-- Robert Campbell is a Reuters market analyst. The views expressed are his own. --
By Robert Campbell
NEW YORK, Dec 5 (Reuters) - The roaring bull run in Asian crude oil markets has been brought to a screeching halt by arbitrage players but traders would be remiss not to keep one eye on the Dubai screen for signs of another flare-up.
The gap between Asian benchmark Dubai swaps and Brent crude futures has tumbled to a one-year low near $3 a barrel, completing the unwinding of the blowout in the spread caused by the Libyan civil war. (See Chart 1)
Not surprisingly the relative weakness in Atlantic basin crude markets has prompted some arbitrage players to move cargoes east in a rare and risky trade.
In the best known trade, oil major BP (BP.L) is believed to be taking 2 million barrels of North Sea benchmark Forties crude to South Korea. Total (TOTF.PA) is also believed to be moving another 2 million barrels east. [ID:nL4E7N12A0]
Market participants say other companies, including Chinese firms, have been moving oil to Asia, including Russia's light sour Urals crude, which has shown unprecedented strength against the Dated Brent benchmark in recent weeks.
In any arbitrage trade, there are two sides to the coin. So what is the driver here? Is it relatively weak European demand and improved supply with Libya coming back?
Perhaps. Certainly European refiners, already battling very weak gasoline prices, will be hammered by the sudden tightening of regional supply caused by the arbitrage flows, given the limited amount of short-haul European crude that is on offer at any moment. [ID:nL5E7N12L7]
But there is also the Asian side of the equation. The backwardation in the Dubai swaps market soared last week to multi-year highs, suggesting, at least in the short term, a very tight market east of Suez.
Arbitrage flows have dented this backwardation but even at today's levels the market is signaling for prompt crude supplies. (See Chart 2).
Chart 1: Dubai-Brent spread: r.reuters.com/dem45s
Chart 2: Dubai timespread: r.reuters.com/bem45s
The final leg in the tightening of Dubai timespreads started off in early November, coinciding with the return of tensions between the West and Iran over Tehran's nuclear program.
So have Asian refiners been scrambling for alternatives to Iranian crude as a hedge against possible military conflict? That may well be the case.
Cheap tanker rates owing to an oversupply of long-range vessels are helping the crude oil flows, as well as strong fuel oil prices which encourage simple refineries to maximize runs.
But the rally seems to be driven mostly by crude oil market dynamics rather than product flows. Middle distillates, in particular, do not seem to be racing ahead.
Distillate cracks in Asia have fallen since October, knocked lower in part by China staying out of the spot market and relying on its expanding refineries to meet domestic diesel fuel demand. [ID:nL4E7MT1T1]
A lack of demand from Europe for Asian diesel fuel is further helping to keep the Singapore distillates market stable.
So a case for this being a crude oil driven rally can be made. Given Asia's heavy reliance on crude oil imports from the Middle East which could be threatened by military action against Iran, a bit of urgency in crude buying should not come as a surprise.
If so, some of the new buying may be for crude oil stockpiles and not immediate consumption. But this is hard to tell given the paucity of data on Asian oil stockpiles.
But in any case, to peg this as a one-off rally following an escalation of tensions with Iran ignores the steady tightening of Dubai timespreads over the last several months.
Some 1.8 million barrels per day of net new refining capacity is due to start up next year, most of which will be in Asia. A series of closures in Europe and the United States will further amplify the impact of these new plants on crude flows.
The simple fact is that the market for crude oil is growing fastest in Asia as the overall market shifts eastward.
Soft demand in the Atlantic basin due to economic weakness in Europe and the Americas will more than likely materialize in the form of lower crude runs in Europe. And in turn that could lead to more crude arbitrage east. (Editing by Marguerita Choy)