Blended returns

Published at 09:42 28 Sep 2018 by . Last edited 11:18 22 Aug 2019.

Middle Eastern fuel oil premiums spiked over $15 per tonne earlier this month, reflecting fears that Iranian supplies are set to drop sharply. But with prompt Singapore fuel oil spreads moving up towards $6 per tonne, how much room is left for prices to climb from here? Cracks are already strong in anticipation of turnarounds and the loss of supply from Iran. And even though soaring Oman (and sour) crude prices mean there will be a bid for fuel oil as a refinery feedstock, the market will need a squeeze play or supply disruption to move higher.

Traders are increasingly resigned to the idea that a lot of Iran’s fuel oil supplies could soon be inaccessible and that the smuggling (via the UAE or elsewhere) of the Iranian grade often used to blend up cracked material to specification is going to be much less than under the Obama administration. Since the Obama administration lifted some sanctions on Iran in 2016, the Islamic Republic has exported roughly 0.3 Mt per month of fuel oil to Asia.

This time around, the UAE is actively supporting the US sanctions regime and big players seem far more reluctant to court danger by trading with Iran, either directly or indirectly. Without Iranian fuel oil barrels, blenders must resort to higher-cost substitutes, including gasoil, which makes bringing cracked residual fuels up to specification much more expensive. If the blending returns are not there, then supply tightness in the finished bunker market is all but guaranteed.

Even if some smuggling does take place, there simply may be less available to export because the present US sanctions regime threatens Iran’s natural gas production. South Pars Condensate (SPC) was excluded from the Obama-era sanctions but this time there are plenty of signals that condensate will not be exempt. Indeed, South Korean petrochemical firms have already halted imports of SPC.

The loss of SPC export markets is forcing Iran to store this material in tanks and on ships, but the capacity to store this material is not unlimited. We estimate that there is 18.5 mb of workable storage space for unsold SPC onshore in Iran and that once this space is filled up, Iran will need to resort to floating storage and then cut back natural gas output.

The anticipation of Q4 18 strength points to a deeper issue for 2019. IMO 2020 is a 2019 story, starting from around June, as tanks are emptied out and cleaned to handle clean fuels. This will lead to inventories being dumped at times and reduced liquidity as available physical stocks in Singapore (both onshore and offshore) shrink, fuelling volatility as one-way bets against fuel oil ahead of IMO 2020 collide with operational challenges that will likely trigger short squeezes.

This does not mean that fuel oil blenders are poised for extinction. On the contrary, new low-sulphur fuel oil blends are likely to capture significant market share from MGO once shippers get used to using them. Already, Asian traders are showing greater willingness to entertain the use of hybrid 0.5% blends than many western traders, which is likely a function of the Asian market’s closer ties to physical bunker markets and long history of blending to produce on specification HSFO. IMO will give blenders and refiners new opportunities even as it snuffs out the traditional HSFO market.

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