Casualty of war

Published at 09:33 20 Dec 2018 by . Last edited 11:18 22 Aug 2019.

Please note that this is the last Products Outlook of 2018. The next monthly oil products publication (Light Ends Monthly) will be published on 11 January 2019. Happy holidays to all! 

Demand has underpinned the strength in fuel oil markets for the past few years but the wobbles in the global economy can no longer be ignored. Although there is evidence that the most pessimistic scenarios can be ruled out, the market must also pay attention to the signs that bunker fuel demand may be coming off the boil after a strong run of many months. This is not to say that the supply side of the ledger has become any less supportive. But a slowdown in demand would take the edge off pricing with just two quarters remaining until the first shockwaves of IMO 2020 are felt.

Optimists on the demand front can point to the recent recovery in the Baltic Dry Index and other market signals that suggest that freight rates are far from collapsing and that recent slowdowns in bunker demand have more to do with ship owners’ behaviour than anything else. For instance, Singapore bunker fuel sales in November slipped by nearly 0.1 mb/d y/y but this was largely driven by the drop in the average bunker stem size to a 17-month low. Once shippers return to larger purchases, the argument goes, demand will recover.

But there is another reason to be worried about bunker demand: the state of global trade. Despite the recent US-China truce in their trade dispute, the tensions between the two countries have not been resolved. Container throughputs at some key Asian ports are weak, a reflection of the challenges facing Asian exporters, weighing on spot container shipping rates.

Lower prices for fuel oil do offer some hope on the demand front. Fuel oil is again competitive with spot LNG in Asia, which may encourage more spot buying, particularly if the weather gets cold. Utility grade fuel oil in Asia has fallen sharply amid a dearth of demand, which is one of the factors weighing on market structure at this time. However, the problem here is that Asian LNG buyers stocked up on supplies early ahead of this winter and available nuclear generating capacity in Japan has tripled from last winter, so there is less spot demand to fill. Term contracts in some markets will also limit the appeal of fuel oil to some buyers, at least in the short run.

Fuel oil markets are therefore at a key point. Unless demand has truly collapsed, fuel oil prices can only get so weak because the supply shortfall that took the market to recent highs has not been resolved. Yet there are just two quarters left before the first signs of the IMO 2020 transition start to be felt in the European market. So, there is not much time left to trade HSFO in isolation from this momentous shift.

Arguably, there is little prices can do in the time that is left to stimulate significant shifts in demand. Bunker fuel demand will obey the overall macroeconomic pattern while spring will erode whatever advantage fuel oil may gain over natural gas as heating demand comes off. Similarly, the supply side of the market is unlikely to be greatly affected by falling oil prices unless Brent crude takes a further tumble below $50 a barrel because it would likely take that sort of a move in crude to get Russian supply dynamics to start to shift towards lower exports. If the macroeconomic sentiment that is dominating trading starts to fade, then fundamentals may reassert themselves, though the risk is that the latest volatility will only accelerate the retreat of liquidity from the HSFO market.

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