Fuel Oil on the boil as supplies tighten

Market analysis
Although fuel oil demand is under threat due to a bunker fuel specification change in 2020, recent production cuts from OPEC and several non-OPEC countries have provided a lifeline to the bottom of the barrel. Furthermore, the advent of complex refineries in the Middle East, Asia and Russia is leading to tighter supplies. The fuel oil market has been on boil in all key refining regions this year and any increase in OPEC cuts has the potential to keep on buoying its prices, although the end of the cooling demand season in the Middle East could put a ceiling on cracks.

• In the Middle East, regional demand for fuel oil is at its seasonal peak. Saudi Arabia consumed 625,000 bpd of fuel oil in April, the highest since October 2016, although the total fuel oil burn over the summer looks likely to be less than last summer because the kingdom’s utilities are using more natural gas.
• In South Asia, Pakistan is seeking 950,000 mt of fuel oil for September as stocks at the country’s power generators have fallen to just 3 – 4 days of supply compared to the obligatory level of at least 10 days. In Pakistan, debt-stricken power companies frequently fail to pay their fuel oil suppliers on time, which leads to knock on problems in the international market. There has been talk that the government in Islamabad may intervene, but a long-term solution is not in sight.
• Fuel oil flows to the Far East from the West are well below normal levels, because the strong fuel oil market in Europe is limiting flows to Asia. Arbitrage shipments for July are estimated to be just 5 million mt.
• Fuel oil cracks in Asia have been around $5/bbl stronger than last year. The discount of Singapore 380 cst fuel oil to Dubai crude averaged around $1/bbl in July this year, compared to around $6/bbl in July 2016.
• Venezuela’s fuel oil exports to China have almost vanished from the market in the East, as refinery problems have tightened supply. The country’s refineries are operating at less than 50 percent of capacity according to the trade union representative of the Venezuelan Federation of Petroleum Workers. Moreover, some Venezuelan ports are also facing problems, reducing refined product exports to Asia and Europe. This has exacerbated an already tight market. Less and less fuel oil is being produced in China. In fact, fuel oil output in the Middle Kingdom was down more than 1.5 percent year-on-year in June.
• Although flows from the Middle East could pick up once the cooling season is over, reports have circulated that Saudi Arabia might reduce its crude oil exports unilaterally by up to a further 1 million bpd. This would reduce medium and heavy sour crude supply, indirectly cutting fuel oil production capacity. This means that fuel oil cracks could remain supported even in the northern hemisphere winter, when demand for the fuel usually eases.
• Tighter prompt fuel oil markets from Durban in South Africa to Rotterdam in Holland have led to a backwardated market structure. One reason for this has been lower inventories. In the US, for example, residual fuel inventories have fallen to their lowest levels since January 2015. in Singapore, fuel oil stocks remain seasonally low, although they have recovered from the 2 1/2 year lows seen at the beginning of June. Euroilstock data shows EU-16 fuel oil inventories in June stood at around 11.5 percent below levels a year ago. Fuel oil stocks in the Amsterdam-Rotterdam-Antwerp (ARA) are down around 12 percent year-on-year. Although fuel oil stocks are relatively abundant at Fujairah in the UAE, this is largely due to weaker bunker demand in the wake of a trade embargo on Qatar imposed by Saudi Arabia and a number of its regional allies.
• Due to surging demand, some trading houses are opting for shorter-period stockpiling of fuel oil . In Singapore, fuel oil storage rates have tumbled to $5-6 per cubic metre from $6.50-7.00 per cubic metre a few years ago. Indeed, some traders are stockpiling fuel oil on tankers as VLCC freight is down more than 50 percent from levels 18 months ago.
• The fuel oil price rally has been helped by OPEC’s decision to extend its 1.2 million bpd production cut until March 2018. OPEC agreed the cuts, which were supported by pledges for a further nearly 600,000 bpd by a group of non-OPEC countries, in November 2016. Resource Economist estimates the production cuts have taken as much as 1.3 million bpd of medium and heavy sour crude off the market. Lower supplies from Latin America have resulted partially from natural declines rather than the OPEC/non-OPEC agreement. Only Saudi Arabia has tried to reduce lighter crude exports instead of heavier barrels but any additional cuts if implemented are likely to be medium and heavy sour.
• Global fuel oil production supply is also decreasing with the start-up of sophisticated new refineries in India, China and the Middle East, which produce little or no fuel oil. Their advent has also led to the demise of simpler refineries, further tightening fuel oil supply. Russian fuel oil exports are also falling as the country’s refineries boost their processing depth, while the Kremlin has imposed a tax regime that equalises export duties on crude and fuel oil, lessening the incentive to export fuel oil.
• Though fuel oil demand has been falling in developed countries, a number of non-OECD nations still depend on fuel oil for power generation, particularly in the Far East, the Middle East and South Asia. While China is now gradually reducing its fuel oil consumption, South Asia along with neighbouring GCC countries have become the dumping ground for the bottom of the barrel.

Conclusion
Although the International Maritime Organization’s decision to reduce sulphur specifications in bunker fuel to 0.5 percent from 3.5 percent by 2020 will have a detrimental impact on fuel oil demand, rumours of the death of fuel oil look greatly exaggerated. Downward pressure on fuel oil may re-emerge when oil producers end their crude oil production cuts but until then, fuel oil cracks are likely to remain strong..