Saudi Arabian oil supply moving with demand

23 March 2010

Saudi Arabia is repositioning its oil supply chain to take account of rising demand in Asia and the changing needs of the European and US energy markets

For the past 10 years, the mantra from US policy makers has been that the country must wean itself off its reliance on Middle East, specifically Saudi oil.

That process appears finally to be under way, but for different reasons than might have been anticipated by the US political elite. The reality is that Riyadh’s enthusiasm for its strategic energy relationship with the US is starting to erode, as the main engine of the global economy shifts away from the Atlantic towards Asia.

In numbers
US imports of Saudi oil in barrels a days for 200510 million
Forecast world oil demand for 2010 in barrels a day86.3 million
Source: MEED

Leading oil exporters to China, 2009

US crude oil imports from Saudi Arabia

Asian supremacy

In February, China for the first time outpaced the US in short-term average daily oil imports from Saudi Arabia. Visiting the kingdom last month, US Secretary of Energy Steven Chu revealed that China had overtaken the US as the world’s largest buyer of Saudi oil, importing just over 1 million barrels a day (b/d) compared to the US average of 991,000 b/d in 2009.

Last year, the US recorded its lowest annual import average for Saudi oil in more than 22 years, according to the US Department of Energy’s Energy Information Administration (EIA) data. To some observers, the figures confirm that Saudi Arabia is adapting to the new global reality of Asian economic supremacy, and prioritising exports to China.

This impression has been fed by other highly symbolic moves by state energy giant Saudi Aramco. In December 2009, Aramco relinquished its lease on a 5-million-barrel oil storage facility on the Caribbean island of St Estatius. Having been a major storage facility used to dispatch Saudi oil cargoes to US refineries, Aramco felt able to abandon the facility and it has subsequently been leased to Chinese state-owned oil and gas company PetroChina.

As Aramco scales back its physical presence in the Atlantic basin, it is steadily broadening its footprint in Asian markets. In November 2009, senior Aramco officials entered talks with the Japanese government over the joint use of crude oil storage facilities in Okinawa, conveniently situated just three shipping days from Shanghai. Amid robust demand for Saudi crude in Asia, “the goal is to have a commercially operated, administered operation that will make it more convenient for our customers in the region to utilise our supplies,” said Khalid al-Falih, chief executive officer of Aramco, at the time.

Aramco is seeking to capture a significant portion of the expected increase in Asia’s energy needs. China has the fastest growing demand for oil, but India is seeking to nearly double its oil imports from the kingdom, estimated at 500,000 b/d in 2008-2009, to meet future demand growth. It has offered Saudi Arabia access to planned new oil storage capacity, which will take India’s total storage capacity to 5 million tonnes.

Aramco has taken note of the US’ long-term decline in crude imports, which peaked in 2005 above 10 million b/d, but has fallen an average of 9 per cent in the past two years amid tough economic conditions. In contrast, China’s total crude imports rose by 14 per cent in 2009 to 203.78 million tonnes, 25 per cent of which came from the kingdom. In December 2009, imports from Saudi Arabia rose faster than the average at 15 per cent and reached a record 1.2 million b/d. 

Such figures have fuelled speculation about a radical transformation in Riyadh’s oil priorities. Yet Washington appears relaxed about the implications of the erosion of its close energy relations with Saudi Arabia. “In the long run we fully expect China’s demand for oil to increase, as well as India’s,” said Chu in February. The US, he said, would like to slowly decrease its demand for imported oil.

While Saudi Arabia has traditionally priced its oil in order to appeal to the US market, as a way of ensuring continued influence in Washington, the two countries’ relationship goes well beyond oil trade.

Dampening demand

“[The change in strategy] isn’t new, but rather [has been] under way over the past decade,” says David Kirsch, director of market and country strategies at US consultant PFC Energy.

“A key change in Saudi strategy after the disastrous market share fight with Venezuela was to ground oil market decisions in the assessment of supply-demand balances, and not on political factors. That China has been the most robust market over this period while the Organisation for Economic Co-operation & Development [OECD] demand declined, explains the apparent move eastward.”

