23 APRIL 2019
Demand for the shipping industry’s main fuel is widely expected to collapse like never before in 2020, so it might come as a surprise that its value is soaring.
High-sulfur fuel oil at the Dutch port of Rotterdam in January is now trading at about $16 a barrel less than crude oil, close to the strongest in 18 months, according to data compiled by Bloomberg. The discount was $28.50 less than a year ago, since when prices have been rallying steadily. Regulations starting January will bar most ships from using what is essentially a byproduct for refineries, destroying millions of barrels of demand.
The surge in forward contracts suggests traders are becoming less concerned about the impact of regulations that were expected to hit everything from oil prices, to refining, shipping, aviation, and even world trade. The rally has been driven in part by a more-immediate market, which itself has been buoyed by the loss of heavy, sulfurous crude from the likes of Venezuela, Iran and other OPEC nations — oil that’s handy for making ship fuel.
“The market is really tight at the moment,” said Jonathan Leitch, senior analyst at Wood Mackenzie Ltd. in London. “For some people, the perception is that if it’s tight now it will stay tight.”
Prices for fuel oil in Rotterdam in May are trading at about an $8.20 a barrel discount to Brent crude, according to fair value data compiled by Bloomberg.
Traders say that, while more-immediate prices are supported by physical activity, there’s little hard evidence on exactly how supply and demand will look later this year or early next — a lack of clarity that’s probably helped forward prices to rally.
Leitch’s view is that fuel oil will weaken relative to Brent again as the demand weakness starts to become apparent. He estimates the January spread should reach about $25, with the decline starting in mid-November.
The International Energy Agency anticipates that shipping’s demand for the product will drop to about 1.4 million barrels a day in 2020, down from 3.5 million this year.
Roughly 2 million barrels a day will have to find alternative buyers in 2020, and there aren’t enough units at refineries to upgrade all the excess that will emerge, according to Steve Sawyer, a senior analyst at FGE in London. Fuel oil’s discount to crude can “easily” drop down to $30 a barrel below Brent, he said.
“There’s a fundamental change coming on the 1st of January which I think isn’t properly priced in,” he said. “The market is underestimating how difficult it’s going to be for refiners to consume this stuff.”
Production cuts from the Organization of Petroleum Exporting Countries and allied nations, compounded by U.S. sanctions on Venezuela and Iran, are part of the reason behind a gain earlier this year in spot fuel oil prices relative to crude. Those nations produce relatively heavy, high-sulfur or “sour” crude that’s ideal for making the product that ships consume today. Consequently, with those crude supplies lower, the fuel oil market also tightened.
“The current forward market has already been pricing in the impact of IMO 2020, but may not be showing the full impact, with part of this masked by tight heavy sour crude markets,” Citigroup analysts including Anthony Yuen wrote in a report last week.