The market is faced with a paradox. Demand is softening, but not as quickly as supply. Yet at the same time, we know that HSFO demand is going to fall off a cliff some time in H2 19. Shipowners will probably seek to burn fuel oil right up until the last moment before IMO 2020, but bunker sellers have probably won’t have the same incentives. The coming six months look to be a tussle between two clashing narratives: slowing demand and a growing crude quality mismatch.
For now, fuel oil markets are dancing to the sour crude tune. Despite demand worries and a plunging Asian viscosity spread, timespreads have tightened significantly, as the long-term supply-side trends that have underpinned prices for the last three years return to the forefront.
This time, fuel oil values look to have been pushed higher by the dramatic tightening in sour crude values worldwide as the recent OPEC cuts have compounded the ongoing trend of dwindling heavy crude production in most parts of the world outside of Canada. Renewed political unrest in Venezuela only adds to the pressure, even though Venezuelan oil output is a shadow of its former self.
More importantly for the fuel oil market, Russian domestic crude prices have failed to keep pace with international values, and the cut in export duties at the start of 2019 has firmly flipped spot crude export margins into positive territory, which will squeeze runs at independent Russian refineries, cutting Russian fuel oil output further.
Given the tightness in sour crudes in the Atlantic basin, there is little room for refiners to respond to rising cracks. Indeed, further declines in fuel oil output are likely as refiners are forced to run more sweet crude. For fuel oil markets, the key point is the dearth of heavy bottoms in some of these light crudes. This shortage of heavier crude appears to be becoming a problem for other markets, notably middle distillates, yields of which have been struggling to rise despite strong signals.
Indeed, one only needs to glance at the Urals market in Europe to see how tight things have become. Urals in the Mediterranean has traded at a premium to Dated Brent since the start of 2019, reaching levels unseen since 2013. Turkey’s 0.21 mb/d Star refinery, which is on the verge of starting up and which will process Urals and Kirkuk blend, will only exacerbate this tightness.
With IMO 2020 on the horizon, there are those that will say this is a good thing, but the problem is the mismatch on timing. HSFO output has tightened a lot, and any US ban on imports of Venezuelan crude would likely bring a month or two of extreme tightness in local sour markets as trade flows reshuffled.
None of this is to say fuel oil is a one-way bet. There are other signs of concern in the physical market. The viscosity spread in Asia has collapsed again, suggesting poor utility demand, and Pakistan is again exporting HSFO as it seeks to clear refinery tanks of excess supplies. Chinese fuel oil demand is slowing too, partly thanks to the 1 January switch to 0.5% sulphur bunkers in Chinese coastal waters. The market is taking these wobbles in its stride—but the IMO demand shock is yet to come.