The coiled spring

Published at 09:53 10 May 2019 by . Last edited 11:18 22 Aug 2019.

Atlantic basin gasoline cracks have fallen sharply amid heavy liquidation of long positions, driven in part by renewed fears of an escalation in the China-US trade war. Nevertheless, fundamentals remain supportive, particularly for RBOB, and should keep the market on edge through summer.

US gasoline inventories have struggled to build ahead of peak driving season, which usually begins in June. Stocks on the US East Coast have fallen below levels in 2015, when gasoline cracks were substantially stronger. Competition for physical crudes may be one factor keeping cracks lower this year, as well as the shift in crude quality worldwide, but the tightness in octane that precipitated the run up in gasoline this spring has not disappeared.

Extreme backwardation in the cash market has eased, but signs of stress are still prevalent. The octane tightness on the US West Coast, combined with PADD 3 maintenance, has starved the Atlantic Coast of barrels moving up the Colonial pipeline, causing barge differentials to New York Harbor to rise to unseasonably high levels, with driving season yet to take off.

The premium on the USEC is likely to persist even if the situation on the USWC is showing signs of improvement since USWC inventories are similarly depleted and both regions will struggle to rebuild stocks in time to meet peak demand. Tight gasoline supplies in Europe, where inland German prices have risen to a premium to ARA, will only exacerbate the situation.

At this point, the market will need to run to stand still, leaving it vulnerable to any additional refinery outages. Even if inventories build by nearly 4 mb over the pre-driving season period, as they did in 2018, US gasoline stocks would be some 5-10 mb lower than normal levels for early July. The only relief could come from higher Chinese export quotas, but the tightness in the Atlantic basin remains precarious regardless.

The market is currently getting a glimpse of what the market for octane might look like from 2020 onwards. IMO 2020 will create new markets for VGO, diverting streams away from FCCs into the marine gasoil and very-low-sulphur fuel oil pools. The bankruptcy of Russia’s Antipinsky refinery restricted exports, causing VGO to trade at a significant premium to Dated Brent, which illustrates how easily VGO could swing to the marine pool if price incentives are strong.

Also in 2020, the introduction of US Tier 3 gasoline sulphur regulations on 1 January should see FCC margins crimp even further. Most, if not all, US refiners are expected to have little difficulty meeting new 10 ppm specification, though there may be some loss of octane at the margin as plants will need to more severely hydrotreat cat-cracked gasoline, meaning more reformate and alkylate will be needed in a typical barrel to meet specifications.

In short, a long summer lies ahead. This week’s sell off has widened gasoline’s discount to diesel, prompting refineries to shift yields away from gasoline and focus on maximising diesel output in anticipation of much stronger demand for middle distillates from late Q3 19 onwards. Combined with unseasonably low stock levels, the worst is likely behind the market for the rest of Q2 19, as gasoline only stands to benefit when demand starts to swing higher.

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