If you could pick the worst set of circumstances in which to start up a giant, export-oriented oil refinery, you might well have them right now.

Saudi Aramco and joint venture partner Sinopec have started test runs at their 400,000 barrel per day (bpd) Yanbu refinery, located in the kingdom.

This puts the new plant on schedule to begin commercial exports in November, possibly even by the second half of October, according to trade sources.

Yanbu will be the second major refinery to come online in Saudi Arabia in little more than a year, following the September 2013 start-up of the similar 400,000 bpd Jubail plant, a joint venture between Aramco and France's Total.

Both these plants are largely aimed at the export market and can supply to both Europe and Asia because of their location.

However, Yanbu is coming online at a time when crude demand growth in Asia is disappointing, the region's refiners are struggling to make decent profits, crude prices have gone into contango and Middle East producers are cutting official selling prices (OSPs).

The extra refined products from Yanbu may have two undesirable impacts, from a Saudi perspective.

The first is that they will lower demand from the region's refiners for crude deliveries as competition in the refined fuels market gets tougher, prompting some plants to run at lower utilisation rates.

The second is that the additional products will put downward pressure on prices, thus reducing Asian margins, prompting refiners to ask for greater discounts on crude supplies.

Saudi Aramco cut its OSP for its flagship Arab Light blend for Asian refineries for October cargoes to a discount of 5 cents a barrel to regional crude marker Oman/Dubai.

That was a cut of $1.70 a barrel from September cargoes, bigger than the market had anticipated and the largest reduction since February 2012.

It's also the first time since November 2010 that Arab Light has been at a discount to Oman/Dubai, according to a report from consultants Energy Aspects.

BRENT-DUBAI, DEMAND CONCERN

While the large cut in the OSP is probably in part a response to the sharp fall in the spread between Brent and Dubai crudes, it may also be a sign of Saudi concern about the state of Asian demand.

The premium of Brent to Dubai dropped from a 2014 peak of $4.96 a barrel on June 13 to just 94 cents on August 28, although it has since recovered slightly to $1.25 on Tuesday.

This has led Asian refiners to prefer crude priced off Brent rather than Dubai, thereby prompting Middle East producers to start offering lower OSPs.

The switch to contango for Oman futures traded on the Dubai Mercantile Exchange, whereby prompt prices are weaker than future months, is also a sign of weak current demand.

This market structure has led to traders buying oil and storing it for later sale, which creates a further headache for producers, since when the stockpiled oil is eventually released, it will be a drag on prices.

Asian refinery margins have recovered in recent weeks, with the five-day average for a Singapore plant using Dubai at $5.63 a barrel, slightly higher than the moving 365-day average of $5.35 but weaker than levels above $6 that prevailed for most of the January to April period this year.

Asian refiners are still not making as much money as their counterparts on the US Gulf coast or in Northwest Europe, and the addition of new plants in the region, such as Yanbu, will make life tougher for them.

What the start-up of Yanbu highlights is that Middle East oil producers will probably have to cut crude prices further in the next few months, or hope for a cold northern winter to spark a surge in demand.  - Reuters

* Clyde Russell is a Reuters columnist. The views expressed are his own.