Saudi reduction shows cycle of weak crude oil pricing is not over yet
Although traders expected a bigger cut, the kingdom's strategy reflects desire to maintain share in an over-supplied Asian crude market
Saudi Arabia's decision to lower prices for oil loading in November shows that the battle for market share in an over-supplied Asian crude market is far from over.
Saudi Aramco, the kingdom's state-owned oil company, cut its official selling price (OSP) for its main Arab Light grade to Asia to a discount of US$1.60 a barrel to the regional benchmark Oman/Dubai price for November from a premium of 10 cents for October cargoes.
While the reduction was at the lower end of expectations of traders, it still indicates the Saudis are willing to accept reduced prices in order to keep their crude competitive.
In turn, this shows that there is still likely some distance to go before the end of the current cycle of weak crude prices, especially if one accepts the view that the Saudi pricing strategy reflects their desire to maintain market share over pricing power.
A wider contango in the Dubai market structure in recent weeks, with oil for three months out commanding a higher premium than spot deliveries, was always likely to lead to a drop in the Saudi OSPs.
The OSPs probably didn't decline by as much as indicated by the contango because they hadn't risen by as much in the third quarter, when the contango virtually disappeared amid strong demand for prompt supplies.
The Saudi OSPs set the trend for prices from Middle East rivals such as Iran, Iraq and Kuwait, and are thus the bellwether for as much as 12 million barrels per day (bpd) of crude destined for Asian refiners.
The Saudi OSP also reflects the changing dynamics of the Middle East oil market, where prices have been moved dramatically by the intermittent, but massive, participation of the trading arms of the Chinese state-controlled oil majors.
In the past 12 months, heavy buying on three occasions by Chinaoil, the trading arm of PetroChina, has pushed Oman/Dubai prompt prices substantially higher, thus narrowing the spread between Dubai and global crude benchmark Brent.
This has no doubt complicated price-setting for the Saudis, because their usual method of calculating the OSPs by looking at the Dubai time spreads between front-month and third-month doesn't take into account the relationship between Dubai and Brent.
If Dubai crude rises relative to Brent, then oil from Atlantic basin suppliers, especially Angola and Nigeria, becomes more competitive for Asian refiners. It also helps to boost the competitiveness of other non-Middle East crudes, such as Russia's ESPO, which reaches Asia through a pipeline to the eastern port of Kozmino.
This can be seen in the import data for Asia's top two oil buyers, China and India.
While China has boosted its imports from Saudi Arabia by 8.3 per cent in the first eight months of 2015 over the same period last year, it has bought 28.3 per cent more from Russia, 14.6 per cent more from Venezuela and a massive 99.4 per cent more from Brazil.
India has lifted its purchases from Saudi Arabia by 11.2 per cent in the first eight months, but has increased volumes from Angola by 43.6 per cent, Nigeria by 29.9 per cent and Mexico by 44.6 per cent.
In both China and India, Saudi Arabia remains the top supplier, but other countries are closing the gap and it's little surprise that some of them are producers whose oil is priced against Brent, and not the Middle East benchmark Oman/Dubai.
The main challenge for the Saudis is trying to set prices that remain competitive both to other Middle Eastern suppliers, and also with other crudes that are generally priced against Brent.
In practical terms, this is likely to mean considerably more volatility in the OSPs, a trend that can already be seen, with the Arab Light premium to Oman/Dubai moving from a discount of 10 cents a barrel in December last year to a discount of US$2.30 by March, to a premium of 40 cents by September and then back to a discount of US$1.60 for November cargoes.