Middle East oil producers brace for painful times as 'war' prices kick in

Singapore — The multi-year oil price crash that began in March is poised to dig a deeper hole into the Middle East producers' pockets in April, as sharp discounts in contractual prices by top suppliers led by Saudi Arabia came into effect this month.

ICE Brent futures sank to the lowest since 2002 last month, but prices realized by the Middle East producers for key grades in March were lowest only since 2016, thanks in part to the whole-month average pricing mechanism used by most of the region's oil suppliers and the contract prices set prior to a full blown "price war" that started in early March.

Saudi Arabia supplied March barrels of key Arab Light grade to Asian customers at $37.17/b, down 36% from February. The previous low for the grade was $34.69/b seen in March 2016.

But the story of April-loading barrels could be a harbinger of bad news for the Middle Eastern producers. Besides the sharpest global demand contraction caused by the coronavirus pandemic and a slump in crude oil, the steep price cuts announced by the Middle East producers became effective April 1.

The April-loading barrels of Saudi's Arab Light crude are now being supplied to Asian buyers at a discount of $3.10/b to the monthly average of Platts Dubai/DME Oman this month, representing a fall of $6/b in differentials from March. Based on prices so far this month, the OSP differential is worth a discount of almost 14% to oil benchmarks that are already lowest in nearly two decades, versus a premium of 8.4% in March.

Deeper OSP cuts or a surprise?

As the discounts begin to bite, all eyes will be on Saudi Arabia this week with the next round of oil price announcements set to get underway, especially with US President Donald Trump nudging major producers towards a supply cut agreement to support prices.

Given the extent of reduction in demand, market participants say a production cut -- even as deep as the one put forward in the failed OPEC+ negotiations -- may only be partly effective. Already, much of the excess barrels across the world is going into storage as land and air transport are severely impacted by travel bans and social isolation.

The limited effectiveness of a production cut is now prompting some to wonder if Middle East producers could take a backhanded approach to supporting prices.

This could come in the form of a surprise increase or more likely a lower-than-expected cut in OSPs by Middle East producers, which is likely to eventually circle back to production cuts if demand doesn't bounce back as storage options begin to shrink.

"Producers are acting in an arbitrary manner and there's no guarantee which way they'll turn next," said a senior trading manager with one of Asia's largest refiners. "So there's no idea what will happen to the next OSP."

However, the price war, alongside demand destruction caused by the coronavirus pandemic, has pushed spot differentials for Middle East benchmarks to the lowest on record, starting a chain of events that many say now leaves producers little choice but to cut prices even further.

For now, based the market broadly expects Saudi Arabia to cut its OSP differentials for Asia by a further $2-$3/b for May, S&P Global Platts reported earlier this week.

Survey results showed expectations are for Saudi Arab Light to be cut in a range of $1.50-$4/b for Asia. The wide range of estimates reflect the high degree of uncertainty in the current market, especially after the surprise deep cuts last month.