul CL spread settled at a record-setting $4.28/bbl backward. At that time, Jun CL was trading at nearly $109/bbl, nearly $10/bbl higher than Friday’s front-month settle at just over $100/bbl.

More critically, Cushing inventories were at 35% utilisation back in May but are currently sitting at only 27%, up from a recent low of 24.2% in late June.

As a proxy for the actual penultimate settle, Friday’s $4.22/bbl V/X settlement crushes what used to be a solid regression between spread value and utilisation in the month of September.

Based on the regression, V/X should be valued at $0.62/bbl. As of Friday, V/X settlement was nearly 21 standard deviations higher than the 0.85 R^2 regression model’s forecast.

(V/X CL used to be very well behaved)

(This year V/X is pricing in much more than just Cushing inventories)

(V/X spread view on the Sparta platform as of Sunday night)

So, if utilisation rates have been lower and flat price has been higher and there has only ever been one penultimate settlement higher than where V/X went out on Friday, what is the market trying to tell us? Going all the way back to 2011, CL spreads have only settled wider than $2/bbl on penultimate day five times.

In the following table, we offer some very brief commentary on what may have driven settlements so high. Unsurprisingly, they all relate back to concerns about supply. Perhaps even more telling, the top five strongest CL penultimate settlements occurred in spring or summer as global refinery demand is either ramping up or trying to maintain high throughput, whereas October is more of a shoulder month pricing in lower refinery demand.

With news stories popping up this weekend about renewed attacks by the Houthis on Saudi targets and both Iran and the US seemingly bracing for renewed violence, the news from Aramco that Europe will not be receiving October allocations stands out from the rest as a targeted definitive statement while previous supply constraints came with caveats (maybe ships can turn off transponders and get through.

If Russia increases sales to China then China won’t pull as hard on AG leaving more AG barrels for…). We will be watching Monday’s V/X settlement very closely.

(Severe backwardation the new fear meter?)

(Late summer and Q4 CL spreads rarely settle on penultimate day wider than $1/bbl)

Relying on penultimate front-month CL settle has not been a very good indicator of future flat price direction, but we believe it is a good indicator of overall nervousness in the market.

The decision by Aramco not to ship barrels into Europe for October should continue to be bullish sour grades vs sweet, especially in the WTI- and Brent-based markets. As it is likely that Europe will pull WAF and/or South American grades that would normally go to Asia, this will likely support sour grades in Asian markets too in November and December.

We continue to be bullish Mars basis in general. X and Z contracts each traded just over 1,000 contracts last week, giving us a little hope for liquidity in the front months while Q1 has yet to register any open interest.

WTI exports are not looking as robust as we had hoped for October, and we closed out of our Houston/Midland basis spread position at a scratch. We would like to sell into December WTI/Brent again if the spread narrows into the -$6/bbl area.

Both the long Mars basis idea and the potential short in WTI/Brent are workable only so long as hostilities continue in the AG. While we hope and pray for peace, the powers-that-be seem intent on keeping the hostilities going.