The fuel oil market is shifting to a more cautious posture. Longer-term bullish trends are intact, but in the short run, the positive news looks priced in, especially with East of Suez utility demand waning, leaving the market in need of a catalyst. Pakistan, a key standout for fuel oil demand growth in recent years, increasingly looks to be nearing a peak in demand, and fuel oil may even begin to fall as new gas, coal and nuclear power plants come onstream, following a trend started by Japan and South Korea. Iran may need more fuel oil this winter due to the problems at the South Pars field, but overall Middle Eastern demand is on its usual seasonal downswing.
The growth in Singapore bunker sales in August was impressive and contrary to our earlier expectation that a high base would see growth start to slow. Over January-August 2017, demand growth averaged 29 thousand b/d, aided by strong manufacturing and trade. Bunker demand should continue to be strong as shipping rates improve. As for the supply side, LatAm refining is weak and Russian fuel oil yields are dropping. But with Asia’s onshore inventories comfortable and Asian markets already strongly priced, prices were loath to rise further.
Outside of the bunker sector, a holding pattern has emerged. On our balances, Asia’s fuel oil net short in Q4 17 is exactly the same as in Q3 17 and just 30 thousand b/d more than in Q4 16—this is neither definitively bullish or bearish. Thanks to shipping, Singapore, China and Hong Kong are the last bastions of regional demand strength. Demand in India, Taiwan, Japan and South Korea is sinking deeper into contractionary territory as utilities eschew fuel oil. Asian regional demand fell by 28 thousand b/d y/y in July, the third straight monthly decline, and preliminary figures suggest a similar story for August. In July, visible regional stocks had their first y/y surplus since May 2016 and were up by 7.8 mb from January’s six-year low of 57.9 mb.
The slowdown in peripheral utility demand and concurrent rise in local stocks partly explains why fuel oil cracks surrendered so quickly to resurgent crude prices this month. Northwest European gross hydroskimming margins are the weakest since mid-April while Asian gross margins are the worst since early June. The drop in simple margins will discourage refineries from heedlessly using spare topping capacity, but strong diesel pricing still encourages refineries to keep running hard. Indeed, the spread between European ULSD and HSFO recently passed $230 per tonne, the widest gap between clean and dirty products since June 2016, and even the spread between 0.1% sulphur heating oil is the strongest since June 2016 at over $210 per tonne.
But fuel oil fundamentals over the next 18 months are far more bullish than bearish. Into H1 19, supply declines are likely to at least keep pace with demand declines unless global economic growth moderates. Traders will increasingly focus on how the industry will tackle the challenge of the IMO’s 2020 bunker fuel shift as the deadline draws nearer, and we include our latest views on this topic this month.
In the meantime, the market needs a short-term catalyst, which is only likely to come from ongoing supply declines and resilient bunker demand drawing down stocks further. Until a trend becomes established, the market will continue to struggle for direction and may face a winter in the doldrums until Middle Eastern utility demand returns.