Yesterday, there was a sudden rash of news stories about how Libyan crude is light and sweet and it's loss thus is having a disproportionate effect on world oil prices. In particularly, Saudi Arabia's shut-in spare capacity is alleged to be too heavy and sour to substitute for Libyan oil, so that even though the Saudi's have the capacity to produce more, and would be more than happy to oblige the world by doing so, it wouldn't help because it's the wrong kind of oil.
Color me deeply suspicious.
Here's an example of this newly minted genre from the New York Times:
Libya produces less than 2 percent of the world’s oil, and exports little to the United States. But the high quality of its reserves magnifies its importance in world markets.And here's the Financial Times' version of the same thought:
Libya’s “sweet” crude oil cannot be easily replaced in the production of gasoline, diesel and jet fuel, particularly by the many European and Asian refineries that are not equipped to refine “sour” crude, which is higher in sulfur content. Saudi Arabia has more than four million barrels of spare capacity and has promised to tap it if necessary, but that capacity is mostly for sour grades of oil.
Should the turmoil in Libya last for more than a few weeks, oil experts predict that European refiners will be forced to buy sweet crude from Algeria and Nigeria, two principal sources of sweet crude for the United States. That would probably push up American gasoline prices, which have already risen 6 cents a gallon over the last week to an average of $3.19 for regular grade.
“It will force all sweet crude refiners into a bidding war,” said Lawrence J. Goldstein, a director at the Energy Policy Research Foundation, an organization partly financed by the oil industry. “Quality matters more than quantity.”
Sweet crude is particularly well suited for producing diesel fuel, which is far more popular as a transportation fuel in Europe than in the United States. Sour crudes are more expensive to refine, but American refineries are typically outfitted with equipment to refine them because so much oil imported to the United States comes from Latin America, where many oil reserves are sour.
The last time there was a shortage of sweet crude, in 2007 and early 2008, oil prices surged to more than $140 a barrel, although that shortage was caused mostly by spiraling demand and not a sudden cut in supply.
The reservoirs beneath its desert landscape yield crudes that are easily refined into diesel and petrol and also low in sulphur, making them cleaner to burn. Opec, of which Libya is a member, has adequate spare supplies to replace the country’s lost production – but the quality is mostly inferior.And then, here's the BBC:
“Libya is a producer of light, sweet crude,” says Andy Lipow, president of Lipow Oil Associates, a Houston consultant. “The spare capacity among Opec members is heavy, high-sulphur crude.”
This means sustained, widespread stoppages of Libyan production could require oil companies to do more than just replace lost barrels.
They would need to find barrels of equivalent quality from Algeria, Nigeria, the Caspian region or the North Sea. The bidding could further raise prices for the kinds of high-quality crudes that underpin benchmark oil futures contracts and reduce fuel output from refineries unable to afford them.
Crimping Libya’s crude flow comes at an inconvenient time. The world’s thirst for oil is especially strong in diesel and other distillates, which JPMorgan estimates will account for more than half the world’s demand growth this year. Light crudes yield more diesel per barrel than heavier crudes.
On Tuesday, Saudi Arabia's Oil Minister Ali al-Naimi had tried to reassure markets that his country's spare production capacity could help to "compensate for any shortage in international supplies".You get the picture: suddenly many of the developed world's most authoritative news sources are all, at the same time, telling us that although Mr al-Naimi indeed has 4mbd of spare production capacity, and is more than happy to increase oil production, it won't help because it's the wrong kind of oil.
Saudi Arabia has 4 million barrels per day of spare capacity which it can bring online if needed.
However, Amrita Sen, an oil analyst at Barclays Capital believes more concrete actions are required.
"Unless we see an explicit move from... producer countries, i.e. Saudi Arabia, I don't think there is necessarily going to be any downward pressure on oil prices."
There are also concerns that it will not be easy to make up the shortfall in Libya's high quality light, sweet crude.
Much of the spare capacity among the Opec group of oil producing nations is heavy, high-sulphur - or sour - crude, which can be more difficult to refine.
This story sounds superficially plausible. It is true that Arab Light, say, is listed as having 1.97% sulphur, which exceeds the 0.5% limit usually required to consider oil "sweet". Contrast say, the 0.37% sulphur content of Brent, or the 0.24% of West Texas Intermediate (the two benchmark grades of oil that are the most widely used for purposes of trading). So it's certainly true that an individual refinery that had no ability to refine sour crude couldn't switch from a Libyan sweet crude to a Saudi sour crude.
