Author: Brynne Kelly 3/28/2021
When supply is tight, the marginal barrel produced is more at risk to event-driven price spikes. Last week we had one such event, the blockage of the Suez Canal by a vessel named Ever-Given. The Suez Canal is a major choke point in global shipping. A chokepoint refers to a point of natural congestion along two wider and important navigable passages. Maritime choke points are naturally narrow channels of shipping having high traffic because of their strategic locations.
In the present times it is feared that countries with hostile political environment may position their naval troops alongside these global choke points thus adding more vulnerability to an already fragile situation. Alternatively, in choke point areas where political situation is stable there is also the threat of maritime piracy, hijacking, and other crimes. The strait of Bab el-Mandeb and the Suez Canal especially face a huge operational problem because of such pirating attacks.
What happened last week at the Suez Canal is a physical blockage by a vessel at a crucial chokepoint rather than one caused by political instability. This is a transitory issue that shouldn't impact long term prices, but could impact supply agreements. The further away supply is sourced, the more exposure it has to chokepoints and alternative supply routes can be costly.
For some perspective on the amount of oil and oil products this impacts, of the 39.2 million barrels per day (bpd) of total seaborne trade in crude in 2020, 1.74 million bpd went through the Suez Canal, according to tanker tracking firm Kpler. Additionally, 1.54 million bpd of refined oil products such as gasoline and diesel fuel flow through the canal, about 9 percent of global seaborne product trade, Kpler said.
While traffic through the canal isn't necessarily material, the blockage has caused a huge backlog of ships at both the Red Sea and Mediterranean ends of the canal, causing major delays in the delivery of oil and other products. In one sign of the knock-on effects, Syrian authorities said Saturday they had been forced to ration already scarce fuel supplies. The Suez suspension "has impacted oil imports to Syria and slowed arrival of a ship carrying fuel and oil products" from government ally Iran, Syria's oil ministry said.
It's important to note that a transport blockage is different than a supply disruption. Therefore, it's effect should be felt initially in geographic spreads as the market seeks to price in the additional transport costs due to longer or more costly alternative routes.
Geographic Spreads: Brent, Dubai & WTI
A blockage at the Suez Canal should first impact the spread between Brent and Dubai crude oil. These two markets sit on either side of the Suez Canal. This spread is a key indicator of the competitiveness of Dated Brent-linked Atlantic basin light sweet crude relative to sour Mideast Gulf grades. A prolonged high Brent-Dubai spread premium may prompt Asia-Pacific refiners to turn more to Dubai-priced crudes from the Mideast Gulf and Russia's far east. However, because this is not political in nature, it speaks to why there is thus far a muted response. Should this continue as a long-term problem, the market may need to re-evaluate.
Brent vs Dubai
Looking at the 2nd month continuous Brent/Dubai futures spread, the data reveals that while the Brent premium to Dubai has risen more than $1.00 this year, it was relatively unchanged through last week's events.
WTI vs Brent and Dubai
Both Brent and Dubai gained value relative to WTI last week (Brent/WTI=black line, Dubai/WTI=orange line below). At a time when OPEC+ producing nations are still reducing supply, it makes sense that the disruption in the movement of barrels in and around the Suez Canal would have a larger impact on Brent and Dubai prices than on WTI prices. The longer this event persists, the more spreads will need to adjust due to increased transportation costs.
The vulnerability of moving crude oil long distances through major maritime chokepoints was once again exposed this past week. Coincidentally, on Saturday China and Iran, both subject to U.S. sanctions, signed a 25-year cooperation agreement to strengthen their long-standing economic and political alliance. Why is this important? A VLCC sailing at 12.5knots spends 54 days sailing 15,000Nm (+5% sea margin) from Houston to South Korea, while it takes only 22 days sailing from Kharg Island in Iran to South Korea. This is a move that highlights the importance of geographical location. Never underestimate the value of proximity. International trade is a crucial tool used to optimize global supply and demand, but it is increasingly becoming a victim to the physical realities of logistics.
Given that OPEC+ is scheduled to meet this week, the quicker the vessel is removed from the canal the better. Otherwise OPEC+ might be forced to take action to increase production in the area to avoid costlier imports. Bottom line, the dislocations caused by the blockage in the Suez Canal are exposing issues in global deliverability.
The US Deals With It's Own Chokepoint
Behind the scenes in the US, inventory levels in the USGC have had to deal with it's own type of chokepoint - the one caused by last month's winter weather in Texas. The loss of refiner utilization as a result of power outages and storm damage that followed led to a significant build in PADD 3 US Gulf Coast crude oil inventory (pink line below) relative to storage levels in the rest of the country (PADDS 1-2 + 4-5, blue line below). Crude oil backed up in the US system and caused large draws in refined product inventories. This put pressure on USGC crude oil production and led to a decline of around $0.50 in the Midland/WTI spread (right chart below).
In the short-term, the US would welcome the opportunity to offload some of it's gulf coast inventory to global markets and perhaps the blockage at the Suez Canal will provide that opportunity.
The aforementioned inventory overhang is weighing on WTI 1-month calendar spreads.
The post-pandemic recovery is being thwarted by the crude oil inventory build-up in the US this month. As a result, crude time spreads have retreated from their highs. Any bullish sentiment caused by the blockage at the Suez Canal is being offset by the inventory overhang in the US and the rest of the world. This inventory overhang will continue to damped the upside of world events until it is cleared out. Until then, disruptions in the movement of this excess supply only serves as tiny signals of what might be IF markets were actually tight.
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EIA Inventory Statistics Recap
Weekly Changes
The EIA reported a total petroleum inventory BUILD of 6.00 million barrels for the week ending March 19, 2021 (vs a build of 3.10 million barrels last week).
YTD Changes
Year-to-date total inventories in 2021 are DOWN by 8.60 million barrels (vs 14.6 million barrels last week).
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years reflect the imbalance between oil and refined product production created by the winter weather in Texas.
