By Robert Campbell
NEW YORK, May 25 (Reuters) - Oil bulls battered by a recent slump in crude prices can take heart in at least one fact: Japanese utilities are still buying sweet crude heavily, propping up Asian oil prices even as Western benchmarks stumble.
Japanese utilities have been forced to crank up their use of oil and natural gas to generate power, as a moratorium on the restart of nuclear power plants drags on.
Amid the recent correction in oil prices, key Asian markers have mostly held their ground against Dated Brent, suggesting a sudden weakening of Asian oil demand cannot be blamed for the selloff.
Indeed, the economics of arbitrage flows of crude oil from the Atlantic basin to markets east of the Suez canal may well constitute a major support for benchmark oil prices.
All the more reason for oil traders to be keeping one eye on the developments in the Japanese power sector.
Take the Brent-Dubai exchange of futures for swaps (EFS) price. It has hardly budged in recent weeks and remains stubbornly below $4 a barrel.
Contrast that with the same period last year when the Libyan civil war and a spate of North Sea production problems left European refiners badly short of light sweet crude.
A more stark picture comes when looking at more specialized grades. Take Indonesia’s Minas crude , which is often used for direct burning in power plants, and also plays a key role as a regional benchmark.
Since early December, Minas has traded at a huge premium to Dated Brent, peaking at over $16 a barrel on May 4. The spread has since weakened but has yet to dip below $10 a barrel.
Heavy Minas buying by Japanese utilities has priced some Asian refiners out of the market, but it has also opened the door to West and North African grades to flow into the Far East as replacements.
Traders say global firms such as Glencore are reaping huge profits selling West African and Libyan barrels to Asian refiners seeking cheaper alternatives to local crudes.
For now uncertainty over when, if ever, the Japanese government will permit nuclear power plants to restart is playing a huge role in determining the spot price of grades like Minas.
With long-term planning held up by the uncertainty over the timing of restarts, Japanese utilities are mainly operating in the spot market for direct burning crude oil.
This has built a premium into the price. At the same time, utilities’ reluctance to risk operational problems, amid tight power supplies in Japan, has dissuaded them from using cheaper alternative feedstocks.
Traders have tried to interest Japanese utilities in directly burning West African grades of crude, for instance, but caution has kept consumption to a few test samples so for.
As a result, utilities’ need for a narrow basket of sweet crude oils has heavily distorted the Asian market, forcing regional refiners to rely on Atlantic basin crudes for cheaper alternatives.
That, in turn, is supporting Atlantic basin oil prices. Look no further for the steady flow of Forties cargoes to South Korea for evidence.
If anything, Brent crude would probably be under enormous selling pressure in the absence of these arbitrage flows, given slack European oil product demand and the very well supplied U.S. market.
In the short term, the questions for oil prices are: What happens if Japan allows large-scale nuclear restarts, and what happens if utilities manage to broaden their crude slates beyond the traditional direct-burn barrels?
The first case seems unlikely, given the strong skepticism of the Japanese public over nuclear power, and the central government’s reluctance to ride roughshod over public opinion.
The second could provide some relief, but ultimately, the switch would only be from regional grades to extra-regional grades, which means the arbitrage window between Brent and Asia would need to remain open.
In any case, a hot summer in Japan could easily negate the impact of a few nuclear restarts and a modest broadening of crude slates by utilities anyway by sending power demand soaring.
Things get more interesting in the autumn. Japanese power demand should fall back then as air-conditioning loads decrease. Will that reduce the call on crude oil for direct burning sufficiently to knock away support from the Brent market?
For now, the mainstream opinion amongst oil analysts is that demand, regardless of how soft it is right now, should rebound strongly through the second half of 2012.
That would probably take up any slack in the market that might come with decreased Japanese utility buying in the fall. Combine that with a higher call on OPEC crude and a resultant diminution of spare capacity in Saudi Arabia, and the stage could be set for a run higher in Brent prices.
But if demand fails to rise as expected, and Japanese utilities ease off buying enough to diminish Asia’s thirst for Atlantic basin sweet crude, the current healthy supply situation in the Atlantic basin augurs for weaker Brent prices going forward.