But it's an entirely different matter to claim that the entire global refining industry cannot make more use of Saudi crude right now, which is what these news stories are implying. After all, if there's any refinery anywhere that could take more Saudi crude and refine it into gasoline, diesel, or some other useful product, then that refinery could substitute for the lost output from refiners of Libyan crude that cannot switch. So there's no requirement for individual refineries to switch as long as someone, somewhere, anyone, anywhere can refine more Saudi crude at present. If that were to be true, then global production of refined products need not fall, as long as at least 1.3mbd of additional Saudi oil can be refined to replace the 1.3mbd of Libyan crude exports that are soon not going to be showing up at oil terminals in Europe.
But if the New York Times, the Financial Times, the BBC, etc, are to be believed, this is not so.
So we see that this is really a claim that although the world has spare capacity in oil production, it has no spare capacity that can actually be refined. In short, it has no effective spare capacity in oil production whatsoever. Because if there was a surge in demand, or a loss of any other sweet oil capacity anywhere in the world, then the supposed Saudi spare capacity couldn't solve that problem either, since, we are told, no-one can refine the stuff right now. The only problem that Saudi spare capacity can solve is a loss of sour crude production from somewhere else.
Next, let's think about the implications of this claim for the prices of different grades of oil. Happily, the EIA maintains prices for a variety of grades of oil around the world. It's weekly data, and currently goes through the week of 2/11/11. This next graph shows the price of the three main Saudi grades - Arabian Light, Medium and Heavy, together with Brent (since something strange is going on with WTI at present).
You will immediately notice a couple of things - Saudi grades of oil generally run at a slight discount to Brent, reflecting their sourer nature. However, the discount is only slight, and it is not higher in recent years than historically. In particular, recall Clifford Krauss' New York Times piece above stating "The last time there was a shortage of sweet crude, in 2007 and early 2008, oil prices surged to more than $140 a barrel". Note that during that interval, Saudi grades climbed just as high as the light sweet crude supposedly in particularly short supply.
To get a clearer look at the situation, let's look at the discount of each Saudi grade, relative to Brent:
And then let's take a moving average (7 wk centered) just to make the data a little less noisy:
So, we are asked to believe that no refiner can take another barrel of this stuff, even though in recent weeks, refiners have been paying discounts of only $2/barrel for Arab Light, ranging up to $6 for Arab Heavy?
The real tell will come in a couple of weeks when we see what happens to these discounts once the Libyan situation comes out in the data. Will Brent spike while the prices of these Saudi grades languish, since after all, it's only the light sweet stuff that's in short supply?
Here's my guess. When multiple major news sources run apparently independent stories at the same time, all propagating the same plausible but completely false line, I get suspicious and cynical. I think we are seeing the effect of someone's (rather successful) P.R. push. Someone, probably the Saudis, wants us to think that Saudi production can't be substituted for Libyan, and it isn't their fault. If that's true, then I hypothesize:
- Saudi production is not going to increase in response to the Libyan cutoff, or not enough, anyway
- Prices for Saudi grades of oil are going to spike in a very similar manner to Brent
It touched $119 this morning. If Saudi Arabia fully increases production to compensate for Libya, it will go back down to around $100. I could be wrong, but that's not the way it smells to me.
Update: In the last couple of hours, there are signs of Saudi backpedaling:
The kingdom is considering two options for increasing supplies. The first would be to boost Saudi production and send more crude through the kingdom’s East-West pipeline, which links the Gulf region with the Red Sea port of Yanbu, for shipment to Europe.
Another possibility, which is currently only being “studied”, would be a swap arrangement, whereby West African oil intended for Asian buyers is redirected to Europe, with Saudi Arabia stepping in to supply the Asian customers.
West African oil, such as Nigerian crude, is very similar to the gasoline-rich Libyan oil, traders said, noting that West Africa is geographically closer to Europe than Saudi Arabia.
“Right now, there are active talks in order to implement what is needed,” the Saudi oil official added. He stressed that the kingdom retained spare capacity of some 4m barrels a day – more than than double Libya’s entire output which totalled 1.58m b/d in January, according to the International Energy Agency.
Saudi Arabia has not yet decided whether to increase its output in response to Libya’s crisis, the official added, saying it would depend on the requirements of European oil companies.
If it proved necessary for Saudi Arabia to produce more, “then that will happen, there’s no problem at all”, he added.