NEW YORK: Benchmark oil futures are wallowing as hedge funds retrench after their latest burst of enthusiasm for crude but the cash market is sending a clearer signal: Refineries are wading in and buying heavily.
Light Louisiana Sweet, the grade that oil from shale plays was supposed to put under pressure this year, has leapt to a near $3 a barrel premium to Dated Brent as strong gasoline prices spur Gulf Coast buyers to step up purchases. Competing grades, such as medium sour Mars are also showing strength.
The phenomenon is not confined to the United States. Light sweet international crudes from West Africa like Nigerian Qua Iboe or Angolan Cabinda are also rallying.
The strength in LLS and West African crude is all the more
remarkable given the expectation most analysts had that growing US shale oil output from North Dakota and Texas would drive LLS down to a discount to Brent, driving out West African crude.
Clearly that is not happening right now. US refineries are gobbling up the shale oil and banging on the table for more crude.
West African grades have been supported by a string of disruptions to production in Nigeria where the Bonny Light, Qua Iboe and now Bonga streams have all suffered problems. These issues have kept West African grades tight even as Asian buying has edged lower from a year ago.
Over the first quarter of 2013, Asian customers lifted 1.71 million barrels per day of West African crude, down from 1.82 million bpd in the first three months of 2012.
So where is this strength in the cash market coming from?
The answer lies in refining margins and plants gearing up to resume operations after seasonal maintenance.
With traders reporting most West African supplies for April lifting now sold out, refineries are scrambling for alternative supplies.
Indeed the main pockets of weakness in the Atlantic basin cash crude market are in Europe. Russian Urals prices have sunk on weak spot buying while North Sea cargoes are fetching only slim premiums over Dated Brent.
The strength in cash markets, if sustained, could well be the signal that a fresh rally in oil futures prices is in the cards.
But to get there some follow-through in European cash grades is needed. Otherwise what is happening is merely a short-covering rally caused, perhaps, by US refiners getting a
bit complacent over sweet crude supplies.
Indeed, some of the upward pressure in US cash markets looks to be a readjustment of prices amid infrastructure improvements. Heavy crude oil producers in Latin America started the year complaining bitterly about Mexico's continued linking of Maya crude prices to West Texas Sour amid the pipeline bottlenecks that sent WTS prices tumbling.
These complaints have dried up in the last few weeks as WTS prices have rallied in anticipation of the opening of new pipelines such as the Longhorn line from West Texas to Houston.
The recovery in WTS prices has directly boosted the value of Maya and indirectly returned pricing power to other producers who compete on the US market.
Also supporting the market is continued strength in gasoline prices. Despite the recent recovery in stockpiles, inventory levels on the East Coast remain below year-ago levels.
US gasoline demand remains anemic. But foreign demand for US supplies is surging. The United States was a net gasoline exporter in December and Gulf Coast refiners are working to expand their ability to serve overseas markets.
A key question will be the nature of this export demand. How much of this is growth in demand, particularly from Latin America? Are Gulf Coast refiners meeting new demand or are they displacing other suppliers in Europe from this market?
If the bulk of incremental gasoline exports is to meet new demand then it is an unequivocally bullish signal to the market. If it is displacement of European suppliers, the effect is far less positive for oil prices because it likely means European refiners will be forced to reduce production.
So far the evidence is mixed. Mexico, the largest importer of gasoline in Latin America has been reducing foreign purchases amid improved local refinery production.
The country bought only 355,000 barrels per day of gasoline in December, 70,000 bpd less than in December 2011. Yet US gasoline exports to Mexico fell by more than 100,000 bpd in December from a year earlier, according to US government data.
So Mexico's dependence on non-US gasoline suppliers actually increased. At the same time other countries are buying more American gasoline.
Venezuela stepped up purchases dramatically in December, buying 94,000 bpd of the fuel. So too did Central American countries and, ominously for European refiners that depend
heavily on West African gasoline demand, Nigeria.
Perhaps portending a downturn in gasoline prices are rising stocks in Europe. Supplies in the Amsterdam-Rotterdam-Antwerp hub have hit a fresh two-year high of 1.027 million tons.
That suggests a surge in exports should be coming.
But if gasoline prices hold in the coming weeks that should feed into better bids from refiners for North Sea and Russian crudes. And if so, oil prices could be off to the summer races.
— Robert Campbell is a Reuters market analyst. The views expressed are his own.
