Saudi struck, No SPR lifeline in sight

Deep Dive Summary:

• Medium sour grades should continue to perform better than light sweets. We are looking for liquidity for Q1 Mars basis.
• Houston WTI to outperform Midland again.
• Soaring freight rates a massive headwind for AG grades that can get to market.

The rekindling of hostilities between Iran and the US at the beginning of September has now expanded markedly this past week as the Iranian backed Houthi took strategic positions in southern Yemen as well as an attack originating from Iraqi territory on Saudi’s East-West pipeline, the repairs for which may take up to a month.

The net effect if these attacks, combined with recent attacks on Saudi’s Jizan refinery, amount to a quasi-pincer movement against the kingdom. The recently signed Mecca Accord could bring Pakistan and Turkey into fray as well, thus expanding the scope of the war.

With some 400-500Kbpd of Iraqi/Kurdish oil making its way to market via Ceyhan, the fallout from the Iraqi-based attack on the Saudi East-West pipeline could trigger Turkey to (again) shut down the Kirkuk Ceyhan pipeline.

Sabre rattling between Israel and Turkey over expansions into Syria culminated in a mid-August airstrike on a Syrian airbase with the intention of pushing Turkish forces back.

Meanwhile, CPC flows continue to be at risk due to the terminal’s proximity to the Russian/Ukraine war.

Saudi flows of both crude oil and refined product north through the Suez Canal have slowed to a crawl.

The net oil-related result of kinetic action on the Arabian Peninsula seems to primarily impact the Med and long-haul voyages that the Asian market had recalibrated towards. The capacity for various conflicts to escalate into a larger regional war remains high and the complicated web of political allegiances to rival those of the Byzantines.

Furthermore, we should not assume that if one of these conflicts were resolved the others would be as well. While the Houthi actions and attacks from Iraq are undoubtedly connected to Iran, they will likely need to be resolved individually. In a sense, the market is back to April or May type conditions in terms of AG exports. The biggest differentiator, however, is there is no SPR calvary on the horizon, and it is unclear how global medium grades will balance out in the near term if AG grades are either unavailable to too expensive.

North Sea physical markets reacted very strongly to the situation in the Middle East with the front month DFL spiking to levels not seen since early May. Broker commentary reported seeing both commercial and financial buyers crowding into DFL futures.

Balmo DFLs spiked north of $10/bbl on refinery buying and on top of Brent futures already north of the $100/bbl mark. Dubai futures rallied on the week as well but by the end of the week the Brent/Dubai EFS returned to the $11/bbl area.

(Brent futures leading the flat price rally)

Dirty freight markets continue to rally as well, further bolstering landed prices. The Sparta platform shows a huge spike in VLCC freight for Ras Tanura to Amsterdam for October was showing nearly $78MM. For about a third less, the same VLCC from Ras Tanura could go to Ningbo.

But even that looks rich against the $35MM route from Nigeria to Ulsan. Freight rates just south of Hormuz, at Fujairah, are less than half the cost from Saudi’s Ras Tanura port.

While a Fujairah lifting is the cheapest of the major routes to Far East we selected, voyages from USGC and Guyana are the cheapest when viewed as a $/day figure.

As we have seen quite a bit lately, Asian buyers would do well to look to the Atlantic Basin or Med/Black Sea to limit freight cost exposure.

(VLCC rates to Far East originating inside the AG are more than double those just outside Hormuz)

WTI/Brent spreads widened out to our -$9/bbl target late last week. This financial move, along with stronger cash prices in NW Europe, helped to open export opportunities from the USGC once again.

Our initial reaction to the spread widening to our target was to reverse the trade and go long. However, with the fast-moving development in Yemen, Saudi Arabia, and Iran we might be better off letting things play out for another couple days.

One of the revelations from APPEC was the consensus among analysts that the Hormuz and Bab al-Mandab restrictions will continue into at least Q1 27. This fits well with our earlier call to extend or add length in Q1 27 Mars basis.

With the situation in the AG getting materially worse for the global oil market, we would likewise suggest that crude importers and trade shops look to lock in forward volumes of South American or North Sea medium grades.

Of the medium grades we track on the Sparta platform, a little under 60% originates inside the AG. Within the remaining 40% outside the AG, WAF barrels offer the best landed value into Far East but Brazilian grades offer better complex margins.

(Best landed value for medium grades in the Far East)

(Best complex refining value for medium grades in the Far East)

With the anticipated pick up in WTI exports in Q4 and the $100 spot price encouraging US shale producers onward, we would like to initiate a Houston/Midland basis spread in the December contract at around Friday’s settlement of $0.64/bbl.

Back in the calendar month of April, the M2 (June) ‘Longhorn’ spreads crossed north of the $1/bbl threshold more than 60% of the time while the front month (May) spent the first 8 days well north of the $1.50 mark.

Using the pre-war Q1 26 minimum spread of $0.19/bbl as a stop, and an upside target of $2/bbl, we think we’ve found a relatively low risk moneymaker in a time when flat price is chopping around several dollars per barrel every day.

(Houston/Midland WTI spreads may return to levels seen in April)

We think the flat-price market will continue to march higher in the very near future. Brent futures market will likely continue to lead the market higher.

We continue to look for entry points and liquidity to get long Q1 Mars basis. We also think Dec WTI/Brent will eventually start to narrow back in, but the current headline risk is too great at the moment, to carry much of a position.

As mentioned above, we will look to enter a Dec ‘Longhorn’ spread on Monday.

Of course, these views assume ongoing friction in the Middle East. If the peace we hope for does somehow break out we have to rethink these positions.