Fuel oil has been largely treading water for the past month, but relatively high stock levels at key pricing points mean there is little enthusiasm for aggressive positions in the near term. Looking ahead to 2018, however, the market is facing a renewed tightening of the supply side. The Russian refinery upgrade story is well known, as are Latin America’s persistent output difficulties. But supplies are set to fall in Europe and Asia next year as well.
The market has relied on massive stockdraws for the last two years to meet booming demand. European stocks fell from 92.9 mb in February 2016 to less than 70.5 mb in August. While most of the declines were in ARA, inventories in peripheral areas have come down sharply as well, with fuel oil stocks in non-ARA Europe down by 8.3 mb between February 2016 and August 2017. US inventory declines must also be considered. Between February 2016 and August 2017, those stocks fell by 11 mb and stocks reached 32.1 mb in late October, which is the lowest level since June 2012.
Indeed, the declines in European inventories have come despite rising fuel oil output every year since 2014. European production rose by some 80 thousand b/d between 2014 and 2017, largely due to higher refinery runs. However, this was dwarfed by the huge declines in Russian fuel oil output over the same period. Next year, European fuel oil output will decline, dragged down by two new cokers in Belgium and Poland, and we conservatively think production could fall by 70 thousand b/d next year, though there is scope for declines to be sharper if crude slates lighten.
The looming 2020 deadline set by the International Maritime Organization is the worst-kept secret in the market. Refiners are already moving to adapt their operations with an eye to capitalising on the dramatic shift in fuel oil component values that will come when marine fuel prices move much closer to clean product values. Therefore, in all likelihood refiners will already be taking action to curb excess fuel oil output when shutting for maintenance. Given that plants will likely want to be moving towards manufacturing post-2020 compliant fuel in H2 19, the first signs of this shift will become visible as refineries undergo maintenance.
Meanwhile, the demand side of the equation is mostly performing well. Bunker fuel demand is very strong, but utility demand has been dented by competition from lower-cost fuels in Asia. We retain our view that the market will likely need to wait for Middle Eastern fuel oil demand to swing higher in the spring before balances get very tight. But given the rapid drawdown in Atlantic basin inventories, it will not take much to push fuel oil balances to the point where it will be the responsibility of prices to bring the market into balance. We see fuel oil supply falling globally by 0.2 mb/d in 2018, while demand will fall by only half that amount.
However, with inventories in ARA and Singapore at comfortable levels, the prompt side of the market should not be the beneficiary of this emergent bullish scenario for 2018. Stocks will need to be run down at these pricing points first and the upward move in East-West spreads in response to anaemic arbitrage flows is probably the first step towards rebalancing these short-term fundamentals. Bullish factors should continue to grow in the market over the course of 2018, especially if the broader decline in stocks in the US and Europe persists.