Saudi Arabia to capitalise on Iraqi export lull

Asian refineries and oil traders are cooling their interest in purchasing Iraqi crude, according to a recent report compiled by Reuters.

Despite the fact that the majority of Iraq’s oil is produced and exported from the southern port of Basra, the speed with which ISIL militants seized control of Iraq’s northern and western oilfields last month has seriously dented confidence in the country’s ability to deliver reliable supplies.

OPEC production fell by 70,000 barrels per day in June, as Iraq’s oil export infrastructure creaked under the strain of political tensions and spot trading of Basra Light grade crude waned.

Iraq posted the largest decline as production fell by 170,000bpd in June and domestic use also fell due to the closure of the Baiji refinery after it was overrun by militants. Exports from Iraq’s southern port of Basra fell from 2.58mbpd in May to 2.43mbpd in June.

This lull in confidence in the Iraqi oil sector could open the door for other OPEC producers to increase their export levels to lucrative Asian markets in the coming months. Saudi Arabia stands to be the biggest beneficiary of this and the country has already pledged its support to OPEC.

“Saudi Arabia has the capability to produce up to 12.5 million bpd when the customers ask for it. The oil resources, production facilities and the management all support this,” a spokesperson for the Saudi Arabian oil ministry said.

Increased production from Saudi Arabia would be necessary to avoid a spike in oil prices should demand for Iraqi crude decline.

“Stabilising oil market in terms of balancing supply and demand and reducing volatility of oil prices has been the top concern of Saudi Arabia in the past 40 years at least,” said the spokesperson.

The sectarian violence that is tearing at the very fabric of the Iraqi state couldn’t have come at a worse time for the country’s oil industry, which has set itself ambitious plans to increase production levels. The violence came only a month after Asian refiners raised concern over the quality of Basra Light grade crude oil.

Two Chinese oil companies complained earlier this year about high water content in deliveries of Basra Light grade crude. Most refineries can process oil with a water content of up to 0.1%. However, recent deliveries of Basra Light to Chinese refineries have contained between 0.3% and 1.0% water.

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“Normally you should have a monitoring system in place. As production levels rise, this is not always the case. This water is going to degrade the pipelines, the pumping systems and all off the infrastructure. Also the buyer will feel cheated, because he will be buying water for the same price as oil. It hurts the consumer and the producer,” an industry expert who asked not to be named said.

The quality issues surrounding Basra Light coupled with the renewed security fears that are engulfing the country could severely impact on long term demand for oil from Asian refiners.

Iraq’s State Oil Marketing Organisation (SOMO) has already negotiated term agreements to sell around 1.7mbpd of Basra Light grade Crude to Asian refineries in 2014.

Asia is Iraq’s biggest market for oil exports, with Asian companies importing more than half of all the Basra Light which is exported from Basra.

The impact of the current crisis of confidence will be felt if and when Asian refineries decide not to renew these contracts in 2015.

Losing their key customer would be devastating to Iraq, but could be a perfect opportunity for Saudi Arabia, as the GCC looks to strengthen its ties with the Far East.

“I think that governments prefer to cooperate with China and other Asian companies in the future to market their oil resources because the Asia is their main market and has the fastest growing demand” said Li Li, head of research & strategy (Refining/Oil/Gas), ICIS C1 Energy, China.

The recent violence in Iraq highlights how quickly, and drastically fortunes can change in the region. Many analysts believe that increased Iraqi production is more of a threat to the established OPEC pecking order, than a decrease in production levels.

“Later in the current decade we foresee increased competition within OPEC, particularly as US production grows. Iraq and Saudi Arabia could find themselves competing for a limited share within OPEC. This clash has been foretold for a few years but has been delayed because of production problems elsewhere in OPEC, particularly Libya and Iran. The question is whether it will continue to be put off indefinitely,” said Robin Mills, head of consulting, Manaar.

Saudi Arabia is keen to strengthen its position within OPEC by making up for any shortfalls in production. To do so at the expense of one of its biggest rivals will only reinforce the perception of Saudi Arabia as a dependable and reliable producer of hydrocarbons, strengthening its claims for a bigger share of the OPEC pie in coming years.

Facts:
– 12.5mbpd Saudi’s maximum production capacity.
– 1.7mbpd the amount of Basra Light purchased by Asian refiners
– 1% The water content of recent deliveries of Basra Light to Asian refiners