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The Globe and Mail

Oil's physical strength defies slowdown woes


Javier Blas is commodities editor at the Financial Times

The physical oil market continues to show a remarkable strength even if futures prices are lagging amid worries about the impact of an economic slowdown on demand.

The latest signal of supply and demand tightness comes from Asia and the Middle East. On the one hand, the cost of Oman-Dubai crude, the regional benchmark, in the spot market has surged significantly above their price for delivery later on the year and into early 2012. The downward slope of the curve, known as backwardation, is an indication of immediate tightness. On the other, the premium that Saudi Arabia charges to Asian refiners for its main crude stream has jumped to an all-time high.

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As Edward Morse, the veteran oil watcher at Citigroup in New York, put it earlier this week, "the dire macro outlook continues to weight on the oil complex … but there remains very little in the way of weakness visible in the oil market itself".

The first-to-second month backwardation in Oman-Dubai crude - an indicator of physical tightness - has spiked this week to $1.40 a barrel, up from just 7 cents a month ago and about 60 cents six months ago. The backwardation is among the strongest in recent years, according to Reuters data. The strength of Oman-Dubai is even more surprising taking into account that the seasonal peak in oil demand in the Middle East - the air conditioning season over the summer - has just ended.

Just at the same time, Saudi Arabia has raised the premium at which it sells its main crude stream, known as Saudi Light, to Asian customers in November to a record $2.70 a barrel above the cost of Oman-Dubai crude, up from $1.65 in October. The premium is 35 cents higher than the previous record, set in November 2007, when the market was heading towards the super-spike of nearly $150 a barrel in 2008.

Asia and the Middle East will account for the bulk of oil demand growth both this year and in 2012, according to estimates by the International Energy Agency. The western countries' oil watchdog estimates that Asian oil consumption will growth by 915,000 barrels a day this year, with the Middle East adding another 226,000 b/d. Global oil demand will grow by 1.04m b/d because of drops in the U.S. and Europe.

The strength of Asian demand is lifting the physical market even as Saudi Arabia, Kuwait and United Arab Emirates supply almost record volumes of crude.

The strength of the physical crude oil market for Asia and the Middle East contrasts with recent weakness for Brent and West Texas Intermediate crude oil. Brent oil dipped briefly earlier this week below $100 a barrel, although prices have recovered to around $104 a barrel since then. If the physical market in Asia points to the right direction, Brent and WTI prices could be moving higher over the next few days.

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