Saudi Aramco cut the price of
December crude deliveries to U.S. refiners on Monday in order to
protect its competitiveness amid an erosion of its U.S. market
share by rival exporters such as Canada and Iraq.
In August, U.S. crude imports from Saudi Arabia slipped
below 900,000 barrels per day, according to the U.S. Energy
Information Administration.
With the exception of a brief period in 2009 and early 2010,
Saudi exports to the United States fell to the lowest level
since 1988 (link.reuters.com/jez33w).
U.S. imports from Saudi Arabia in August were just 70
percent of the average level for the past ten years which has
been around 1.3 million barrels per day.
Saudi oil, which is priced at a differential to a U.S. sour
crude marker, had become too expensive compared with
alternatives available to U.S. refiners.
So Saudi Aramco has been forced to cut the differentials for
U.S. refiners by between 45 and 50 cents (depending on grade)
per barrel even as it raised differentials for refiners in
Europe and Asia.
RIVAL EXPORTERS
Some commentators have interpreted the U.S. price cuts as a
signal the kingdom is initiating a deliberate price-war
targeting U.S. shale producers. The reality is more complex.
Most Saudi exports to the United States are much heavier and
certainly sourer than the light sweet oils being produced from
shale formations like North Dakota's Bakken and Texas' Eagle
Ford.
Aramco has therefore been spared head-to-head competition
from rising U.S. shale output, which has mostly fallen on U.S.
imports from West Africa.
However, the company's market share over the summer was hit
by competition from Iraq, Venezuela, Brazil and Canada, so
Aramco has cut its prices in the region to stabilize sales and
buy back some of its lost share.
OFFICIAL PRICES
Saudi Aramco prices its crude sales against different
benchmarks in the United States, Europe and Asia and applies a
different set of differentials in each region to reach a final
selling price.
Past experience suggests differentials are primarily used to
offset variations between the regional benchmarks to ensure
Aramco's crude sells at broadly the same price in each region.
Final selling prices vary much less between the regions than
the differentials themselves.
For example, the differentials for Arab Medium grade
delivered in December range by more than $4 per barrel from a
discount of $5.00 in Europe and $1.60 in Asia to a discount of
just 65 cents in the United States.
But the outright prices (benchmark plus or minus the
differential) currently range just over $2 between the most
expensive region (Asia) and the cheapest (the United States).
For Arab Light, the differentials vary by $4.95 per barrel,
but outright sales prices currently vary by just $1.78.
MARKETING STRATEGY
Traders and refiners need liquid benchmarks to hedge their
exposure to fluctuations in crude. But none of the benchmarks
closely resembles the grades of oil marketed by Saudi Aramco,
which is why the company has to apply large and variable monthly
adjustments to its selling prices via the differentials.
Saudi Aramco's marketers attempt to ensure (1) refiners buy
all the cargoes which the company has on offer and (2) sales
prices in the three regions are broadly equalised.
The first point is obvious. Saudi oil has to be priced
competitively with other similar grades or refiners will buy
something else instead.
The second is more subtle. Saudi exports are protected
against inter-regional arbitrage by destination clauses: oil
sold to a refiner in the United States cannot be diverted and
resold to a refiner in Asia.
But other crudes can be arbitraged between the regions and
so can the final products produced from refined oil.
Refiners are all, to some extent, competing against one
another in both the market for buying crude and in the sale of
refined products.
Aramco must price its crude to ensure its customers are not
put at a competitive disadvantage in either market.
While most Saudi oil is sold on long term contracts (with
market-linked pricing) Aramco would rapidly lose customers if
its oil proved to be expensive compared with other grades.
The potential for arbitrage in both crude and product
markets ensures that inter-regional differences in final selling
prices are ordinarily no more than $2-3 per barrel.
ARAMCO IS REACTIVE
Changes in official selling prices are often interpreted as
evidence of a "grand strategy" for market management by senior
policymakers in Riyadh and Dhahran.
For the most part, however, Saudi Aramco's pricing strategy
is reactive rather than proactive. The company adjusts
differentials in response to current and forecast market
conditions to maintain the competitiveness of its oil sales.
At the margin, Saudi Aramco can adjust differentials to push
slightly more oil into the market or hold sales back, as well as
to alter the balance of sales between regions.
But most of the changes in differentials are driven by the
need to react to external events (such as refining demand and
the availability of competing crudes) rather than Saudi
strategy.
The distribution of Saudi sales to the three regions
displays a high degree of stability over time (in contrast to
the differentials themselves).
In the case of the United States, Aramco's crude was too
expensive in June, July and August, and export volumes slumped
by almost 700,000 barrels per day.
Like any other marketer, to reverse some of those losses,
Aramco has cut its differentials to make its oil more
attractive.
The price cuts will intensify the competitive pressure on
U.S. shale producers, but that is an indirect consequence of the
policy, not its primary objective, which is to maintain market
share.
In any event, the Americas accounted for less than 20
percent of Saudi exports in 2013, according to the U.S. Energy
Information Administration.
In the much larger Asian market, which accounted for almost
70 percent of sales in 2013, where Aramco's oil has been
competitive, the company has actually boosted differentials for
December sales by around $1 per barrel.
Changes in differentials in the U.S. market are not a sign
that Saudi Aramco is declaring a volume war on U.S. shale
producers or other oil exporters (any more than differential
increases in Asia signal the opposite).
But that might be the unintended consequence if everyone
tries to defend their market share. Sooner or later someone
somewhere has to cut: whether it is the Saudis and OPEC,
non-OPEC suppliers like Canada, U.S. shale producers, or all of
them.
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