Fuel oil market fundamentals remain solidly bullish and hindsight has shown we were perhaps too cautious on the upside left in the market. With arbitrage flows from Europe to Asia set to be higher in November and more Middle Eastern fuel oil (ex-Iran) headed to Singapore, next month will not be quite as favourable as October. But into December, the loss of Iranian supply, growing Saudi demand and sliding West of Suez production will take centre stage once again.
Over the next 6-9 months, there is only modest downside. Global fuel oil supply has been falling all year, and as we move into 2019, the decisive year ahead of IMO 2020, declines will accelerate. There is a mismatch between supply and demand in the market that will violently reverse at some point. Until conventional fuel oil demand starts to fall sharply in H2 19 as the marine fuel market starts switching stocks from HSFO to 2020 compliant fuels, the market will tend towards tightness. For now, demand has held up while Caribbean supply has fallen further, ARA supplies are dropping on refinery upgrades, Iranian fuel oil is being pushed out of the market by sanctions and more refinery upgrades are coming in Russia. Meanwhile, soaring freight rates are complicating arbitrage flows from Europe to Asia. Unsurprisingly, the HSFO forward curve has steepened materially for the first six months out.
The closure of Trinidad’s sole refinery will remove another 0.2 Mt per month from Caribbean exports. Even with Mexican demand falling, helping to free up some barrels, refining in Latin America continues to decline. The other big development on the supply front is in Europe, where ExxonMobil’s 50 thousand b/d delayed coker at its 0.33 mb/d Antwerp refinery in Belgium is ramping up and the company reportedly sold its final barge of RMG bunker fuel from Antwerp in mid-October. More upgrades are also coming in Russia that will slash HSFO production starting in November.
There are further tailwinds for fuel oil arising from the Middle East. Although Kuwaiti exports are higher, Iranian supply losses will be more acute going forward, and Saudi fuel oil demand will continue to grow even in the traditionally slow months with the impending start of new power generation capacity. Given that the UAE seems to be cracking down more heavily on smuggling Iranian fuel oil into Fujairah, the East of Suez fuel oil market is going to remain tight even with Pakistan skipping imports and Japanese demand likely to fall sharply this winter.
But after a tight H1 19, the poles flip in H2 19. Indeed, heading into late 2019, there will almost certainly be a permanent decline in Asian demand for HSFO arbitrage flows. Bunker suppliers will need to take tanks and barges out of service from mid-2019 to clean them out and to be able to start building stocks of compliant 0.5% sulphur fuels in time for the 2020 switch. Likewise, ship owners will need to start clearing their own tanks and once a ship’s tank has been converted to clean fuel use, there is no going back to HSFO. When these phenomena gather momentum, HSFO demand will come off sharply, bringing supply and demand back into alignment and likely pushing the market into oversupply. Demand declines will lag supply falls for the next several months, but demand will, at some point in Q3 19 or perhaps Q4 19, fall sharply, dramatically reversing the trends of the last two years.