Saudi oil prices show no Iran worries

Launceston, Australia

If you were looking for a sign that the oil market has shrugged off the loss of Iranian supplies, look no further than the Saudi decision to raise prices for August cargoes to Asian refiners.

While Saudi Aramco uses a formula to calculate changes in its official selling price (OSP), it’s also very unlikely that the state-controlled company would have boosted them if there was any doubt that the market was sufficiently supplied.

Traders had been expecting a modest lift in Saudi OSPs, and that’s largely what they got.

The kingdom’s main Arab Light grade was raised 70 cents to a premium of $2.05 a barrel over the Oman/Dubai regional benchmark, with heavier grades raised slightly more and light crudes by slightly less.

The technical explanation for the moves is likely that the Saudis raised prices because of increasing backwardation in the Dubai June-July spread, while the bigger increase for heavier grades reflects stronger fuel oil profits and the lesser gain for light crudes shows the weakness in naphtha cracks.

However, the Saudis also appear to use OSPs as a way of signalling their views on the state of the market.

For instance, when refiners in Asia, who take 60 per cent of the kingdom’s output, were scrambling to find replacements for Iranian crude earlier this year, the Saudis cut the premiums, and by more than the market had anticipated.

June loading cargoes, which were announced May 7, saw a premium of $1.15 a barrel to Oman/Dubai, the lowest since September last year.

The Saudis would have been working out what to charge for June cargoes in late April, a time when Brent crude was trading around $120 a barrel, not far from the March high above $128.

Lowering the premium then was a way of showing refiners that the Saudis had plenty of oil and were willing to sell it at attractive prices, thus alleviating refiners’ fears that they wouldn’t get enough oil if Iran output left the market.

So, the raising of the premium for August cargoes could be interpreted as showing the Saudis believe there is enough confidence in the market that they can afford to wind back some of their earlier price cuts.

All this bodes ill for Tehran, which has been getting only bad news of late.

Japan decided to join South Korea in cancelling cargoes from Iran this month, as the West’s sanctions that prevent European reinsurers from providing coverage for oil tankers proved too difficult to overcome.

And to make matters worse for the Islamic Republic, it’s arguing with China over freight rates after the top buyer of Iranian crude insisted that the National Iranian Tanker Co deliver crude.

No vessels have been named to carry the 20 million barrels of crude China had booked from Iran in the first 20 days of July, according to industry sources.

While this is a dispute over money and not politics, it can only serve to tighten the financial squeeze on Tehran.

It also remains to be seen whether Japan and South Korea will return as buyers of Iranian crude, since they, like China, have obtained a waiver to continue taking cargoes.

Japan passed a law allowing for it to provide insurance coverage, and refiners may take advantage of this for August cargoes.

As recently as the first quarter of 2011, Japan and South Korea were taking more than 650,000 barrels per day (bpd) of Iranian crude, while China’s consumption peaked at about 600,000 bpd late last year.

These three buyers represent just under half of total Iranian exports, with the other major buyer being European Union nations, which since the start of this month, have halted purchases altogether.

With even minor customers like Kenya cancelling an 80,000 bpd contract, Iran is facing the loss of much of its former 2.3 million bpd export market.

And the Saudi pricing decision shows that this isn’t much of a problem so far.