Saudi Crude Output and Asian Demand

Last month, Asian refiners mostly declined Saudi Aramco’s offer of extra crude oil barrels, with the exception of one refiner: India’s Reliance Industries which is increasing Saudi imports by 90,000 bpd, (representing close to one-third of Saudi Arabia’s production increase over the last few months).  The reason for such disinterest in Saudi crude, at a time of high crude oil prices, is the quality of oil on offer. Asian refineries are facing losses, and thus are increasingly desirous of higher-quality crude oil that can yield gasoline more easily. However, the discounted Saudi crudes made available were the medium-heavy Arab Light and Arab Extra Light variants, and the Saudi-s continue to maintain relatively high prices for lighter crude variants.

The macro-perspective, however, indicates that Saudi Arabia and its largest Asian customers view heavy crude oil as a panacea for perceived future supply shortages of conventional, lighter crude oil from the Kingdom, and elsewhere in the Middle East. By 2010, India will be the fourth-largest consumer of crude oil, after the United States, China and Japan, and will consume 5.5 million bpd, while China’s crude oil consumption is expected to cross 8.0 million bpd that year. For the moment, Asian demand is being slaked. However, the world’s giant fields, such as Mexico’s Cantarell and Kuwait’s Burgan, are experiencing falling production, and many analysts are skeptical of Saudi Aramco’s pledges to increase conventional crude oil production levels, owing, in part, to claims that the country’s Ghawar field is already past its point of peak production. Globally, light crude production continues to fall as demand remains robust, notwithstanding the recent price fall due to financial market turbulence and slowing US growth.

With over 40% of the world’s oil reserves in the form of heavy crude, resource-holders, such as Canada, are witnessing a dramatic rise in investments designed to exploit these additional barrels. However, global refining capacity, as it exists today, needs to develop to meet future supply of heavier crude oil grades. Along these lines, Saudi Arabia is planning on boosting its refining capacity by roughly 80% over the next five years, through deals with various IOCs and NOCs. This strategy makes sense for Aramco, as it would allow it to earn greater profits, as opposed to selling heavy crude at a US$5-10 per barrel discount, which is the case currently.

Aramco is active in China – it has purchased a 25% stake in Sinopec’s 200,000-bpd refinery in Qingdao and is working with ExxonMobil to set up joint ventures in Fujian province; both these facilities will import Saudi crude oil. Furthermore, while Aramco chose not to buy a stake in India’s 300,000-bpd (post-expansion) Vishakapatnam refinery, it was offered stakes in three other Indian refineries as recently as 2007, with a total capacity of approximately 500,000 bpd. Additionally, as both the Indian and Chinese governments have set retail price ceilings for gasoline, refiners have opted to switch to lower-cost high-sulfur Middle East crude varieties to help recuperate profits. Farther afield, Aramco has made financial commitments in two of its most important Asian consumers – Japan and South Korea. It acquired a 10% stake in Japan’s Showa Shell Group refiner, as well as a stake in South Korea’s SSongyang Oil Refining Company.

Whether by boosting domestic refining capacity, or increasing its stake in such capacity overseas, Aramco is increasing its downstream activities as a way to ensure consistent future demand for its key export, even as critics charge that the company’s light crude production forecasts are too rosy to be realistic. Asian consumers, meanwhile, being highly dependent on imports, are keen to lock in supplies and increase their own upstream skills through bilateral deals with Middle Eastern exporters.

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