NEW YORK: Oil bulls are hoping that the current correction in Brent crude prices is nearing an end. Perhaps many weak hands have been pushed out of the oil complex by the selloff, but fundamental rot persists in places, suggesting all is not well.
The recent selloff in Brent is not due to any one factor. A halt to the flow of Forties blend crude to South Korea, refinery turnarounds, a retreat from commodity markets by speculators and a host of other factors have been cited.
No doubt all these items are in play. But the selloff in Brent was preceded by a slide in the ICE gasoil crack spread, which started early this month as demand for diesel fuel and heating oil slowed in Europe.
Oil demand fell in Europe by 800,000 barrels per day in February from a year earlier, according to the Joint Oil Data Initiative. A combination of the poor economy and warmer weather in parts of the continent were the cause here.
Europe is important for distillate fuel markets because it is structurally short the fuel. It needs imports from elsewhere to meet consumer demand.
Therefore there is little surprise that oil refining margins have fallen steadily in recent weeks. Plentiful supply and weaker demand are driving down returns to those supplying the European market.
Traders are now looking for signs that consumers in Germany, the continent’s largest heating oil market, will restock their tanks with prices pushing lower.
But restocking of heating oil will provide only short-term relief for the oil market. Once consumer tanks are full again, demand for diesel fuel from the transport and power generation sectors will have to take over.
Here the risk is that Europe’s weak economies keep diesel demand in check this summer. That seems very optimistic given the sharp declines seen in oil demand in the countries worst hit by the economic downturn, including large oil consumers such as Italy and Spain.
Unfortunately, the softness in diesel fuel markets is not limited to Europe. What ought to be more worrying for oil bulls is the sudden slump in Asian gasoil cracks that have moved lower in tandem with the decline in Brent crude prices. In other words, as Brent has weakened so too has the incentive in Asia to turn oil into diesel fuel. That cannot be seen as bullish.
Asian diesel and other gas oil prices have been hurt by lackluster demand in key importers and China’s re-emergence as a significant exporter of the fuel. Chinese diesel exports, estimated at 400,000 tons in April, or roughly 100,000 barrels per day, are due to growing refinery capacity in that country and what appears to be a slowdown in domestic diesel demand growth.
With Asian and Middle Eastern refining capacity set to continue to increase this year, the region’s refiners need to push their surplus products out to other markets, such as Europe, to stay in balance.
This surplus is what is weighing on Asian gasoil cracks even as crude oil prices decline in absolute terms. To remain competitive in the European market, Asian prices have to keep declining to make shipping the fuel thousands of miles a profitable proposition.
The need for Asian diesel prices to push lower to remain competitive in Europe calls into question the sustainability of the strength in Asian crude oil prices that is a key support for the global oil market right now.
Already there are some signs that weaker players in the Asian refining sector in Japan and South Korea are curtailing crude oil runs amid poor profitability.
And while these cutbacks and regional refinery turnarounds have supported fuel oil prices in recent weeks, traders fret that the main support for fuel oil is a lack of on-specification, low-density fuel oil blendstock rather than an overall shortfall.
For now Asian refiners are still buying crude. Perhaps they see the current soft patch in oil prices as an opportunity to rebuild stocks drained earlier this year. Partial stocks data released by China suggest crude oil runs have exceeded domestic production and imports for five months running so there may be pressure there to replenish supplies regardless of refining margins.
Asian refiners may also be grimly girding for an environment of much lower refining margins that will be needed to force a new round of refinery rationalization amid shifting demand patterns and a continued overhang of obsolete and unneeded refining capacity in Europe and North America.
— Robert Campbell is a Reuters market analyst. The views expressed are his own.
But what does seem clear is that barring a totally unexpected rapid acceleration in Asian economic growth, the global distillate fuel balance is becoming increasingly comfortable. The days of King Diesel supporting the entire oil market on his back alone are probably over.
Refineries will have to look to total profitability from their entire product slate rather than simply counting on robust diesel pricing to always bail them out.
Refiners ability to endure margins, more than woolly notions about what oil price is needed to balance OPEC members budgets, will be a key determinant of oil price action in the coming months.
But one thing is clear. Either diesel demand gets strong enough to start mopping up excess supplies or oil demand will take a hit. If refiners keep producing more fuel than the market needs they will eventually slow down.
— Robert Campbell is a Reuters market analyst. The views expressed are his own.
