Asia-Pacific refiners are preparing to scale down operations to confront a collapse in global fuel demand. As storage fills up, they will have to reduce the amount of crude they process, but not at the expense of competitive feedstocks from the Middle East.
Soaring freight rates are rendering long-haul crude shipments from the Atlantic basin too expensive to Asia-Pacific, so it is North Sea, US and Latin American grades that face the biggest challenge, while west African cargoes and short-haul Russian supplies may remain competitive.
Podcast - Opec and US shale: the latest coronavirus casualties | Episode 3
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Hello everyone, I am Alejandro Barbajosa, VP for crude in Asia-Pacific and the Middle East at Argus, and I would like to welcome you all to the fourth episode of our coronavirus podcast series, where we discuss the impact of the disease on global oil markets. Today we will address how Asian refiners are reacting to the pandemic as crude inventories bulge worldwide.
Refiners across Asia-Pacific from India, to Thailand to Taiwan are reacting to the coronavirus shock to global oil demand, and most are cutting refinery runs, or at least considering to reduce their processing rates even after the dramatic drop in crude prices over the past two weeks. While surging use of ride-hailing services has supported domestic demand for motor fuels as people try to avoid public transport, the picture for aviation fuel is very different as airlines aggressively cut capacity or even ground their entire fleets. The profitability of making jet fuel has all but disappeared in the Asian market. Jet-kerosine cracks collapsed to less than $2/bl by 18 March, well below their troughs during the 2008 financial crisis. That’s down from as high as $10/bl in the previous week, right after the shift in Opec production policy triggered the biggest drop in crude prices in almost three decades.
This sharp and widespread contraction in refining margins is accelerating a complete rethink of crude procurement strategies, triggered by aggressive cuts to the official selling prices for crude exported by national oil companies in the Middle East. Shipments of Atlantic basin crude to Asia-Pacific are particularly under threat, facing the danger of outright interruption, unless prices of North Sea, US and Latin American grades fall to discounts deep enough to compensate for soaring freight rates. The cost of sending a barrel of crude from Houston to Ningbo in China jumped to almost $10/bl in mid-March from less than $4/bl at the start of the month, led by strong demand for tankers to deposit a surging oil surplus into floating storage. Values of west African grades are also under pressure, but they benefit from better shipping economics as freight rates for smaller vessels used for Angolan and Nigerian grades to Asia have risen by a lot less than for very large crude carriers, or VLCCs, normally used for US and North Sea crude. West and north African producers are no longer restrained by Opec output quotas, and as they pump more, their grades should become more competitive, displacing higher cost North American crude.
Buying interest for US crude has vanished both on a delivered basis to northeast Asia and at the Gulf coast. Notional values for waterborne crude in Houston have tumbled to discounts close to $1/bl below the pipeline price of WTI Houston, at the Magellan East Houston or MEH terminal, the preferred location to set the value of physical Midland crude from the Permian basin, given its proximity to the domestic refining hub in the Texas-Louisiana border and the loading terminals for export cargoes. While WTI Houston generally trades about $1-2/bl below Ice Brent, the discount ballooned to almost $6/bl on 18 March because of a lack of demand for crude for export, a direct reflection of Asian refiners’ diminished interest in US grades. Even northeast Asian refiners in South Korea and Taiwan, which have made WTI a staple for their refineries, may now reconsider short- and long-term supply agreements based on the expected persistence of abundant Middle East crude at more competitive prices. This is already resulting in the accumulation of stockpiles throughout USGC and midcontinent infrastructure. When storage capacity there is exhausted, prompt prices for physical WTI will have to drop enough to compensate for elevated shipping costs and encourage at least the continuation of marginal flows to the Asian market.
Meanwhile, prices of short-haul Russian crude in Asia-Pacific have held relatively well in an oversupplied market. Russian producers have rushed to sell their cargoes earlier than usual in the monthly trading cycle in an attempt to fetch higher prices ahead of peak spot trading of cargoes from the Middle East. While some market participants expected this to materialise into a fire sale, the differential for East Siberia-Pacific Ocean crude, or ESPO as it is called, remained at premiums of about $2/bl to benchmark Dubai, a similar level to trades seen before the disintegration of the Opec+ agreement earlier this month.
A key question among Asian refiners is whether there is any bright spot in the market that may help compensate for the extraordinary weakness of oil demand and the resulting poor refining margins. As the outbreak in China subsides and refiners there restart as much as 3.5mn b/d of idled refining capacity, markets may get some relief from a consumption rebound by the world’s largest crude importer. However, product stockpiles across Asia, including China, are already near capacity and this has limited Chinese refiners’ ability to aggressively increase their crude intake and fully benefit from the attractive prices that Middle East suppliers are offering. And China has relaxed price floors for domestic fuel sales in the wake of the oil price drop, compressing exceptional margins enjoyed by state-owned refiners and by independents in Shandong. While margins in China remain exceptionally high compared to international levels, refiners there still need demand from export markets to clear their product. If the pandemic keeps suppressing mobility and industrial activity, the outlook will remain grim for Asian refiners.
As I have mentioned before, you can access more timely news and analysis on this topic through our Argus Crude market services and we also have a special page dedicated to the effects of coronavirus across all commodity markets on our Argus website at www.argusmedia.com/coronavirus. Thank you for listening and goodbye.