LONDON Feb 13 Seasoned oil market observers have struggled to find an adequate explanation for the surge in Brent prices over the past fortnight, which has taken front-month futures to the highest level since July 2011.
But the conundrum becomes easier to unravel if the focus is switched from the overall crude supply-demand balance, which remains comfortable, to balances for individual fuels (especially distillates) and the types of crudes being impacted by the supply disruptions.
Dieselisation and the increasing imbalance in the global refining system (producing too much gasoline and not enough diesel) has made the crude markets particularly vulnerable to the loss of diesel-rich crudes, which is why both crude prices and European gas oil futures have been rising in recent sessions in response to the loss of exports from South Sudan.
Most analysis of the oil market still focuses on the overall supply-demand balance, implicitly treating all crudes as undifferentiated. But the price surges triggered by Libya and North Sea outages in 2011, and now Sudan in 2012, illustrate the need for a more fine-grained approach, in which relatively small losses of key crudes (low in sulphur or rich in middle distillates) can produce an outsized response in prices.
PAPER VERSUS PHYSICAL
There has been a strange disconnect between the financial (paper) markets, which appear comfortably supplied, and reports from traders of far greater tightness in the physical (crude) markets, as my colleague Javier Blas explained in the Financial Times last week ("Crude defies supply and demand forecasts", Feb 9).
After months of ignoring escalating tensions with Iran, the never-ending crisis in Europe, and first signs of a slowdown and then recovery in the United States and China, crude futures have been shaken out of their torpor by a series of apparently minor developments.
Observers have blamed the transit dispute between Sudan and South Sudan, as well as lingering problems in the North Sea, for adversely affecting crude supplies.
Cold weather across Europe has signalled the belated arrival of winter and focused attention on distillate supplies. And signs of economic recovery and continued central bank stimulus have rekindled appetite for risk assets.
But on a global scale these supply disruptions are small. Current losses from South Sudan and the North Sea amount to perhaps 350,000 barrels per day, which is tiny compared with the 1.3 million barrels per day of exports lost from Libya plus the losses from the North Sea and Azerbaijan last year.
Cold weather will make only a small and temporary addition to seasonal fuel consumption.
Economic news from the United States and China might have improved recently, but the International Energy Agency (IEA) has nonetheless cut its forecast for demand growth by 250,000 b/d to just 800,000 b/d in 2012, less than 1 percent higher than 2011, citing persistent economic weakness in Europe and worldwide .
None of these developments seem significant enough to justify the rise in oil prices to a six-month high.
DIESEL-RICH NILE BLEND
But not all crudes are the same. Libya's civil war had an outsized impact on the oil market last year because the low-sulphur crudes which the country exported were difficult for refiners to replace elsewhere.
The main alternative supplies were in the North Sea, Azerbaijan and Nigeria. Two of these areas were suffering production problems of their own and the third is perennially unstable.
In the case of South Sudan, the amount of crude lost is small in absolute terms (around 250,000 b/d), but the disruption is still significant because Sudan's Nile Blend can be refined to produce large quantities of valuable middle distillates like diesel, and relatively little gasoline, which is in over-supply and currently commands lower margins.
Simple distillation of Nile Blend yields relatively little naphtha (10 percent) for gasoline production but plenty of middle distillates like kerosene (9 percent) and gas oil (18 percent). It also yields unusually large amounts of residue (62 percent).
Residue would normally be undesirable. But in this case it can be upgraded in a complex Asian refinery through fluid catalytic cracking (FCC) and coking units optimised for diesel production rather than gasoline to push final diesel yields sharply higher.
So the key characteristic of Nile Blend is not how much residue it produces but how little naphtha it yields. South Sudan's low sulphur waxy crudes are therefore ideal for minimising (less economic) gasoline production and maximising (highly profitable) diesel output.
Nile Blend is normally exported to customers in Asia. Sudanese crude accounts for around 5 percent of all China's oil imports.
The export interruption has sent Asian buyers scrambling for diesel-rich replacements. Most crudes have substantially lower yields of mid distillates so refineries have to process more just to produce the same amount of diesel, tightening both the distillate and crude markets still further. (Editing by Jason Neely)