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October 2020

Oil Products Overview

At a quick glance, one could assume Q3 volatility has been relatively low when compared with the previous
2 quarters. This has been the case for front month ICE Brent futures contracts, starting Q3 a few cents
over $41/bbl, reaching a high at the end of August just under $46/bbl before sliding off on the increased
risks of regional lock downs, and a cessation in Chinese buying of various crude grades for SPRs, looking
to end the quarter roughly where it began around $42/bbl.

However, this is far from the complete story for the oil complex, as several subplots across the barrel have been playing out in the products markets. The villain of the products markets has been and remains to be ULSD. Despite a perceived recovery, stocks have remained stubbornly high across all regions, floating storage economics work to sail new build VLCCs from Asia to Europe and leave them anchored outside ARA, driving the front-month diesel crack vs ICE Brent to historical lows, dragging down refinery margins with it as building inventory continues to steal demand from the future.

Front Month European Diesel Brent Crack During Q3 2020, $/Bbl. Bloomberg Data

Despite a deeper and longer refinery maintenance program this year vs seasonal averages, there remains no way out for European diesel other than longer-term refinery closures.This is something we are starting to see with several unprofitable refineries looking to be converted to biodiesel plants or storage facilities. Should more of these projects be announced over Q4, the future upside for ULSD is possible when a vaccine is administered globally, coupled with fiscal spending. However, with Indian refinery rates set to increase, and increased refining capacity coming online in China in Q4, refinery margins and the oil complex is to
remain the antagonized by ULSD.

Although a much smaller market, Jet prices remain below ULSD, offering no respite to the refiner. Q3 saw gains in demand vs the previous quarter in all regions, as holidaymakers rushed to make the most out of a brief window in travel restrictions. Yet YoY demand numbers remained significantly lower, with several airlines continuing to cut capacity going into Q4, as it is expected business travel will suffer significantly more than recreational travel, especially as regional lockdowns and quarantine measures appear to be increasing again. As with ULSD, Q4 looks torrid for Jet demand, but as other analysts pointed out towards the end
of September, should a vaccine be readily available by late Q1/Q2, longer-dated jet prices look very cheap by historical metrics.

Jet Consumption Comparison, U.S. Energy Information Administration

Q3 has seen the lighter end of the barrel in gasoline and naphtha proceed as the hero of the complex, and while ULSD containment issues look set to remain, so does Ebob and Naphtha strength. The combination of lower refinery runs during the U.S. driving season, a switch from public to private transport, the avoidance of air travel and increased demand for PPE, taking molecules out of the gasoline blending pool, has seen light end cracks go from strength to strength, coupled with falling stocks in all regions.

DOE Distillate Inventory Seasonality. ‘000 bbls  Bloomberg Data

This trend is set to continue, especially with the Chinese Golden Week holiday approaching, with citizens having missed out on seeing family over their Lunar Holiday due to Covid19 restrictions. Coupled with India coming out of lockdown, eastern demand should continue to rise, as Jakarta looks set to come out of lockdown in Mid-October. With U.S. demand returning quicker than expected refinery outages on the East Coast muting supply, and the prospect of further stimulus cheques imminent in the run-up to the November election, this will continue to provide a pull-on molecule from Europe.

Bunkering demand remained resilient throughout Q3, coupled with Middle Eastern cooling demand for HSFO keeping Rotterdam Barges vs ICE Brent at a year to date highs throughout the quarter. With tepid refinery run rates subduing supply and an increase container lines being operation trans-Pacific, the outlook for HSFO remains bullish, especially if some of Europe’s more basic refineries become mothballed. VLSFO, or 0.5% looks a lot more precarious. Market share is being lost to HSFO as more scrubbers are installed and enter the market. At just under $4/bbl, the VLSFO crack is currently a refiner’s most profitable product,
something which is unsustainable for a mere 2-3mbpd market. This imbalance is further worsened as China looks to create itself a bunkering hub. Any scrubber currently unhedged is only set for a longer payback period. Headline markets have cast a façade of calmness, while subplots beneath have brewed a never-ending riddle for refinery planners. As we head into Q4, it remains to be seen if Chinese buying for SPRs return and depletion rates in the U.S. shale patches produce significantly less crude than forecast, both further hurting refinery margins, or whether the return of Covid lockdowns once again wreak havocacross energy markets and further afield.

About the report
Report is written by Global Risk Management team. Access
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