Analysis: A severe oil scarcity will increase shipping and road construction costs.

 

Reduced exports from Mexico and a rerouting of Canadian output are reducing the already scarce supplies of heavy oil in the Atlantic basin, increasing the costs for refiners and probably having a ripple effect on the building and shipping industries as well as Middle Eastern power plants.

Long-term OPEC supply restrictions as well as international sanctions against Russia, Venezuela, and Iran had already caused a scarcity of heavy crude, making it difficult for sophisticated refineries like those in the U.S. Gulf to secure affordable supplies.

More residual fuel oils from heavy-sour crudes can be refined into more expensive road fuels or transformed into bitumen and marine fuels.

Fuel oil cracks, or the difference between the price of crude and refined product, are predicted to increase in the next weeks due to a mix of factors including limited supply of heavy crude and fuel oil and a seasonal increase in demand for electricity generation. This is according to Vortexa analyst Xavier Tang.

Longer ships traveling around Africa in order to avoid the Red Sea region require more marine fuel oil, while Saudi Arabia uses more fuel oil for air conditioning during the summer months due to increased road construction and demand.

In an effort to reduce its expensive reliance on fuel imports, Mexico reduced its crude exports in April to allow for increased domestic processing. Refiners in the Atlantic basin have been getting ready for the inauguration of the Trans Mountain pipeline extension, which will redirect more heavy Canadian crude to the Pacific, but this further jeopardized the region's sour supply.

As refiners looked for alternative supply, heavy crude prices in the U.S. Gulf surged. According to LSEG statistics, on April 1, the Mars grade reached an almost four-year high against WTI.

"U.S. Gulf refiners have a much more expensive Canadian base feedstock via pipelines, they have less Mexican available, and as a consequence other heavy-sour options are significantly more expensive," Viktor Katona, head oil analyst at Kpler, stated

Price agency Argus Media reports that the Argus Brent Sour index in Europe, which includes Norway's premium Johan Sverdrup grade, reached a 14-month high in mid-April and is currently trading fairly in line with the light-sweet benchmark dated Brent.

The sour market is still fundamentally tight, despite a small price cooling as domestic crude demand in Mexico increased less than anticipated, freeing up more for export.

Referring to the Organization of the Petroleum Exporting Countries and its allies like Russia, "the global crude slate is getting increasingly lighter and sweeter as a direct result of constrained OPEC production, meanwhile non-OPEC+ countries are supplying growing volumes of lighter, sweet crude," stated Jay Maroo, head of market intelligence at Vortexa.

"Unless there is any major change in course by OPEC, it's hard to see that trend reversing."

Based on Kpler data, since 2019, more than half of Europe's imports of crude have been light or medium-sweet. In the first four months of 2024, only 26% of the continent's imports were medium- and heavy-sour, the lowest percentage since at least 2012.

ACT OF BALANCING

Because they are more difficult to refine, higher-density, higher-sulfur crudes are typically less expensive than lighter oils. Refiners who have invested in the expensive upgrading facilities that enable them to process the heaviest grades are particularly affected by the higher prices.

According to Patricio Valdivieso, vice president of oil market analysis at Rystad Energy, "the lack of heavy sour crudes goes directly against refinery profitability and it is a waste of capex for complex refineries."

In the event that heavy crude such as Mexican Maya becomes scarce, refiners will need to adjust by blending whatever other comparable grades they find that work for their setup, says Hillary Stevenson, director at IIR Energy.

For U.S. refiners, it may be financially and operationally challenging to capitalize on the relative supply of light crudes.

A lighter crude diet can affect the stability of a refinery's downstream units, according to Rommel Oates, founder of Refinery Calculator. "If they try to go lighter, the end impact would be lower profitability," Oates said.

Refiners can feed residual fuels into downstream units to counterbalance a lower crude diet. Francisco Goncalves, a FGE analyst, estimates that an additional 50,000 barrels per day of Mexican fuel oil might be processed by U.S. Gulf refiners to replace heavy crude.

However, Kpler's Katona noted that Europe's refineries might not be able to handle such heavy-sour fuel oil and turn it into road fuels.

Before 2022, Russia was the primary supplier of heavy fuel to Europe. However, due to the G7 embargo imposed on Russia due to its invasion of Ukraine, refinery feedstocks such vacuum gasoil and straight-run fuel oil are no longer available.

According to price data from Argus Media, high-sulfur fuel oil barge crack spreads versus Brent futures in Northwest Europe reached their biggest level since January 4 on Wednesday at a discount of about $11.