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Crude oil prices have changed – and now so have the trading patterns

By Joel Hanley

August 28 - The changing landscape of oil in the run-up to – and since – the onset of recession in many of the world's major economies goes beyond simple prices.

Once the preserve of the refining and investment community, crude oil prices have become fodder for water-cooler conversation and now, with values in the spotlight, other aspects of the crude markets are gaining attention too.

Since the end of 2008, for example, the British public for example have become used to seeing large tankers off their coastlines, chartered on a long-term basis for crude oil storage.

It is not so much the market price but the underlying structure that has made this contango play possible, where prices for oil in the future are stronger than prompt demand can support.

This waterborne stockpiling of crude has been a major feature of 2009 from Northwest Europe to the US Gulf Coast, where up to 20 million barrels of one grade – North Sea Forties – were held on vessels awaiting delivery into a stronger price environment.

This contango strategy is symptomatic of a market beset by weak demand and only which sees better value further down the curve.

Prompt demand has fallen since even before the onset of July 2008's record highs of $147/b, and certainly showed few signs of growing as crude values fell to below $40/b as early as December the same year.

The International Energy Agency's forward looking estimates for crude oil demand have been adjusted and readjusted as oil prices fell and now have shown a rise from their sub-$40/b levels earlier in the year.

In its latest monthly oil market report, issued at the end of August, the IEA said it now expected demand for oil to average 83.94 million b/d in 2009, 190,000 b/d more than previously predicted, with the corresponding figure for 2010 raised by a smaller amount of 70,000 b/d to 85.25 million b/d.

Bullish traders often latch onto such figures, hoping for a recovery that will support prices, but these upward revisions could eventually hamper any recovery, as economies struggle with higher energy bills.

"There are green shoots [of recovery]," said an OPEC minister recently. "But we must be careful not to crush them."

The OPEC effect

OPEC has played a crucial role in price behaviour in 2009, as the 4.2 million b/d cuts agreed by its members at the end of 2008 really took hold and created interesting new trading patterns.

Given the nature of the Saudi Arabia-dominated volumes the cartel produces, a typical OPEC barrel might be considered heavier and sourer than many on the market.

The cuts and increased compliance with quotas have removed many of these barrels from the market, leading to a shortfall for such grades.

As a result of the scarcity of heavy, sour cargoes, buyers in Asia, where buying has not seen quite the demand fall as that in Western economies, have had to look further a field for their staple diet.

Russian Urals crude, a medium-heavy, medium-sour grade, has found its way over to China, which has not been a typical route for it in the past.

The Eastbound exit for Urals was a contributing factor to the differential of Urals crude in the Mediterranean rising above benchmark grade Dated Brent for the first time on July 10. While values have now fallen to within a dollar under Brent, prices are still historically strong.

Another more visible result of the pull from Asia has been an inversion of the Brent/Dubai spread, the bellwether of Middle Eastern sour crude and its sweeter Northwest European counterpart.

As the dearth of sour crude has persisted over the year, Brent fell below Dubai for the fist time in history on June 29.

The popularity of heavier crude has been in stark contrast to the length in lighter crude. Grades such as North Sea Forties has been in such oversupply that new buyers have emerged, such as Chile's ENAP for whom the grade can now make sense over local crude.

Heavier grades have been en vogue for most of 2009, with West African crude also providing a clear illustration of the effect of Asian buying and the gradual shift in refining capability in countries such as India and China.

Companies such as Indian Oil Corporation and Reliance, which operates the giant 580,000 b/d Jamnagar refinery in Western India, have been buying more West African oil than ever before, as upgrading equipment shifts the demand pattern to heavier crudes.

India now takes around 20 million barrels of West African oil. It is no coincidence that imports to India from Angola rose from effectively nothing in 2004-2005 to over $1 billion in 2007-2008.

Given the rise in Indian buying of heavy, sweet Angolan crude oil, many feel the likelihood is that this is just the beginning of a booming source of revenue for Angola.

The narrowing of value between heavy sweet Angolan grades and lighter sweet Nigeria grades bears this out, traders have been saying for some time, as product demand for the more expensive middle distillate- and gasoline-rich grades has dropped and that of fuel oil-rich grades have risen, along with the capability to further refine heavier products.

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