For Asia’s Oil Consumers, It’s a Buyer’s Market

by Eric Yep
Wall Street Journal
July 16, 2015

With ample supply, oil refineries in Asia have increasing influence over prices

SINGAPORE—With oil prices at half what they were a year ago and crude flooding into Asia from all directions, buyers from the west coast of India to southern Japan are, for the first time in decades, spoiled for choice.

The changing balance of power is already affecting the regional market share of key producers. With a full return of Iranian supplies now looming, following a nuclear accord this past week, competition will likely heat up further.

Oil consumers, mainly the refineries that turn crude into products such as gasoline and jet fuel, face a dilemma in this “new normal” era. Do they stick with multiyear contracts with long-established suppliers, primarily from the Middle East, or buy more oil on spot markets, getting cheaper prices but risking security of supply?

Asian refiners, located far from major oil-producing regions, previously have tied up as much as 95% of their crude intake through long-term contracts with reliable producers such as Saudi Arabia’s state-owned oil giant Saudi Aramco.

“This is a buyer’s market, especially in Asia,” said Ed Morse, global head of commodities research at Citigroup Inc. He said Asian refiners are letting some contracts lapse or renegotiating them, and buying more oil on spot markets.

The likely end result: Oil prices will be determined by the purchasing habits of Asia’s oil refiners, which underpin the region’s physical oil market, and the market share of competing oil producers looking for a home for their oil cargoes.

Some of the biggest changes are in the Far East, home to Middle Eastern producers’ previously most loyal customers. Several Japanese refiners plan to cut reliance on long-term contracts to around 70% from more than 90% of their oil imports, while some South Korean refiners are reducing long-term procurement to just 50% from around 75%, a prominent oil trader said.

The increased competition has sweetened terms for buyers, too. Saudi Aramco, for example, has slashed its selling price to Asia to a historically low level, while Indian refiners have persuaded several Middle Eastern producers to absorb the cost and risk of oil delivery, normally borne by oil buyers. And Russia’s state-owned Gazprom Neft has allowed Chinese buyers to make payments for oil purchases in China’s currency, the yuan, rather than dollars.

In May, Russia became China’s largest crude supplier for the month, overtaking Saudi Arabia for the first time, according to customs data. The Saudis also fell behind Nigeria as the top supplier of crude to India, a position it had held for more than four years.

More South American crude is being shipped to Asia. India’s private oil refiners now buy 30% to 40% of their intake from the region, trade data show, compared with less than 3% a decade ago.

Supplying countries are mimicking Middle Eastern oil producers’ long-held strategy of investing in Asia to secure a captive market. Petróleos de Venezuela SA is setting up a refinery in Jieyang in southern China to process 400,000 barrels a day beginning in 2017, in a joint venture with China National Petroleum Corp. It will likely use Venezuelan heavy crude oil as its main feedstock, says Richard Gorry, a consultant at JBC Energy.

Heavy crudes are harder to refine and hence cheaper. Many Asian oil refiners have spent heavily on advanced refineries to process them.

In April, Russia’s Gazprom Neft signed an initial agreement for a 49% equity stake in Vietnam’s sole refinery, Dung Quat, while Rosneft has signed an oil-supply deal with India’s Essar Oil Ltd. and bought a 49% stake in the refiner, and plans similar moves in China.

Still, oil traders and buyers suggest few refineries will risk slashing their long-term procurement by more than 20% to 30%.

“No one in their right minds would want to cancel Aramco crude purchase contracts unless they really have no choice,” one trader said.

In the key Chinese market, the Middle East’s share of oil imports has been growing long-term: 46% of China’s oil imports came from the region last year compared with 40% in 2003, according to data from BP’s Statistical Review of World Energy. That has helped make up for lost markets in the U.S. and Japan, which each imported around 25% less oil from the Middle East than they did in 2003.

Oil-supplying countries such as Nigeria, Angola, Venezuela and Russia don’t offer the long-term security of a Middle Eastern exporter like Saudi Arabia, analysts say.

Russia still has “a somewhat dodgy record on reliability as a supplier,” said Alastair Newton, political analyst at Nomura. In 2006 and 2009, for example, Russia cut gas supplies to Ukraine, a key transit country to Europe, amid a dispute over payment terms. Venezuela’s flow of oil to China also has been unpredictable, as the country trimmed its exports to the world’s No. 2 economy despite receiving its ample financial assistance. The International Energy Agency predicts Russia’s crude oil exports will decline by one million barrels a day over the next 20 years as its output declines.

Technical constraints mean refiners often choose to stick with tried-and-trusted oil sources. “A lot of oil trading is still about comfort levels,” said one oil trader. “If my usual supplier offers [oil] at market price, why should I risk getting barrels of unknown quality?” he said.

When Iraq began exporting its new Basra Heavy grade in June, the price was discounted heavily because refiners couldn’t adapt to the new crude fast enough. Even for emergency stockpiling, which has been a pillar of support for oil prices, both China and India are still opting for Middle Eastern oil grades that are better-suited to their refineries.