Middle East flare-up and ramifications for European oil markets

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Gary Clark:

Hello and welcome to the Platts Oil Markets podcast by S&P Global Energy, where today we'll be talking about the impact of the Israel-Iran conflict on European oil markets. This podcast recording was done on the afternoon of June the 17th.

Since the conflict started on Friday, June the 13th, it has quickly escalated and remains a fast moving situation, which has affected both the flat price of oil and is having an impact on supply and demand fundamentals in Europe. Concerns about further attacks on critical infrastructure like Iran's Kharg Oil Terminal, which handles over 90% of Iran's oil exports, or the risk of disruption to the Strait of Hormuz, linking the Persian or Arabian Gulf to the Arabian Sea and the rest of the world, are keeping oil markets jittery.

I'm Gary Clark and I manage the EMEA Clean Refined Products price reporting team based out of London. I'm joined by Joey Daly, who is a senior price reporter looking at crude oil markets, Jan Kedzior, who reports on middle distillate markets, and Dias Kazym who looks at light ends products. The strikes appear to be targeted around domestic energy needs for now, but the conflict risks major disruption to global oil markets if Iranian exports are curtailed significantly or the conflict widens regionally. There is a lot to digest but let's focus on the impact on all markets in Europe.

Typically, when geopolitical tensions or conflict arise which could affect Europe, we see a rise in flat or outright prices in European oil derivative markets as risk premiums build. Turning to you, Joey, what has been the impact on Brent Crude Markets?

Joey Daly:

Thanks, Gary. Yes, certainly. So if we look at Platts Dated Brent, which is Platts' light sweet crude oil benchmark, which reflects fundamentals in the North Sea and in the wider Atlantic Basin, the impacts of this conflict on this benchmark are going to be indirect because the crude in this benchmark is not crude that's loading out of the Persian Gulf. However, it's a global market. So there were some pretty substantial moves on Friday the 13th when these headlines broke. So the headlines were across the board, across the Brent Complex, bullish as participants begin to price in the possibility of what could be a large-scale supply disruption in the form of, as you mentioned, the closure of the Strait of Hormuz.

We assessed the benchmark, Dated Brent, at $75 and 19 cents per barrel on Friday, June the 13th. Which was actually the highest level we'd seen since the US's liberation date tariffs. So we are kind of returning to these pre tariff announcement levels. Now, that move was driven by gains actually across the whole Brent Complex, which is a network of derivatives used in the trading and supply of Atlantic Basin crude. So firstly, perhaps the most publicized move was this large surge in the forward market flat price. That's ICE Brent Futures and Cash BFOE. So on Friday when these headlines broke, there's a large jump in flat price, which as I mentioned is associated with this rising risk of a global supply disruption, which is this gain is sometimes referred to as the geopolitical risk premium. So those flat prices surged on Friday.

We then saw the same kind of bullish momentum in the spreads. So this is for example, the prompter intermonth ICE Brent spreads also gained a lot on Friday. And then you also saw big gains in the more physical end of the spectrum. So things like the dated-to-frontline swap and the Brent CFDs also gained a lot, which reflects the market moving into a steeper backwardation as paper traders begin to, again, price in a potentially much tighter market. So those spreads then again, help to support the complex and support the value of Dated Brent, as well as the surging flat price.

Then of course in the physical market, which in the Dated Brent assessment is 10 days to one month ahead, crude in the North Sea, trading activity that we observed in our market on closed assessment process took a fairly notable swing to the bid side and physical differentials also gained on the day. So that's of all the key sections of the Brent Complex pushing up on the day, really on the back of people anticipating or trying to price in the potential for supply disruption if this escalates and you see, for example, the Strait of Hormuz closing. Because whilst cargo is in the North Sea or a cargo of WTI Midland heading to Europe is not necessarily under risk of attack or disruption, obviously it's an incredibly global market and these flows will impact the crude oil around the world no matter what happens.

Gary Clark:

I see. So suddenly the flat price in the crude paper complex and also the physical market has been rising as risk premiums have been building. But we are not seeing a disruption to say physical supply at this moment in time, right?

Joey Daly:

Yes. So far, particularly in Europe and in the Atlantic Basin, it's this anticipation of the risk of supply disruption that's driving the gains and continues to drive gains.

Gary Clark:

Okay, I see. So let's move a little bit to refined products. And maybe Jan, I know you look at the middle distillate markets very closely. What's been the middle distillate market impact for Europe?

Jan Kedzior:

So the first impact was a bit similar to what Joey described, right? So on Friday, June the 13th, we've seen a rally in the prices of ICE Low Sulfur Gasoil Futures, which is the contract linked then to the spot prices we assess for diesel, gas, oil, and jet fuel. Interestingly, Joey mentioned that the Dated Brent assessment reached the highest level since US Liberation Day, but for example, looking at gas oil specifically, we've seen the flat price reach levels last seen in the end of February, which is even before that US Liberation Day, which is a proof, and this is also something that we saw in other products, that the diesel crack spread, rose on Friday, June 13th, very rapidly with [inaudible 00:06:21] Geofutures effectively outpacing Brent Futures.

