Tainted crude: Europe responds to Azeri Light contamination

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Kelly Norways:

Hello, and welcome to the Platts Oil Markets Podcast where today we delve into the recent outbreak of Azeri Light crude contamination and what it could mean for the European market.

I'm Kelly Norways, an oil news reporter focused on refining here in London. Today I'm joined by Nick Coleman, a senior editor on the Platts Oil News team, along with Sam Angell, who manages our EMEA crude oil pricing, and Dias Kazym, one of our light ends reporters.

Azerbaijan's Azeri Light crude has found itself at the center of a new contamination in recent weeks, which has spread harmful chemical compounds across the Mediterranean and Central Europe. It started on July 23rd when BP announced its discovery of organic chloride, a corrosive contaminant, in some of its tanks at Turkey's Ceyhan terminal. In the time since, tainted supply has spread from Ceyhan, the main access point to the Med for Azerbaijan's oil, into the refineries, pipelines, and storage tanks of its largest consumers, and late last week, BTC or the Baku-Tbilisi-Ceyhan pipeline, declared force majeure at the Turkish terminal with no guarantees over for how long loadings would be disrupted.

So Nick, organic chlorides are something that the market is forced to care about every once in a while when we have these kind of incidents. Can you tell us more about what they are and why they're such a big deal?

Nick Coleman:

Yeah. These chemicals are used actually for cleaning, mainly in the upstream industry. They're used for cleaning wells, maybe cleaning pipelines, so they're a useful product, but you don't want them actually in your crude oil. So yeah, they have this purpose in the upstream industry, but it's a bit of a mystery, really, how exactly these organic chlorides have actually got into the cargoes loading Ceyhan. It seems that they're probably... They've been found in storage tanks at Ceyhan, this is on the Turkish Mediterranean coast before the crude is loaded onto tankers, but there's no sign of it contaminating BP's upstream facilities in Azerbaijan, where the oil comes from, and I don't know if there's been a little bit of doubt and uncertainty introduced about whether there's been any organic chloride contamination in the actual BTC pipeline.

Originally, we were assured there was none, that it was all confined to Ceyhan, but one of the force majeure letters that we saw did seem to kind of raise some questions about that, so there's a lot of things still not really explained about this, but basically problem seems to be confined to Ceyhan, but, as you say, some of the crude has got to Europe. ENI was one of the companies that identified this crude in its system somewhere.

So basically, you can have an acceptable level of organic chlorides in crude oil, but it has to be a low level, and if it exceeds a certain amount then it becomes very harmful. As you said, it can be kind of like a corrosive. If you can imagine any kind of strong cleaning fluid, if it gets beyond certain limits, it'll have a corrosive effect on refining equipment or pipelines. It could even lead to claims of compensation if this kind of got out of hand, but I'm not sure we're at that point yet.

It seems like we've had some assurances from some of the refiners who actually take this stuff and have noted the contamination issue. I'm sure you've been following this yourself quite closely. So Poland's national oil refiner, Orlen, have noted this contamination, but they can kind of deal with it. But it's not an easy thing to deal with. Obviously I'm not a refiner, but it sounds like a bit of a logistical nightmare because basically what you've got to do is dilute the amount of organic chloride in your crude oil down. Essentially, you're adding uncontaminated crude, as I understand it, until the level drops to an acceptable overall content.

They have said that there's no way to sort of chemically treat the chloride to just make it disappear. It's a question of... From what we... I'm largely going on previous experience, which has been widely reported. So in Russia, there was a very significant issue with organic chloride contamination in the Druzhba pipeline, and dealing with it involved basically shunting all this crude oil around into sort of empty pipelines somewhere on the border with Belarus and sort of pushing it to one side and then basically gradually over time diluting it, so that was certainly a time-consuming process.

But BP, I should add, we don't have a clear timeline on how long this is going to take to deal with. As far as I know... And Sam, you might have insight into this, but as far as I know, some loadings did continue for a while after this was announced. It wasn't a complete stoppage of the loadings, but again, I think we're looking for a bit of clarity on that.

