The sudden rally in crude prices that took Brent above $70 a barrel could not have come at a worse time for fuel oil, with Pakistan slashing imports just as Middle Eastern outflows have picked up and Russian exports climb to their usual year-end highs, so cracks have fallen hard, imperilling the profitability of less complex refineries in Europe and Asia. Lower runs at such plants will help stabilise the market as fundamentals start to improve into the spring, but there are risks on the horizon.
Saudi Arabia’s decision to slash electricity subsidies from 1 January ought to give pause to long time fuel oil bulls. The reforms eliminate some of the cheapest rates at the lowest tiers of demand. Cash handouts will ease the pain for many households, but soaring rates will incentivise power conservation.
Riyadh hopes the reforms will shave demand by 40 GWh this year, or 13% of 2017 demand. Even if the cut is only 20 GWh, fuel oil consumption will be affected, though given the distortions in the local market, the drop will be less than what some may believe. On a heat equivalent basis, fuel oil is the cheapest power generation fuel in Saudi, 50% cheaper than gas.
Gas-fired power generation predominates in eastern Saudi Arabia, while many new fuel oil-fired plants are located on the Red Sea coast. Power transmission infrastructure connects regions, but neither can rely exclusively on power from the other. Direct crude burn will probably be the hardest hit by the reforms, though Saudi Arabia has been careful not to flood the market with crude this winter so eliminating direct crude burn may not be on the cards either.
The potential downturn in fuel oil demand perhaps explains why Aramco Trading has been so quiet in the fuel oil market lately. The unit had previously bought fuel oil in the Baltic Sea and the Black Sea, but in recent weeks these activities have dried up. Increased fuel oil exports from Iran, owing to rising South Pars gas production and higher exports to Iraq, as the latter uses more gas from Iran in its power sector, have added to Middle Eastern outflows to Singapore, keeping pressure on Asian prices.
The market is therefore again reduced to waiting for things to improve. It will take time to chew through the end-of-year deluge of Russian barrels and strong Middle Eastern exports, even with robust bunker demand. Rock-bottom topping margins in the Mediterranean and Asia will discourage supplies at the margin, as will Russia’s onerous export taxes on fuel oil exports, but the market may well struggle until spring refinery turnarounds in Europe cut supplies and warmer temperatures boost Middle Eastern demand—in other words, only by June.
By then it could be the last hurrah for fuel oil, as traders will be increasingly positioning themselves to capitalise on an anticipated slump in fuel oil values from H2 19 as prices realign themselves to encourage maximum residual fuel destruction and inventory holders dump unwanted supplies. A deep contango may form in prices as well if the market starts to bet heavily that oversupply will persist in 2020 as outlets for fuel oil other than bunkers are getting increasingly scarce. The window of opportunity for the bulls is narrowing.