Now again, similarly to crude, a lot of the fears and anxieties are coming from the risks of any possible disruption of the transit of product for the Strait of Hormuz. This is particularly important for European middle distillates, because Europe imports a lot of diesel and jet fuel, which often originates in the Gulf countries of Kuwait, for example. Iran itself is not a major exporter of middle distillates, but of course any closure of the Strait will limit the ability of those Gulf producers to supply Europe and also other countries. Because we need to remember that any disruption to supply also in Asia and Africa for example, then would also impact Europe by just limiting the volume of product available.

Now, speaking to traders, they say that obviously although the situation is evolving rapidly and we cannot fully exclude the possibility of the Strait being closed by Iran, there appears to be a consensus in the market that the actual risk is quite low. This is because the conflict that Iran is involved in is with Israel, and obviously Israel is not located in the Gulf. And if Iran was to close the Strait, that would hurt most Iran, but other countries in the region, which so far have refused to take a very one-sided position in that confrontation.

So we're yet to see a resolution to the current conflict, but for the time being, the market is waiting. Not very patiently, there is a good bit of volatility. Sources also said that in recent years, the space in tanks in the Amsterdam, Rotterdam, Antwerp hub used for middle distillates has decreased. So as we have less tanks able to store products, the inventories that we have in Europe will last for a shorter period of time, and that's why we see a lot of that volatility. But the market is in a wait-and-see mode, anxiously looking at the developments in the region.

Gary Clark:

That's understood. And Joey mentioned how supply for crude hasn't been affected yet per se, right? We know obviously Iran exports a lot of crude oil. A lot of that goes to China at this point in time. That hasn't been affected. That's not the case, right, in the Mediterranean basin. We know that Israel's Haifa refinery has shut down. How's that affecting supply for refined products in the Mediterranean?

Jan Kedzior:

I mean, we are yet to see the impact of the closure of Haifa. As you rightly mentioned, Haifa Refinery, owned by Bazan Group, supplies a lot of diesel fuel in Eastern Mediterranean. The refinery was struck by Iranian missile on Sunday, June 15. And then in the late evening hours of Monday, June 16, Bazan Group published a statement saying that the refinery will stop operating. We have seen some early reports of European countries exporting extra product to Israel to cover the shortfall in production at Haifa Refinery. But the medium term impact of that closure at Haifa depends to a large extent on the duration of the conflict.

Gary Clark:

Understood. And that's roughly a 200,000 barrels per day refinery. So turning to you, Dias, what has been the impact on the light ends complex?

Dias Kazym:

I think the way I would look at it is there's the twofold impact. The first side you would look at is a more short term, immediate changes to the market. And of course that would be the move in the flat price. On June 13th, the flat price moved up in line with the crude, and then we saw a slight retreat on Monday, June 16th. But I think when you look at the short-term impact, it's also very important to look at the freight side that impacted the light ends. Even though the arbitrage for the light ends from the Arab Gulf and the Red Sea area to Europe is not as big as for the middle distillates, the freight economics impacts and changes very quickly for the light ends as well. So what happens, if you see tighter market for say, diesel cargoes from that region, what that means is equally the freight for light ends and the vessels for light end products get tighter.

Gary Clark:

Sorry. And by light ends you mean gasoline, naphtha?

Dias Kazym:

And LPG, yeah. So the first impact on naphtha for instance, was that the freight rates for naphtha to go from AG to Asia went up significantly. And that also escalated to the European freight. Another thing that we saw as a short-term impact on the side of naphtha was the concerns were the Haifa Refinery outage that we just mentioned would have an impact on the supply and demand balances of naphtha. However, the refinery is not the biggest producer of naphtha and the flow would be from AG to Asia rather than to Europe. So the impact on naphtha directly would be only through the impact to the Asian market.

For LPG, the situation is a bit different, where Iran is a big producer of LPG, particularly exported to China. So that could potentially be of a bigger factor. But we are yet to see the full impact of that. And on the gasoline side, I think the reason why we saw a much smoother impact on the market was because the gasoline Northwest Europe fundamentals are a bit weaker at the moment because of the high production of gasoline in the WAF region, and therefore lower arbitrage and lower demand for gasoline at the moment. But I think the market is still at what the traders call wait-and-see mode, where probably more impact on the light ends, gasoline, LPG, and naphtha, will be seen shortly.

Gary Clark:

That makes sense. And yeah, obviously with gasoline, right, we know that Europe's [inaudible 00:12:31] gasoline prior to the Dangote Refinery exporting a lot to WAF, but now the Dangote refinery is a buffer for Europe. And the only off-taker really that leaves is the US, right? But we're not quite into the summer driving season so a little more bearish fundamentals going into this conflict for gasoline relative to the other refined oil products.

So obviously we are price reporters and we aren't in the business of forecasting, but obviously we're all speaking to sources regularly, daily. What are your sources telling you about the potential price impact going forward as a result of this conflict? Maybe Joey, if I turn to you first, I'm curious.

