Product fundamentals summary:
- Strong Asian Gasoil market in Q2’17 due to heavier than usual refinery maintenance and high demand
- Strong Fuel Oil cracks in the past month not just due to falling crude oil prices but also fundamental reasons
- Gasoil East-West spread and fuel oil cracks are expected to stay supported in the near term.
Very strong Asian gasoil market
The East of Suez Gasoil market has been strong due to a combination of supply (heavier than usual refinery maintenance) and demand side factors which have outdone seasonal factors that were supposed to weigh on the gasoil market.
In China, diesel demand reached a record in Q2’17 on underlying demand from heavy industry and freight and is expected to be stronger in Q3’17 despite China implementing a fishing ban this year that began earlier and is tougher than normal years. Unusually low diesel exports from China have also supported the Asian gasoil market in recent weeks, although additional diesel export quotas awarded to Chinese refiners and additional refining capacity soon coming online will soon change this.
In India, delays in refineries returning from maintenance has seen the country’s refiners increase buying of ULSD to comply with the tighter Bharat IV fuel standards which stipulate that diesel import must contain no more than 50ppm sulphur. This is despite the monsoon season in South Asia which should have weighed on gasoil demand from reduced economic activity. As a result, India’s diesel imports have reached a 13 month high, with diesel being pulled from the Middle East, the Mediterranean and Northwest Europe, an unusual turn of events considering that India typically supplies up to 0.3 million tonnes of diesel to Europe each month. There has also been strong buying elsewhere in Asia with Indonesia and Thailand buying more than their usual allotment.
To compound the strong demand side picture in Asia, unusually high temperatures in South Asia and the Middle East have resulted in droughts and low water levels which has in turn resulted in reduced availability of hydroelectric generation in countries such as India and Pakistan. Middle distillates imports/demand have duly risen due to its role as substitute for power generation.
Supported European middle distillates complex
In the west of Suez, ULSD is pricing strongly due to good demand for road fuels in Europe, longer than expected refinery outages and emptying stocks. Refinery problems in Latin America are also pulling molecules from the U.S. Gulf Coast away from Europe, exacerbating the tight diesel situation already caused by Asia. As a result of these near term bullish factors, the Jul17/Aug17 ULSD-ARA Futures spread have gone into backwardation and is trading at +0.50 at time of writing.
Looking ahead to Q3 2017
Looking to Q3’17, however, a large supply of distillates is expected to hit Europe and U.S. this summer as refineries ramp up to their seasonal peaks. And while European diesel demand is expected to remain strong, dropping Rhine levels will reduce barge loadings to 60-70% of capacity, hence making it challenging to supply inland where demand is the strongest. The big economies in Latin America are also struggling to grow, reducing the possibility that demand from Latin America can absorb the increased distillate supplies from U.S. Gulf Coast. These supplies would inevitably end up in Europe and together with the aforementioned factors, lead to a build of ARA stocks and a weaker European distillates complex as we head into the next quarter.
Asian refineries are also expected to start ramping up output. Together with increased Chinese refinery capacity (if China do not cut refinery runs) and exports from additional diesel export quota, the tightness in the Asian gasoil market could ease. That said, we expect the additional supplies into Europe to hit first and the East-West arbitrage spreads in gasoil to remain strong for the better part of Q3’17.