The Fuse

Saudi Sale to Chinese Teapot Refinery a Big Move in Fight for Asian Market Share

by Matt Piotrowski | May 03, 2016

Geopolitics is typically supportive for oil markets, but not when it comes to the rivalry between Saudi Arabia and Iran. The tension between the two large producers has formed a wedge in OPEC and means the two regional powers appear poised to keep pumping at high levels to battle for market share instead of striking a deal to manage the global surplus.

Saudi Arabia’s spot crude oil sale last month to a Chinese teapot refinery, Shandong Chambroad Petrochemicals, is the latest maneuver in the market share battle between Saudi Arabia and Iran.

Saudi Arabia’s spot crude oil sale last month to a Chinese teapot refinery, Shandong Chambroad Petrochemicals, is the latest maneuver in the battle between the two countries. The sale is not only a symbolic move in that it is the first of its kind; it is also a deepening of the competition for buyers in Asia, the main center for demand growth globally, as the Saudis look for new outlets.

“This is one more indication that the Saudis are willing to fight for market share,” Matt Smith of ClipperData told The Fuse. “They’re in it for the long haul and will keep output and exports elevated to weed out high-cost production.”

The Saudis, for the most part, sell their volumes to customers on a term basis using formula prices, but with the teapot deal, they are showing flexibility by selling spot cargoes in order to find more buyers. Moreover, by using oil as a political weapon, they are trying to aggressively undercut regional rival Iran, which is boosting export volumes now that international sanctions have been lifted.

“Market share is not just an economic concept. It’s one that has deep political connotations as well.”

“That tension [between Saudi Arabia and Iran] is a central point in the oil market,” said Daniel Yergin, Vice Chairman of IHS, at last week’s Columbia Global Energy Summit in New York. “Market share is not just an economic concept. It’s one that has deep political connotations as well.”

He added: “The Saudi message is we’re not going to cut production to make room for Iranian oil in the market. And so what is happening goes far beyond the oil market. It’s really about who is the dominant power in the region.”

The Iranians, who weren’t part of the “freeze” negotiations in Doha, aren’t holding back either. April data show Iran pumped some 3.4 million barrels per day for the month, up from 3 mbd at the beginning of the year, setting the stage for fiercer competition as the year goes on and keeping a ceiling on prices for the time being. High levels from both countries have put OPEC output now around 32.64 mbd, according to Reuters, one of the highest levels in recent history.

China’s crude imports skyrocket

Interesting patterns are emerging in regards to flows heading to China. Crude imports have reached eye-opening levels, more than what product consumption would indicate. The high volumes are likely due to commercial and strategic stockpiling. Moreover, teapot refineries, small independent plants, for the first time are allowed to import after Beijing lifted restrictions last year. Giving the green light for the 20 teapots in the country to import has provided Middle East producers another outlet for their crude.

Teapot refineries, small independent plants, for the first time are allowed to import after Beijing lifted restrictions last year. Giving the green light for the 20 teapots in the country to import has provided Middle East producers another outlet for their crude.

In April, China’s waterborne crude oil imports reached the highest level in two years, averaging 7 million barrels per day, according to ClipperData. In fact, the last three months have been particularly strong, up 10 percent year-on-year, with Saudis sending over 1 mbd and the Iranians .55 mbd. Interestingly, imports from the Saudis spiked to 1.35 mbd in February, the same month that Iran began its post-sanctions recovery by increasing crude export volumes.

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The February bump was also soon after the Iranians were outraged at the Saudi execution of several Shia prisoners, including a prominent cleric, marking the strongest direct tension between the countries in three decades. The Saudis also have to keep an eye on Russia, whose production hit a post-Soviet record earlier this year, as Moscow wants to deepen its oil and gas sales to China.

China will continue to be a main outlet for both OPEC producers. China’s refined product demand is set to rise by .33 mbd this year, according to the International Energy Agency (IEA), while the country is also taking advantage of the low price environment to fill its strategic petroleum reserve and commercial crude tanks. But the big question is whether the country eventually runs out of storage space, a development that would significantly undermine imports. The fight for market share, though, goes beyond China—all of Asia is expected to see demand rise by .90 mbd this year, making up three-quarters of the world’s growth.

While China accounts for roughly 14 percent of Saudi exports, the U.S. is taking in a similar amount, exemplifying how the Saudis are trying to hold onto market share in all regions.

While China accounts for roughly 14 percent of Saudi exports, the U.S. is taking in a similar amount, exemplifying how the Saudis are trying to hold onto market share in all regions. After dipping below 1 mbd from September-October, U.S. crude imports from the Kingdom have averaged above that level for the past six months, thanks in part to the decline in shale output. According to final data from the Energy Information Administration (EIA), Saudi exports to the U.S. for January-February of this year rose by 22 percent versus the same time in 2015. Preliminary numbers for March put Saudi imports at 1.25 mbd, up 14 percent year-on-year.

More surprises in store?

The Saudis continue to surprise the global oil market. In November 2014, the Kingdom abandoned its role as swing producer amid a collapse in prices; earlier this year, it said it was mulling opening up part of state-owned Aramco to outside investors; it tore apart the agreement with non-OPEC and other OPEC producers in Doha to freeze output levels; and it is now selling spot cargoes to small refineries in China. It will be important to watch Saudi exports and the country’s formula prices going forward to gauge how aggressive it is in the fight for market share. More surprises are likely in store.