Joey Daly:

It's a good question. It's the question really. Of course, really so much depends on what happens in the Middle East in the next few days, the next few weeks. That really what we hear is the market's in a state of uncertainty. It's like Dias, like you said, it's that favorite trader word, wait-and-see mode. What we've heard beyond Dated Brent, what I was discussing earlier, what we've heard in West Africa and in the Med crude markets is that trading has really kind of paralyzed. Sellers of West African crude are heard to have actually withdrawn some of their offers or raised them. And we hear that buyers aren't necessarily particularly keen to buy either because there's so much price uncertainty that it's kind of put trading to a halt. And we've heard the same in the Med.

So I think actually differentials in these regions, price differentials for physical cargoes of crude have been actually steady or heard to be likely to be quite steady in the midst of this. And whichever way it goes will be determined by the headlines we see in the next few days.

Gary Clark:

Makes sense. Makes sense. And yeah, I think some of what you're describing there is what we're seeing for middle distillates, certainly, right, in the market on closed process, a lot of bidding and hearing that people are cautious about offering either because they want to hang onto the oil, or potentially seeking further prices higher down the line before they sell. Jan, what are your observations?

Jan Kedzior:

No, no, you're right. You're exactly spot on. Spot on, Gary. And I think it's interesting also to see how what we are seeing in middle distillates is in a way similar to crude, and showing how those trends and this uncertainty in the market is affecting every product and extends well beyond crude oil. Yes, in Platt's market [inaudible 00:14:53] assessment process for distillate cargoes, especially diesel and gas oil, we have seen a lot of bidding activity on both Friday, June 13, and Monday, June 16. Yet there were no offers in the MOC.

In the days prior to that, obviously, we also had the expiry of ISLS Geofutures, which can create a little bit of volatility, again because of that limited tank space in ARA and general tightness in the prompt diesel market. But even then, when sources were saying that there is barely any product available, we still saw those offers, right?

You also asked about prices, the direction of prices in the days ahead, what the sources are saying. Well, the sources see and confirm what we are saying, which is that the prices are responding very quickly to the headlines, right? So on Friday, after the first news of this of the Israeli strike targeting Iranian nuclear facilities, we saw prices rally immediately, right? Then throughout the weekend, as Israeli Air Force was continuing its operations in Iran and Iran retaliating with some missiles against Israel, but with fewer and fewer missiles. By the time we reached Monday, June 16, and there were some news of a possible ceasefire talks, suddenly the price has tapered off in a matter of hours.

So I think right now, people are still waiting. But it seems, it appears that as that balance of power is in a way tilting in Israel's favor and people see more discussions around the possible ceasefire or US also potentially getting involved or at least bringing some of their forces closer to the region to exert some sort of secondary pressure, this could keep a bit of a ceiling on prices. But again, as always with those developments, there's a lot of uncertainty and we can also expect some degree of volatility in the days to come.

Gary Clark:

I think price volatility is, yeah, certainly the phrase of the week, is it not? Dias, light ends, what are your sources telling you about potential risk premiums going forward?

Dias Kazym:

I would say, I think usually the way how we look at that is it seems more of a supply shock driven price moves, right? In the sense that if there's a change in the freight rates or there's change in the flows, most of it is still supply driven. And usually what happens, as Jan was saying, the flood price and general prices can be quite reactive in case the supply normalizes very quickly. What I'm trying to say is that I think longer term, it really depends on how sustained that supply disruption is going to be in the markets. For light end specifically, there is no strong demand at the moment in the European markets, especially if you look at the petrochemical industry. What that means essentially is that even if naphtha price goes up significantly due to the supply disruptions, still the market can easily accommodate that and come back once the supply disruption is hopefully over.

One thing to caveat that is of course the higher flood price can also contribute to what they call a demand destruction. And it's essentially for the petrochemical industry, what that means is the [inaudible 00:18:16] may face an even more challenging time to buy and source feed stocks, including both LPG and naphtha, at the times when flood price is quite high. So that could add to further challenges specifically in the European petrochemical industry.

Jan Kedzior:

Which is interesting. If I can maybe add to what Diaz is saying, it's precisely the case also of, for example, heating oil consumers in Northwestern Europe. Obviously in summer, demand for gas oil decreases, gas oil is often used as heating oil, because obviously warmer temperatures mean you don't need to heat your home as much. But a lot of customers in Germany and Switzerland closely monitor the flood price even in those summer months to see if they could maybe buy some product in advance and store it for winter.

So I think that also, if those elevated prices were to last for longer, we could see I think as Diaz says, this effect on demand. But also we need to remember that the governments will also probably be watching the situation carefully because prolonged periods of high oil prices are supporting higher inflation, which can then eat obviously into economic growth at the time when especially many European economies are still fighting to come back to economic activity to pre-COVID levels.

Gary Clark:

Absolutely. Yeah. So that's a potential supply disruption obviously can then affect demand as well. Well, look, it's been a fantastic conversation with you all. It's a fast moving situation with many possible outcomes. And as discussed, the impact on both crude and refined oil product flat prices and risk premium has been significant. Keep up to date with Platts, Live, the professional platform built exclusively for the energy industry and have your say and join the conversation at plattslive.com. Thank you, Joey, Jan and Diaz, and thanks for listening.