Tight then loose

Published at 09:15 22 Jun 2018 by . Last edited 15:12 5 Nov 2018.

Genuine tightness continues to grip fuel oil markets largely due to the challenges of making on-specification material, sending prompt timespreads up above $5 per tonne in both Asia and Northwest Europe. A dearth of exports to Asia from the Atlantic basin in recent months and structural shifts in the East of Suez market mean Singapore is struggling to meet demand from shippers. Strong demand from Saudi Arabia amid soaring temperatures and a desire to maximise crude oil exports to try to dampen the crude price rally is further soaking up fuel oil supplies and supporting prices.

The long-awaited start-up of some of Pakistan’s gas-fired power plant fleet should provide some relief by allowing state oil company PSO to curtail fuel oil purchases, but real relief may not come until later this summer, when Saudi buying winds down ahead of the cooler months of the year, and even then, Asia may still need to work to pull barrels out of Europe for a while.

Even our 2019 balances paint a picture of surprising tightness over the first nine months of the year as supply will be adapting to 2020 norms long before demand shifts. We expect global fuel oil production to fall from some 7.4 mb/d in Q4 18 to around 6.8 mb/d in Q3 19 largely due to refinery upgrades. This pattern quickly reverses in Q4 19 as fuel oil buying interest will be dramatically lower, which will put the fuel oil market into massive oversupply as we do not expect a significant drop in fuel oil output q/q in Q4 19. During the switch to 0.1% sulphur fuel in the Emissions Control Areas (ECAs) on 1 January 2015, reported LSFO demand fell off several months before the deadline.

For now, the market is pricing as if diesel will be IMO 2020’s sole winner, which we disagree with. Not only is the 0.5% sulphur specification required by the IMO much easier to produce than conventional ULSD but there are also multiple pathways to compliance. Ship owners will likely gravitate to MGO at first, as the IMO 2020 transition begins, but as they get used to the new operating environment, very low sulphur fuel oil (VSLFO) will likely start to regain market share, perhaps as soon as Q2 20.

The experience with ultra-low sulphur fuel oil (ULSFO) in the European ECA in 2015 is instructive. LSFO sales went into a freefall in Europe in late 2014 as the ECA switch to 0.1% sulphur loomed, but they began to recover just one year into the shift. The 0.1% sulphur spec is far more challenging than the post-2020 0.5% spec, so we are likely to see a repeat in 2020. The 0.5% VLSFO blend will be a strong competitor and the uptake may be quicker than with ULSFO, as there will be ship operators familiar with ULSFO blends willing to experiment with VLSFO. If so, the big bets on diesel becoming the exclusive fuel source are likely to go sour. Diesel is likely be the winner over the first 6-12 months of IMO 2020 (a process we think starts in H2 19) but it will lose ground to the blenders after that.

Bunkering has been about blending for a long time now, which explains the murkiness of fuel oil statistics today, and it will get worse after 2020. Whether marine gasoil and special fuel oil blends get classified under the distillates or residual fuel categories is highly debatable and will be very complicated.

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