Middle East crudes are rallying from the lowest level in four months relative to Brent oil as Asian demand for the region's grades increases and Western sanctions on Iran tighten supply.
Dubai crude, the benchmark for Asia that started the month at the widest discount to North Sea Brent oil since November 10, is now closing the gap. The Dubai front-month swap was $3.42 (Dh12.55) a barrel below Brent futures at Tuesday's close, compared with $4.56 on March 1, according to data from London-based broker PVM Oil Associates Ltd. The spread will probably narrow further, according to Citigroup Inc. and JBC Energy GmbH.
Asian refiners are adding capacity and upgrading plants to use more oil grades from the Arabian Gulf that are heavier and cheaper than Brent, just as Western sanctions on Iran threaten to disrupt supply. Companies such as Royal Dutch Shell are shutting European refineries amid shrinking profits, curbing demand for lighter crudes, and investing in plants in China.
"You're seeing a multiyear trend of the narrowing of the Brent-Dubai," said Seth Kleinman, head of global energy research at Citigroup in London.
"You're seeing a massive shift of refining capacity out of the Atlantic Basin to Asia. The tightness has switch to Dubai" as the loss of Iranian barrels boosts prices for other Middle East grades, he said.
The gap between the two regional benchmarks, also known as the exchange of futures for swaps, narrowed to as little as $2.41 on January 13 as investors bet that sanctions against Iran's nuclear programme would boost competition for Mideast oil supplies, according to PVM data tracking Brent on the ICE Futures Europe exchange and Dubai swaps in the brokered market. April Brent was at $125.95 a barrel yesterday.
The EFS widened to $4.75 by March 1, as Dubai fell in value relative to Brent, after reports that China had settled a disagreement on crude purchases from Iran, relieving an anticipated clamor for other types of Mideast oil such as Dubai.
The spread has shrunk 29 per cent since then to $3.35 yesterday, signalling Dubai crude gaining on Brent again, a trend that will continue because refining capacity is being slashed in Europe and added in Asia, according to JBC Energy. The newest Asian refineries are typically designed to use oil that's relatively heavy and high in sulfur, or sour, strengthening demand for grades similar to Dubai. "The spreads are going to be narrow," said Eugene Lindell, an analyst at JBC in Vienna. "We have massive refinery capacity additions, mostly in India and China, and the feedstock for these is going to be your medium-sour or heavier grades. In the Atlantic Basin you have refiners dropping off, and these typically process the lighter grades."
Refining capacity in Asia is forecast to increase 1 million barrels a day in 2012, with a similar-sized reduction forecast for Europe and the US East Coast combined, according to a December 12 Citigroup report. Oil consumption in the Asia-Pacific region will expand by an average 600,000 barrels a day this year, or most of the global gain of 800,000 barrels, according to an estimate from the International Energy Agency yesterday.
China may process 470 million metric tons of crude in 2012, up 5.4 per cent from last year, and as much as 700 million tons a year by 2015, the country's biggest oil company China National Petroleum Corp. said in a report last month. That equates to about 9.4 million barrels a day this year and 14 million by the middle of the decade.
Essar Oil, the operator of India's second-biggest non- state refinery, is increasing the capacity of its facility at Vadinar in the western Indian state of Gujarat to 405,000 barrels a day in September from 300,000 now. The refinery will be able to process a higher proportion of heavy, ultra-heavy and sour crudes, it said last month.
In Europe, Petroplus Holdings AG filed for bankruptcy on January 25 and cut capacity at the continent's largest independent refiner. The company joined LyondellBasell Industries NV, Eni SpA and Total SA in closing European plants amid lower profits.
"There are serious structural issues at play here," JBC's Lindell said. "These will be either exacerbated or cooled by what happens with Iran, but there are very strong issues at play here on a global level."