As the data for January and February start to trickle in, it is clear that the short-circuiting of the bull play seemingly planned for Asian fuel oil markets was an astute move. Fuel oil demand continues to rack up impressive numbers, but the refiner response to high cracks has also led to sharply higher supplies, as well as a surge in stocks at key hubs.
Yet cracks are hardly behaving as if the market is on the verge of a massive glut. Singapore bunker sales continue to set records, more than offsetting weakness in Asian utility demand, and with the OPEC cuts, the worldwide trend towards lighter crude slates has also accelerated. But a significant narrowing of light-heavy crude prices means the phenomenon is unlikely to repeat itself any time soon.
This situation likely goes beyond the impact of the OPEC cut. A serious quality imbalance is building up in the global oil market as a surfeit of light crude, led by the US shale revolution, tries to supplement waning medium and heavy oil output. All the naphtha in the world will do little to meet demand for more dense fuels, yet those who see shale production eroding all of OPEC’s efforts see little need to address this point. At some point, this shift in slates is going to have huge implications for the oil market, perhaps in the form of sharply higher diesel cracks.
Consequently, fuel oil supply is at risk of falling because refinery crude slates will keep getting lighter, limiting output. Latin American production looks poised to trend lower and spring turnarounds are looming just as Middle Eastern demand typically rises. Difficult arbitrage economics out of Europe this month are likely to turn up in lower arrivals into Asia in May and June, while heavy April maintenance in Russia should slow stockbuilds in Europe.
At the same time, the picture for demand remains positive. Rising oil prices pose a risk to bunker demand, which is extraordinarily price sensitive, but consolidation has so far not hit fuel demand too hard. The Baltic Dry Index hit 1,333 points in late March, triple the level it stood at a year ago, and container rates have also surged. Industry consolidation is helping shippers, but trade volumes are picking up sharply as well, and global economic data suggest there is more to come.
So, notwithstanding brief uptick in supply that has led to an accumulation of stocks at the main hubs, fuel oil balances are poised to turn more supportive. Our balances show draws in Q2 17 on a global basis, and there is more downside than upside risk to supply in the coming months. With Asian fuel oil swaps languishing near contango in some months, there is plenty of room for bullish traders to express a view on the market.
Indeed, if OPEC rolls over its commitment to cut oil output in May, the supply side should continue to tighten as the global crude slate will get even lighter as the bulk of the OPEC cuts will again be in medium and heavy grades. Given that OPEC’s stated policy is to draw down the global crude overhang, we think a rollover will be needed to reach that goal by year-end. Even if cheating on quotas picks up in H2 17, the key point for fuel oil markets is that such extra supply will simply be too little, too late.