Kelly Norways:

Right. Yeah. So I suppose the market will have that Druzhba incident fresh in mind where the pipeline was actually forced to stop its deliveries for a while, and now the focus will be turning to some of the biggest customers for Azeri Light crude. Obviously we've seen the Italians struggle, which are typically some of the largest recipients of this grade, but, as you note, it seems like there's been crude that's gotten into the TAL pipeline system and gone beyond into Central Europe, so certainly something the market's watching quite closely.

If I throw it to you, Sam, how are you seeing the reaction on the crude side of things? Is this triggering any kind of reluctance in the Azeri market to load more supplies? How are you seeing the fallout?

Sam Angell:

Yeah. There's been quite a significant reaction in the crude markets, in the Mediterranean sweet market in particular, as you might expect. I mean, coming into July, Azeri was performing quite well just in terms of its differential. To dated, we're kind of at the height of summer demand, the European gas oil cracks were very strong, and it's kind of traditionally a very lucrative middle distillate yielding crude, so it was trading quite strongly.

There was sort of a period of softness already developing in early July, and this contamination has really compounded that. So there were sort of rumors that had begun to swirl kind of within the trading community I think on the 21st, 22nd of July, and it was really at that point we saw a sort of complete drop-off in the Azeri Light differential [inaudible 00:06:27], so on the 22nd we had two cargoes trading the MSC. That was at a 40 and I think 45 cent premium to dated. That was Socar selling to... Socar, of course, being the state oil company of Azerbaijan, selling to Total and Trafigura on those occasions. And so yeah, that's a 40, 45 cent premium to dated, and to think coming into July it was over $4 updated, and this is of course before the contamination is confirmed.

There's been an official statement about the contamination, so that's July 22, and then of course the next day BTC confirmed the contamination at the tanks at Ceyhan. So it's in terms of price action clearly very violent response in the Azeri market, as you would expect given, as Nick kind of alluded to, the damage organic chlorides can do to a refinery. Since we've had confirmation of the contamination, it's really been, as you might expect, very muted in terms of demand for Azeri. Of course, there's been subsequent news about kind of force majeure, but it's been, as you might expect, very quiet since then.

Kelly Norways:

Okay. And I'm interested... Obviously Nick mentioned that this isn't a simple issue where you can treat the chlorides. It's more a case of having to dilute the oil down with clean supply. Does that mean some uplift for other light sweet grades in the market potentially?

Sam Angell:

Yeah. That's a good question. That doesn't seem to be the case at the moment. Already kind of coming into the second half of July, the Mediterranean, just as a base, it was quite well served for light sweet generally, so we haven't seen that kind of uplift just yet, I would say, but it's certainly possible.

Of course, the timelines are quite critical here, as you might expect. Azeri is obviously a very large stream and very premium stream, highly sought after stream in the Med, so for now it doesn't look like there's much spillover into adjacent markets, but if there's over 600,000 barrels per day of very premium light sweet base load crude that's suddenly just off the market for an extended period of time, that's obviously going to have a big effect.

Nick Coleman:

Presumably it means there's some focus on the Kazakh grade, the CPC blend, which is kind of a... It's not a rival, but it's one of the other big East Med crude streams. Would that be fair to say that?

Sam Angell:

Yeah. Yeah. I-

Nick Coleman:

Basically, you don't want to see anything else going down or any other disruption in a situation like this.

Sam Angell:

Yeah, exactly. I mean, that is the other kind of major grade in the Med is CPC, Azeri and CPC being kind of the two key benchmark grade not necessarily substitutes or rivals, but definitely the long-term loss of a crude of kind of Azeri's stature in the market definitely has the potential to create some big problems. It's always been a very kind of reliable grade, good yields, but last time I was covering the Med market on the desk, sort of a trader compared it to the gourmet supermarket option compared to some other grades that are perhaps a little bit more difficult to run or less reliable, so it would be quite a big loss for the Med.

Nick Coleman:

If I can interject, I think we do need to kind of be clear here that we don't know how long-term this is going to be. There is precedent of it being a long-term disruption in other cases, but we simply at this point don't really have a strong indication one way or the other, do we?

