As oil rallies, physical market suggests ample supply

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Weak Urals

The physical traders' views might be hard to reconcile with the rallying oil futures price.

Investors in futures markets for the past year have looked to wider economic data for signs of recovery. Oil has more than doubled since it sank to around USD 33 a barrel in December 2008.

In the view of some, oil's supply and demand fundamentals now are only a part of the picture.

"Anybody who still believes that oil futures prices are a reflection of the true state of the physical market is living in a time warp," said David Hufton of oil brokers PVM.

That may be just as well for OPEC, as some signs from the physical crude market are not bullish.

Russian export blend crude oil, Urals, in northwest Europe was pegged at USD 2.70 a barrel below dated Brent on Tuesday -- the lowest discount since November 2008, according to Reuters data.

To chart the discount of Urals crude in northwest Europe to dated Brent, click here

The discount has widened because of refinery maintenance work and limited demand from outside the region -- as well as signs of more barrels from OPEC members.

"There is quite a lot of sour crude," said a trader with a European oil company. "We also see more Iranian sour coming to Rotterdam. So there's less storage capacity for Urals."

Reduced volumes have been going from Europe to Asia, although Russia is sending supply of its new East Siberian Pacific Ocean (ESPO) blend to a port on the Pacific Ocean. That has lessened the pull of Urals east.

A further sign of weak sour crude markets was seen in Saudi Arabia's lowered official selling prices to Asia for April. In contrast, lighter crudes are being supported by the prospect of summer gasoline demand.

"The sweet grades have recovered, but ESPO is affecting the ability of the sour crudes to follow," a trader with a northeast Asian refiner said. "There is pressure from ESPO, so the Saudi OSP cut was very huge."

To be sure, demand for crude recedes in the second quarter after the northern hemisphere winter, so some of the bearishness in physical markets reflects seasonal factors.

It will be unclear how much was due to the seasons and how much to underlying demand until the summer driving season kicks in, traders said.

Good world

Physical markets were telling a different story a year ago -- tightening rather than weakening in line with the normal seasonal pattern.

One difference is OPEC was then meeting four-fifths of its pledge to curb output by 4.2 million barrels per day (bpd), rather than just over half now.

Another difference is oil futures are above the USD 70-USD 80 range that many in OPEC say they prefer and oil demand is expected to recover later in the year. That makes any supply cut unlikely, despite indications from physical markets.

"This is a good world for OPEC," Tossetti said. "They've raised production and prices have stayed at USD 70 to USD 80 and are now slightly above. There's no reason for them to do anything."