Saudi Arabia's energy minister Khalid al-Falih, as well as his predecessor Ali al-Naimi, has long maintained -- in the face of criticism and even ridicule in some corners -- that the kingdom does not consider US shale producers as direct competitors in a finite oil market.
Receive daily email alerts, subscriber notes & personalize your experience.Register Now
In terms of the physical market, the ministers are correct.
US shale oil is typically light and sweet, while Saudi Arabia and most of OPEC's key Middle East members largely produce grades that are sourer and heavier, and many refineries worldwide are not technically nimble enough to drastically alter their crude slates.
But even as supplies of the heavier sour grades have tightened substantially following OPEC's production cut agreement, the recent output surge in the US, in addition to Libya, Nigeria and even Kazakhstan, has left the world awash in light sweet oil, which now serves as the swing barrel in the global market.
Major futures benchmarks ICE Brent and NYMEX crude are based on relatively light sweet grades from the North Sea and the US, respectively, but often stand in as the global oil price.
Given this, OPEC and its 10 non-OPEC partners in the 1.8 million b/d production cut agreement face a dilemma, as those benchmark prices continue to languish, without reflecting the tightness in the medium sour market.
A further cut, as some ministers have begun to discuss, would seem to only expand the heavy/light imbalance in the market, particularly if Saudi Arabia were to take on the bulk of the cuts, as it has under the current OPEC/non-OPEC cut agreement.
And it would risk further deterioration of OPEC's Middle Eastern members' global market share. To wit: China's refineries in May imported record amounts of crude from Russia and Angola, according to state data, as observers said the country appears to be moving away from heavy Middle Eastern grades due price rises following the OPEC cuts.
"Medium-heavy crudes are being demanded," said an analyst for a European refining company, who spoke on condition of anonymity. "All shale has done is added to an oversupplied light market."
The medium sour Platts Dubai benchmark, as well as fellow sour benchmark Oman, has risen in relative value to Brent, due to the production cuts.
Saudi Aramco this month boosted its official selling price differentials nearly across the board, in line with the stronger sour crude structure and spreads, with some traders telling S&P Global Platts the move appears to signal Aramco's expectations for strong summer seasonal demand.
That may explain why Falih and other ministers, including Iran's Bijan Zanganeh, have said they see no need to make deeper production cuts for now to spur the market's rebalancing, even as traders appear to dismiss OPEC's claims that oil inventories are, in fact, falling.
"Sentiments in the financial markets of course swing like a pendulum, but that doesn't change the fundamentals," Falih told CNBC earlier this month. "What we can influence as oil producers is the fundamentals, the level of supply which will result in drawing down the inventories."
EVIDENCE OF CUTS
Traders have increasingly focused their attention on the US Energy Information Administration's weekly US inventory report on Wednesdays.
Falih, who pledged that OPEC will do "whatever it takes" to rebalance the oversupplied market, has said Saudi Arabia has cut exports to the US in recent weeks, which should increasingly show up in the EIA data and, as he hopes, turn bearish sentiment positive.
Indeed, the four-week moving average of US crude imports from Saudi Arabia fell 114,000 b/d to 856,000 b/d, the lowest level so far this year, the EIA reported on Wednesday.
But the reductions in Saudi medium sour crude exports to the US might only serve to keep similar US grades, such as offshore Gulf of Mexico grades Mars, Poseidon and Southern Green Canyon, from being sent abroad, as refineries use them to replace the missing Saudi barrels.
The Saudi cuts may do little to blunt the growth in exports of US tight oils, which are starting to find their way to Europe and Asia, although market sources say quality consistency in shale oil cargoes remains an issue.
US shale production, according to some estimates, has risen by more than 500,000 b/d since the OPEC/non-OPEC cuts began in January.
Already, the Mediterranean basin is glutted with light sweets, which typically trade at premiums to heavier sour grades but are instead seeing widening discounts.
For example, Kazakhstan's light sweet CPC Blend recently saw its discount to medium sour Russian Urals crude fall to its widest point in two years, and the front-month Brent-Dubai exchange of futures for swaps contract has narrowed for much of the year since the cut agreement went into force.
Within OPEC, as well, Nigeria and Libya have seen their production, which consists mostly of light sweet grades, rise in the last month as militancy has calmed. The two countries' output in May was some 400,000 b/d higher than at the start of the year, according to the latest S&P Global Platts OPEC survey.
Both countries were exempt from the cuts in the OPEC/non-OPEC deal as they dealt with attacks on their oil infrastructure, and analysts say they may need to be brought into the fold if their output gains prove sustainable.
"Slapping an output quota on Libya and Nigeria is always an option if the sweet glut does not resolve itself," said Tamas Vargas, an analyst with PVM Oil Associates.
MONITORING COMMITTEE TO MEET
Beyond that, OPEC appears to have few options at its disposal if it wants to stabilize the market.
Cutting deeper might raise prices temporarily but would encourage more US shale growth, and the resulting price rise for medium sours could prompt some refineries to shift their slates towards light sweets, even if they are not optimally designed to run those crudes.
Several refineries have already begun to do so, particularly in the US, where refinery runs have been at record levels in recent weeks, keeping US gasoline stocks bloated.
But globally, many units still have to mainly process sourer grades because of their configuration and yield of products required.
OPEC may simply have to wait until US production peaks and refineries can no longer absorb the growth in light sweet crudes, as well as examine ending the exemptions for Libya and Nigeria.
An OPEC/non-OPEC monitoring committee is scheduled to meet July 24 in Russia to discuss market conditions and the need for any changes to the cut agreement, although in a statement earlier this month, it said oil fundamentals were "moving in the right direction."
"There are lots of bearish factors out there but the pace of the [price] decline isn't matching up with physical," said Jamie Webster, a fellow at Columbia University's Center on Global Energy Policy. "It's a reminder that an oversupplied market overall still has sharp variations -- US gasoline on one side, medium sour supply on the other."
--Herman Wang, firstname.lastname@example.org
--Geoffrey Craig, email@example.com
--Edited by Jeremy Lovell, firstname.lastname@example.org