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Fuel oil prices seen remaining high

Published: March 6, 2012 | 9:40 am
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Prices for fuel oil, historically one of the least profitable parts of the crude barrel, are close to all-time highs.

This year, prices for fuel oil and fuel-oil cracks climbed to multi-year highs. The price for the February 2012 European 3.5% Fuel Oil (Platts) Barges FOB Rotterdam Calendar swap futures contract reached three-year highs of $688.64 on February 9, a year-on-year rise of 28%. A host of issues are depressing global supply while demand from Asia continues to persist. As a result, market participants are eyeing the fuel market keenly while analysts look for potential opportunities for hedgers and traders.

Due to fuel oil’s low historic price relative to other refined products, refiners have been upgrading facilities in the last few years in a bid to minimise output of fuel oil per barrel of crude. “Fuel-oil output is being destroyed by the increasing upgrades across refineries, and the net affect is a reduced flow of fuel oil into the market place,” says Andy Summers, head of fuel-oil trading at Trafigura.
According to Harry Tchilinguirian, head of commodities strategy at BNP Paribas, the availability of fuel oil in Europe was significantly reduced in January due to the closure of Petroplus refineries in Belgium, Switzerland and France. The three refineries all had low Nelson complexity index values – 4.5 (Antwerp), 6.4 (Cressier) and 7.3 (Petit-Couronne) – and the lower the index value, the higher the yield of fuel oil. “With the closure of these refineries you’re short fuel oil, as they were a key source of supply on the European market,” says Tchilinguirian.
Market participants believe another factor is the hike in Russian export tax for fuel oil from 46.7% to 66.0%, which began in August. The move is expected to push refiners in Russia – the largest producer of fuel oil – to undertake upgrades that would increase the complexity of the country’s refineries.
Although Summers is confident this will have an upward impact on fuel-oil prices, he views it as a longer-term situation. “With the refining system in Russia as it is, you can’t make that change overnight,” he says.
However, Tchilinguirian believes the tax hike is already having an impact on the fuel-oil market. “More recently, we have had less exports of fuel oil from Russia into Europe, you can see how that is quite supportive of the [fuel-oil] crack.”
While international supply looks like it will continue to fall, demand for fuel oil in Asia is likely to remain high. According to research by Barclays Capital, China imported 5.8 million barrels of fuel oil in 2011, an 18% year-on-year rise. Meanwhile, Japan is still using fuel oil to compensate for a reduction in nuclear energy due to last year’s Tohoku earthquake and tsunami. Data from the Petroleum Association of Japan shows the country imported 3.8 million barrels of fuel oil in the second half of 2011, a 128% increase over the first half of the year.
On the back of this, Summers expects prices to remain high but with greater volatility. “[The] range is going to be stronger than we have previously seen, going back over a few years. We see the market remaining strong and operating at these [current] levels going forward, [but] I want to be cautious about putting absolute numbers out there because there is going to be a lot movement,” he says.
Summers believes an example of this movement is in the difference between contracts along the forward curve for fuel oil. “We are at $4–$6 backwardation in different areas, which historically would have been classed as very strong, but today we are saying it is weak compared to where it had been before,” he says.
Supply- and demand-side factors will continue to provide support, especially to prompt fuel oil prices. “We see the market essentially remaining in backwardation,” says Summers.
According to Tchilinguirian, traders could exploit this. He believes the factors that have driven fuel oil are here to stay and so suggests buying very discounted values of fuel-oil cracks further along the forward curve, such as those in the second half of 2012.
On January 20, prices for the European 3.5% Fuel Oil (Platts) Barges FOB Rotterdam Calendar crack spread swap futures settled at –$5.91, the last time prices reached above –$6 was in January 2010. In the past month, prompt prices have since fallen below –$10. During the same time, later-dated contracts (December 2012) have remained in a tight range, around –$12.
For prompt crack contracts, Tchilinguirian views prices above parity in the Singapore crack spreads as a good selling opportunity. By looking at historical values, such levels have been unsustainable since a positive spread means refiners can benefit from an arbitrage by simply buying more crude and refining it.
As prices continue to move for fuel oil and fuel-oil cracks, refiners and traders will need to be wary of further disruptions. Another issue added to the mix last month was the growing political tensions between Sudan and South Sudan, which has resulted in a restriction of the flow of heavy crude for which the region is known. For the foreseeable future, concerns about the bottom of the barrel look set to stay.

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