Iron maiden

Published at 09:49 22 Feb 2019 by . Last edited 11:18 22 Aug 2019.

Fuel oil markets have been buffeted by the accelerated slide in dry bulk freight rates following the collapse of a dam at a Brazilian iron mine and a surge in Middle Eastern fuel oil exports. The latter looks to be a problem that will fade with the return of warm weather, but the drop in shipping demand represents a significant risk for the market given the weakness in utility demand for fuel oil in Asia.

The dam collapse and associated output losses at the Corrgo do Feijao mine could reach up to 70 million tonnes of lost iron ore output this year, equivalent to 350–400 Capesize cargoes. If we assume the mine shutdowns reduce Brazilian iron ore exports by 5 Mt a month, this represents twenty five 0.2 Mt Capesize cargoes lost and, by extension, more than 50 kt of bunker fuel demand per month.

Of greater concern to the fuel oil market is the weakness in other trade metrics. Exports of non-oil products from Singapore tumbled by 10.1% y/y in January, amid a sharp drop in shipments to China, South Korea and Japan. Korean exports fell by 11.7% y/y over 1–20 February, hurt by a plunge in shipments of semiconductors and generalised weakness in trade with China, the EU and Vietnam. Weakening Chinese steel output, partly due to stricter pollution controls, has not helped matters.

With the Baltic Dry Index trading near its lows of 2016, the fuel oil market is on edge after weak demand readings in January. Any recovery in shipping may take some time as Chinese steel mills appear to be in little hurry to resume iron ore buying. Against this backdrop of potentially soft demand from the marine sector, the Singapore market is struggling to absorb relatively high inflows into Asia in January, largely due to a surge in shipments out of the Middle East.

The supply side should improve from here. Inflows to Asia from the Atlantic basin, look set to drop back to around 3 Mt in March as refinery maintenance cuts supplies. Fuel oil output in Singapore itself will be curtailed in Q2 19 as planned maintenance is expected at both ExxonMobil’s refining complex and Shell’s Pulau Bukom refinery.

US sanctions on Venezuela are also likely to curb fuel oil output at the margin by making it harder for heavy crude to get out of the country. With the vast majority of the armed forces still backing President Maduro’s regime, it seems unlikely that the sanctions on Venezuelan oil exports will be lifted soon.

The strength in fuel oil at the start of 2019 was always going to be short-lived with IMO 2020 around the corner, but the mismatch between supply (which is falling quickly) and demand (which was strong) always meant that prices could continue to perform well.

If the weakness in demand can be contained to the iron ore sector, then supply fundamentals should reassert themselves in the spring as refineries enter maintenance. The key to the market is therefore demand—and the severity (or not) of China’s economic slowdown. The trade war between the US and China has so far been more of a preliminary skirmish and there are already signs that Washington is seeking ways to end the conflict before it worsens.

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