US$100-a-barrel oil is already here for Saudi

Stability threat: An employee walks near an oil tank at Saudi Aramco’s Ras Tanura oil refinery and terminal. Riyadh’s pricing strategy is stoking global inflationary pressures, potentially forcing central banks to keep interest rates higher for longer. — Reuters

IN the world of oil, there’s no such a thing as THE price. There are dozens of different measures, one for each variety of crude.

The financial market focuses on two: Brent and West Texas Intermediate (WTI), the grades traded in London and New York, respectively.

They suggest a price hovering around US$90 a barrel. But from the perspective of Saudi Arabia, oil is already touching US$100.

The discrepancy reflects the pricing power that Saudi Arabia has gained over the last year-and-a-half. It has allowed Riyadh to charge a record premium for its oil, particularly for American and European customers seeking alternatives to Russian crude.

The surcharge matters because of the central role that Saudi Arabia plays in the market, pumping roughly one-in-10 barrels worldwide.

Riyadh’s pricing strategy is stoking global inflationary pressures, potentially forcing central banks to keep interest rates higher for longer.

At the same time, the geopolitical hand of Riyadh gets stronger. On Wednesday, the price of Saudi’s flagship oil grade Arab Light rose to almost US$98.47 a barrel in Europe, according to data compiled by Bloomberg. Over the last 40 years, Arab Light has traded above US$100 only a handful of times – in 2008, between 2012 and 2014, and in 2022.

Global market mechanics

The mechanics of the global market explain why Arab Light trades at such a high premium to the closely watched Brent and WTI benchmarks.

Since the collapse of the fixed oil-price system administered by the Organisation of the Petroleum Exporting Countries (Opec) in the mid-1980s, markets have set prices; Opec’s influence lay in adjusting production.

From 1988, Saudi Arabia has sold its crude under long-term contracts based on a formula combining a benchmark, such as Brent, and a relatively small discount or premium. The benchmark and differential are different depending whether the sales are to the Americas, Europe or Asia.

For most of the last 35 years, those differentials were measured in cents rather than dollars. And, except for Asia, they were mostly negative, meaning Riyadh sold its crude at a discount to the European and US benchmarks. Asia paid a premium, but it was relatively small.

Between 2000 and 2020, the kingdom charged European buyers an average discount to Brent of about US$3 per barrel. More recently, it has charged a premium that’s been growing.

For September, Saudi set the price of Arab Light at a record high of US$5.80 a barrel more than Brent.

For American consumers, that premium is also at a record of nearly US$7.25 a barrel. For Asia, the premium is currently smaller, though last year it surged to a record of nearly US$10.

Saudi Arabia’s renewed pricing power is due to two factors, one entirely deliberate, the second down to happenstance. The first, and perhaps most important, is that Riyadh is taking some of the cake that oil refiners are enjoying.

Around the world, refining margins – the difference between the cost of crude and the value of the petrol, diesel and other petroleum products – have surged to records, due to soaring demand combined with a lack of refining capacity.

Gross product worth

Every month, Riyadh calculates the value of the products that a typical refinery would yield processing Saudi crude, known in industry parlance as gross product worth, or GPW.

The higher the GPW, the more a seller can charge a refinery without the buyer complaining. And since mid-2022, the GPW of a barrel of Saudi crude has surged.

So the kingdom is making sure refiners share some of that extra profit.

The second is that the global oil market is particularly starved of the kind of crude that Saudi Arabia produces. That’s mostly the result of the deep production cuts the kingdom has implemented this year.

But also it reflect the fact that the biggest source of extra oil supply – American shale – is very different to Saudi crude.

For many refiners with ultra-modern facilities capable of cracking the most difficult hydrocarbon molecules, Saudi crude is a staple, allowing them to run their plants better.

It’s particularly good for diesel, the workhorse of the global economy. By contrast, US shale oil yields comparatively more petrochemicals.

The bottom line is that oil prices are not only high and rising, but they’re also much more elevated than the Brent and WTI benchmarks suggest.

As in 1973-1974, during the first oil shock when the Saudi grade was the market’s main benchmark, central banks need to watch the cost of Arab Light to judge the outlook for inflation.

As thing stand, the picture isn’t pretty – and it’s getting worse. — Bloomberg

Javier Blas is a Bloomberg Opinion columnist. The views expressed here are the writer’s own.

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