Kelly Norways:

Yeah, of course. And it's been interesting to see some of the early market reaction. I note that on August 5th, there was some... August 4th, rather, there was some news that Romania was releasing some of its state crude reserves and potentially some diesel to respond to this and keep OMV Petrom running. Could potentially compound some refining issues for Israel, which is a big recipient of the Azeri grade. So yeah, certainly. We'll hang on how long this lasts, I imagine.

Dias, on the product side of things, where do you see some of the potential ripple effects of this? Which products could experience the most disruption?

Dias Kazym:

Thank you very much, Kelly. One of the most significant impacts we saw on the oil product side was on naphtha. So naphtha is a major petrochemical feedstock, a light end oil product, but it could also be used as a gasoline blending feedstock, and as Nick mentioned, the organic chloride contamination is not really new to the oil industry and naphtha has been severely affected by the Druzhba pipeline contamination back in 2019, 2020.

Since then, Platts introduced a limit of 3 ppm organic chloride content in naphtha in its OSN specs, and so this time I think once the rumors started appearing end of July, I think the market started already preparing for something similar to that and because of that, backwardation immediately steepened, market got much stronger anticipating potential supply disruption. Speaking to the traders, it looks like mostly Mediterranean refiners were impacted, and the naphtha that I was hearing was contaminated there had a content of around 10 to 20 ppm organic chloride, again which is severely higher than this 3 ppm currently in the limit.

But I think one of the major things that Nick also highlighted is the uncertainty as to how long and also how significant that is for naphtha specifically. People are still wondering what the volume is of that contaminated naphtha, and just like crude, it also has the ability to be blended off in the sense that you blend non-contaminated material with contaminated and thereby reduce the content so that you have the acceptable limit of their organic chlorides. But I think the major reaction of the market was that strength and the potential supply disruption.

Kelly Norways:

Mm-hmm. Yeah. I was interested to hear this morning from our gasoline reporter that this could actually potentially be bearish for gasoline if you see the petrochemicals industry more sensitive to contamination and maybe more naphtha diverted to the gasoline pool. Am I right in understanding that?

Dias Kazym:

Yeah, of course. That's another kind of an important aspect of being a petrochemical feedstock is because it goes then down into the chain of final chemical products, including consumer products like plastics and synthetics. I think petrochemical industry is more sensitive to that contamination, and essentially there's an argument saying that maybe more naphtha is going to be freed for the pool of going into the blending. But I think because it's still uncertain which exact barrels are contaminated and what the kind of specs is of that naphtha, whether it's light naphtha or heavy naphtha, I think it's quite difficult to say at this stage that we'll necessarily see more naphtha going into blending rather than chemicals at this stage.

Kelly Norways:

Mm-hmm. And if you had to give a temperature check for how you're seeing the market respond to this, how protracted an issue it might be, do you have a sense from traders how people are looking at the incident?

Dias Kazym:

Yeah. So as I mentioned on the paper market side, for instance, the market was flat before that. Generally chemical and blending demand for naphtha is quite weak this summer, but once this news started appearing, backwardation got to I want to say high single digits, which is quite significant for naphtha, and the crack spread narrowed significantly as well.

So the idea is if potentially there's less of pure naphtha available in the market, then essentially the supply of naphtha is going to be tighter, and also conscious that the Mediterranean market is still a huge supplier of naphtha, also in the context of Russian material no longer coming since the sanctions introduced in 2023. So I think overall speaking to the traders, it looks like it could be a major issue if the supply is still expected to be disrupted.

Kelly Norways:

Okay. So definitely the possibility that it could shake things up on the downstream side. To come back to you, Nick, you've been covering BP results this morning. How much of a headache is this for them potentially or, indeed, Azerbaijan's upstream oil sector?

Nick Coleman:

So it seems there... So for BP, it's definitely a headache at a time when it's on a bit of a bumpy ride in terms of its actual production levels, I mean, let alone all of the newspaper headlines about investors and whether somebody's going to buy BP or not. BP reset its strategy recently to basically recommit to oil and gas, and there was a core part of the investor community that felt that BP had kind of got diverted into unprofitable renewables projects, and there's been a lot of changes going on at BP as a result, a lot of pressure on the company, and the course that's been chosen is to recommit to oil and gas.

