Fuel oil’s strength is finally catching up with it. Strong cracks in late 2016 and early 2017 gifted short-term decision makers at simple refineries with the unambiguous signal to up their runs, and they duly obliged. In the first two months of the year, European runs jumped by 0.4 mb/d, despite the closure of the La Mede refinery, and regional fuel oil supplies leapt by 80 thousand b/d. Until recently, fuel oil supplies had been falling faster than demand. Now the situation is different, which is why inventories in Singapore and ARA flipped back into y/y surplus in March. Margins are healthy, so refiners exiting maintenance will run hard, and with fuel oil cracks still bobbing close to multi-year highs, there are few reasons for refiners not to run simple topping capacity to eke out a bit more clean product.
However, there are signs in other markets that, despite high cracks, fuel oil yields may be peaking in response to tighter supplies of heavy crude due to the decline in non-OPEC supplies and lower OPEC production. Indeed, the strength in fuel oil cracks alone should not alarm the market, coming as it does at a time when we know heavy crude supplies to be on the decline. While Latin American crude sellers have been boasting about strong pricing, refiners have been telling us for months now about the increased difficulty in procuring cost-effective heavy crude, a reality which is incentivising slate switching in some places, including Korea. So some strength in cracks is to be expected as making the product becomes more difficult.
On top of the discretionary fall in fuel oil yields, East of Suez markets will lose some 0.6 mb/d of simple topping capacity in Japan and Kuwait in Q2 17, further reducing fuel oil yields. The situation in Venezuela is also supportive for the fuel oil market. Away from the country’s political tensions and ultimately successful scramble to meet a major bond repayment deadline, little has changed at PDVSA’s troubled refineries, where CDU outages surged y/y in February and March.
So while supplies are somewhat mixed, with several pockets of weakness potentially offset by higher runs from stellar global margins, the real driver over the next few months will be demand. Asian fuel oil demand has so far refused to concede, growing y/y in March for the ninth consecutive month by 40 thousand b/d. This has been led by strong demand in China, and booming bunker requirements in Hong Kong and Singapore. Crucially, these performances are indicative of a broader rebound across both OECD and non-OECD countries.
The market will also have to contend with a growing fuel oil short into the Middle East, where surging power-driven fuel oil demand in Saudi Arabia and lower availabilities ex-Kuwait are setting the stage for a summer of strength. All in all, fuel oil is quietly taking a ride in the slipstream of renewed economic growth and OPEC’s ongoing cuts. If demand and OPEC keep to their side of the bargain—and we think they will—global fuel oil stocks should draw modestly across Q2 17. But, given the stock overhang in both Singapore and ARA, it is perhaps too much to expect a dramatic rally to push timespreads and cracks even higher. Until stocks are further eroded, fuel oil will need crude timespreads to push closer to backwardation, or the Middle East to suffer a heatwave, to sustain any rally. The fundamentals are balanced to bullish, but the price is probably close to fair already.