After two years of declines, the International Energy Agency (IEA) forecasts global oil demand will rebound by 1.7 per cent in 2010 to 86.3 million b/d, with the bulk of the increase derived from Asia. 

Other factors have served to raise the prominence of Asia as a market for Saudi oil. As part of its Opec quota constraints, Riyadh has restricted supply of lower-cost, heavier crudes in order to shore up profit margins on its remaining crude sales. With US refineries specialising in the heavier grades, this has also served to dampen US demand for Saudi oil.

Preferential pricing

But there are also other strategic drivers at work. Aramco is seeking to use its joint-venture refinery projects in China as a platform to strengthen its supply chain to Asia.

“Aramco has already sought to ensure captive demand in emerging markets in Asia, most notably through joint-venture refineries in China,” says Kirsch. “Certainly output from new export-oriented refineries in the kingdom may be looking for outlets in Asia, but these are also configured to meet product specifications for any potential destination.”

The two planned 400,000 b/d export refineries at Jubail and Yanbu, due on stream in 2013-2014, will target increasing demand for high-quality refined products from Asia and the Middle East.

Aramco is also seeking a strategic positioning in its Asia-based refining facilities, and is looking to the heavy crude grades that will make up an increasingly large component of its export slate. “Aramco is building heavy crude refining capacity in Asia as a means of creating market demand for the heavier crude grades,” says Colin Lothian, Middle East analyst at UK consultancy Wood Mackenzie.

China’s largest refiner Sinopec has been in discussions with Aramco and US oil giant ExxonMobil to build 240,000 b/d of additional crude refining capacity at the groups’ joint refining-petrochemicals complex in China’s southeastern province of Fujian.

The domestic Jubail and Yanbu refineries will also be supplied with crude from the kingdom’s heavy Manifa oilfield. “They are displacing product demand and therefore Arab Light demand globally by satisfying demand with export product rather than light crude,” says Lothian. The outreach to Asia is also reflected in the way Aramco is now pricing its crude.

For April 2010 loading, Aramco has lowered the price for all crude grades for buyers in Asia. In contrast, it has raised official selling prices for all crude grades, except heavy, for customers in the US for the month. The firm increased the formula price of its Arab Light crude to the US the most, raising it by 15 cents a barrel, or 20 per cent, to a 60-cent discount off the benchmark Argus Sour Crude Index.

There has long been a substantial difference between east of Suez and west of Suez prices for Saudi oil. Aramco has traditionally sought to maintain a position in all the markets it serves, so has tended to have three different prices – one for US, one for Europe and one for Asia.

Previously, there was a substantial east-west price differential, with prices for crude oil supply into Asia significantly higher than for exports to Europe and the US – partly driven by the higher transport costs involved in delivery to Asian markets. With demand now so strong in Asia that Atlantic basin crudes are targeting the region, prices are rising and Riyadh must seek to make its crude grades more competitive – hence the recent lowering of contract prices to Asian buyers.

Stable partner

Aramco officials are anxious to reassure Washington that it will remain a significant supplier of crude to the US market. During a visit to Houston on 9 March, Aramco’s Al-Falih took time out to visit the Motiva Port Arthur refinery, jointly owned by Aramco and UK/Dutch Shell. The refinery is undergoing a major expansion, which will make it the largest refinery in the US with a capacity of 600,000 b/d. So Aramco is still committed to the US market. 

By deed and word, Saudi Arabia has proved itself a more reliable long-term supplier to the US market than Opec rivals Venezuela and Nigeria. Whether as a supplier to Asia, the Europe or US, the kingdom’s strategy is to remain a more reliable supply partner to the US than others. The real significance of the shift eastwards is that Aramco wants to be known as a stable partner for all the world’s most important economic centres. Troublingly for US egos if nothing else, these economies are more likely to be located in Shanghai and Mumbai in future, rather than in the US.

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