But having previously said that you're likely to be reducing your oil and gas production is not a switch that you can make overnight, so BP has got to actively invest in new oil production or gas production to actually sustain those production levels. In this particular quarter that they've just reported on today, they actually managed to increase the production a little bit from the first quarter, but they were still saying their production will drop this year. That's not disastrous. You have ups and downs, but obviously we're in an environment of a fairly weak oil price, so it does...

BP has been therefore stressing the importance of maintaining efficiency levels, that you shouldn't have kind of breakdowns in the system, and they achieved very high efficiency levels in the second quarter in... Particularly they talked about in Azerbaijan and incidentally in the UK as well. Their production is actually slightly up at the moment in the UK, a little surprisingly, but we won't... But my point is here that if your oil projects are not quite there to sustain production, you want to be very efficient.

Instead, they're doing well in shale oil. That's been a bit of a strong point for them this quarter, and they do have new projects coming on stream in the coming years or new projects they're committing to investing in in the Gulf of Mexico, for example, but they're going through a kind of lumpy period. As I say, production is expected to be down overall this year year-on-year, so this is definitely not what you want. I think I could've just said that to start with, to be honest, and it's pretty obvious you don't want contaminated crude oil, but for their relationship with Azerbaijan it's not great because obviously BP needs to demonstrate and maintain it.

This kind of might be a bit surprising to people not familiar with the situation, but BP really is the dominant oil company in Azerbaijan in a way that it probably isn't in many other places around the world. They own a 30.37% stake in the largest oil complex there, which accounts for more than half of those volumes loading onto tankers, so at Ceyhan. So the oil complex there is called ACG. BP is the... Well, so far is the largest shareholder, so Azerbaijan is pretty important for BP and BP is pretty important for Azerbaijan.

BP has all sorts of other projects going on in Azerbaijan to try and kind of maintain their relevance because the fact of the matter is that ACG oil production is declining. This is a very mature field. It's way down. It's less than half of the peak level sort of 15 years ago, so it's over 300,000 barrels a day, but in global terms that's quite far off the peak, so BP has to prove its relevance by making new investments.

They did actually unveil a whole lot of new investments quite recently, a lot of them in gas. [inaudible 00:18:09] gas project probably is not covered in this podcast series so much, but people have heard of it. That's an important gas project for exporting gas to Europe, but also oil projects. There's new oil exploration going on which BP is heavily involved in, so there's quite a close, tight relationship between BP and Azerbaijan, and you don't want that relationship to be kind of marred by incidents like this in an ideal world, so they'll definitely be wanting to get back on track quickly and perhaps they'll do it quicker than Transneft did in 2019 with their kind of analogous incidents, and perhaps we'll be surprised by how quickly this is over and done with and forgotten about.

Sam Angell:

How long was the incident in 2019? How long did that take to clear up?

Nick Coleman:

Yeah. So I don't have the clear number on that, but Dias reminded us it actually did stretch into...

Dias Kazym:

It's almost six months, I think, for the [inaudible 00:19:02], but then I think the market, at least on the naphtha side, it took almost a year to just recover after all the impact.

Nick Coleman:

So there will be a lot of storage facilities in Ceyhan, and I guess you could also have offshore sort of floating storage, so there will be... It's just a logistical challenge to deal with, and yeah.

Kelly Norways:

Yeah. I guess what we know for certain is that this will trigger a fair amount of trust issues in the Azeri Light market for the foreseeable, and how materially this influences the market, we'll have to wait and see. It's been interesting to see that it's kind of inflamed some of the energy security conversations that had been happening already from conversations with Hungary's MOL. They've been stressing again that they need as many crude supply channels, including Russian, for example, having previously indicated plans to kind of shift to more of Azerbaijan's supply, so that could put that project in limbo a little perhaps. We'll have to wait and see.

But thank you all. It's been a fascinating conversation looking at some of the repercussions that we might see here. As you say, maybe we come back in a week and it's all done and dusted, but keep up to date with Platts Live, the professional platform built exclusively for the energy industry. Have your say and join the conversation at plattslive.com. Thank you, Nick, Sam, and Dias, and thank you to the listener for joining us.