(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, June 4 In future, light low-sulphur
crudes will command a much smaller premium over heavy sour
grades, as booming shale production in the United States and
growing demand from Asian refineries upend traditional pricing
relationships in the physical oil market.
Journalists and analysts have traditionally characterised
light sweet crudes as "high quality" and heavy sour ones as "low
quality," with light crudes more scarce and valuable than their
heavy sour counterparts.
That simple characterisation no longer holds true.
The marginal barrel supplied to the market comes from North
American shale plays and is light and sweet, while the marginal
barrel demanded by refiners comes from the new complex mega
refineries in Asia, equipped with crackers, cokers and
desulphurisation equipment, and is much heavier and sourer.
The result is a growing mismatch between the crude slate on
offer from oil producers and that demanded by refiners.
ALL CHANGE, PLEASE
Conventional premiums for light sweet crudes were the result
of specific circumstances: (1) strong demand for gasoline rather
than diesel; (2) limited refinery capacity to process heavier
molecules; (3) limited capacity to strip sulphur from feedstock;
and (4) limited supplies of light sweet crudes compared with
abundant supplies of heavier and more sulphurous oils.
Each of these factors has now shifted substantially. It was
only a matter of time before the shift in crude supplies and
refinery demand transformed the traditional pricing
relationships between different crude grades.
The market for light sweet oils is now increasingly
oversupplied, while heavy sour grades are seeing stronger
demand. Conventional premiums for light sweet crudes have
eroded, and in some cases light crudes are even trading at a
The price adjustment will continue until it makes sense for
Asia's complex refineries to start buying light sweet crudes and
forego the technological advantage of utilising their cokers and
desulphurisation units fully.
It is already changing the balance of power among oil
producers. Countries that produce heavier higher-sulphur crudes
like Saudi Arabia and Iraq are the main winners, while countries
like Nigeria and Libya with abundant light low sulphur supplies
that compete directly with U.S. shale oil lose out.
The shift is helping prop up struggling simple refineries in
Europe and on the East Coast of North America, blunting
competition from complex modern refineries in Asia and the U.S.
Gulf Coast, which no longer reap as much advantage from their
heavy investment in coking and desulphurisation plants.
A QUESTION OF QUALITY
All crudes are mixtures of different molecules. But light
crudes have a higher proportion of the light molecules used to
make premium fuels like gasoline, naphtha and to some extent
diesel, while medium and heavy crudes have a higher proportion
of molecules that can only be used to make diesel or sold at a
discount to ships and power producers as residual fuel oil.
Simple refineries that separate different molecules by
distillation have always prized light crudes because they yield
a higher proportion of more valuable products, especially
gasoline, which explains why light crudes traditionally
commanded large premiums.
Modern complex refineries, however, can convert and upgrade
the heavy residuals left over from distillation into lighter and
more valuable molecules by cracking and coking, squeezing out
more premium products from gasoline and naphtha to jet fuel and
Complex refineries also have some flexibility to decide
whether to crack large molecules into very small ones to make
gasoline or slightly larger ones to make diesel. Complex
refineries can therefore tailor their output to meet seasonal
variations in demand - maximising gasoline production to meet
summer driving demand in the United States, and diesel
production in the winter heating season.
Crucially, complex refineries can also make a strategic
decision to upgrade a large proportion of the residuals from
atmospheric and vacuum distillation into diesel rather than
gasoline all year round.
Dieselisation policies in the European Union and strong
demand for diesel as trucking fuel in emerging markets has left
the global refining system producing too much gasoline and not
By processing medium and heavy crudes, which yield
relatively small amounts of gasoline, and then upgrading the
residuals into diesel, complex refineries can maximise diesel
production and generate higher returns from every barrel of
crude they process.
The same story can be told about sulphur, which must be
removed from finished fuels like gasoline and diesel to meet
quality specifications and increasingly stringent environmental
Simple refineries preferred low sulphur (sweet) crudes, but
as more refineries have invested in hydrotreating units that
strip sulphur from feedstock by reacting it with hydrogen, the
advantage for sweet crudes has reduced and the price premium
that they command has fallen.
Light sweet oils may always have a small advantage over
heavy sour ones because conversion and desulphurisation require
extra energy and add to refineries' operating costs, but the
margin is likely to be much smaller than before.
(Editing by Anthony Barker)