--Clyde Russell is a Reuters market analyst. The views expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, Jan 28 Middle East oil prices for Asian buyers are starting to look too high as a series of bearish indicators start to come into play.
While none of the factors are enough by themselves to cause prices to drop, taken together they present a backdrop that should lead to weakness for regional benchmarks such as the Oman futures traded on the Dubai Mercantile Exchange.
Front-month Oman has weakened 4.5 percent since the start of the year, to close on Jan. 27 at $103.69 a barrel, but this level is actually up from the $102.60 it reached on Jan. 16.
Perhaps the resilience of the contract can be put down to the view that the full impact of the bearish factors has yet to be felt.
These include the relatively mild winter in major Asian consumers such as China and Japan, the coming refinery maintenance season in the second quarter, the possibility of the return of Iranian barrels to the market coupled with rising Iraqi output, and soft demand growth in top importer China.
The combination of factors should be enough to ensure prices remain biased toward the downside and that heavier, Middle East grades weaken relative to Brent, the benchmark global light grade.
The Dubai-Brent exchange for swaps DUB-EFS-1M closed at $3.94 a barrel on Jan. 27, slightly up from $3.88 at the start of the year.
Assuming Asian demand does soften in the second quarter, the spread should continue to widen, especially if European consumption continues to improve along with the region's recovery and uncertainty remains over light crude exports from Libya, which have been disrupted by unrest in the North African producer.
There is a seasonal pattern to the spread, which reached $5.43 a barrel in early March last year, before narrowing as Asian refiners ended maintenance and prepared for the summer demand peak.
This year the spread may come under further pressure if Iranian crude supplies do flow back into the market.
IRAN STILL UNCERTAIN
This is still uncertainty as the deal between Tehran and the six world powers over opening the Islamic republic's nuclear programme to international scrutiny does not yet allow for increased crude exports.
Iran will be keen to use the thaw in its relations with the West to regain lost market share, and it appears that major buyers such as China, India and Japan are also eager to increase purchases.
Whether they are prepared to do so prior to a full agreement on Iran's nuclear programme remains to be seen, but the risk is that more Iranian oil starts to reach Asian buyers by the second quarter.
Iraq is also looking to boost its output from its southern ports to 2.5 million barrels per day (bpd), an increase of some 500,000 bpd over what it shipped in December last year.
Both Iran and Iraq are members of the Organization of Petroleum Exporting Countries, which has said it will be able to handle the extra oil flowing into the market and will head off any oversupply.
However, this assumes that Saudi Arabia is prepared to accept the lion's share of output cuts in order to accommodate Iran's return, which is not a certainty given the animosity between the two OPEC heavyweights.
On the demand side, the market has been primed for accelerating demand growth from China this year, after last year's disappointing 1.3 percent rise in implied demand, the slowest rate in more than two decades.
The country's top oil producer CNPC expects this to rebound to 4 percent this year, while the International Energy Agency is tipping oil demand growth of 3.7 percent.
China's oil imports are likely to increase in the first quarter with the commissioning of two new refineries with a combined capacity of 440,000 bpd.
However, increased crude imports may end up being exported as refined fuels, given China's surplus of refining capacity.
If this is the case, then either refiners elsewhere in Asia accept lower refining margins or they cut crude runs in order to accommodate the increased Chinese fuel exports.
With the balance of risks to supply to the upside, and to the downside for demand growth in Asia, it would not be a surprise to see the backwardation of the Oman curve <0#OQ:> increase.
Currently the front-month contract is trading at a premium of around 1.45 percent to the six-month.
This is almost double the 0.74 percent premium that prevailed a month ago, but is well below the 5.1 percent premium from late August last year, just prior to Oman's 10 percent slide in the following 10 weeks to early November.
The Oman futures curve is not currently priced for a significant drop in prices in coming months, but the risk-reward suggests the chances are the backwardation will increase in coming weeks.
(Editing by Joseph Radford)