Viewpoint: European naphtha values to stay weak

Naphtha supply will continue to outstrip demand in Europe in the first half of 2019. Winter consumption should help narrow the product's discount to crude from a four-year record in November, but European naphtha is unlikely to return to trading at a premium to North Sea Dated in the near future.

High gasoline inventories in the US will continue to impact demand for European naphtha as a blending component. PADD 1 (Atlantic coast) gasoline inventories were around 10mn bl higher year on year on 23 November at 61.07mn bl, while those in PADD 3 (Gulf coast) were up by 6mn bl year on year at 82.82mn bl. The US is a key export market for European naphtha. Higher stocks there also affect demand for finished-grade European gasoline, and European naphtha consumption for blending in the region.

Demand from the petrochemical sector, another key outlet for European naphtha, is also likely to come under downward pressure this winter. The rise in US propane consumption as heating fuel in the colder months used to boost global propane prices and push European petrochemical end-users with flexible feedstock slates to maximise naphtha intake. But this year, similar to last winter, propane is set to remain at a significant discount to naphtha because of rising exports from US coastal regions. It will likely be the dominant petrochemical feedstock in northwest Europe.

US propane stocks stood at 79.8mn bl in the week ending 30 November, up by 7.2pc on the year. More importantly, the US restocking in the autumn has been accompanied by steady US LPG exports, which averaged 911,000 b/d between August and November, compared with 808,000 b/d in the same period last year, keeping the global market well supplied.

Propane exports to Europe will increase further following the ramping up of the 275,000 b/d Mariner East 2 (ME2) natural gas liquids (NGL) pipeline in the coming months.

The line will carry Marcellus shale propane and butane to the LPG export terminal at Marcus Hook, Pennsylvania. It is planned to boost the terminal's export capacity to 6-8 LPG cargoes/month, from 2-3/month currently.

Naphtha prices are unlikely to find support in higher utilisation rates at European ethylene plants, a response to steady margin in recent years. And petrochemical demand for naphtha in Europe is likely to be lower on the quarter in the second quarter of next year as a result of maintenance at several large petrochemical facilities.

Naphtha's proportion of western Europe's ethylene feedstock slate is in long-term decline, falling to 57pc from 62pc between 2013-2017, amid rising US output of light end products.

Loadings of Long Range 2 (LR2) tankers at the Black Sea port of Tuapse will be disrupted in the first half of 2019 as a result of loading restrictions prompted by seasonal storms. The smaller Long Range 1 (LR1) tanker loadings will not be affected.

Tuapse loadings account for around 11pc of total European naphtha tanker loadings, at an average of around 300,000 t/month in 2018, according to Argus shipping data. The monthly average total volume is surpassed only by Ust-Luga in the Baltic and Skikda in the Mediterranean.

Tuapse is also the single largest European provider of eastbound volumes at a monthly average of around 290,000t, or around 30pc of the monthly average total. In previous years, charterers looking to ship naphtha east from the Black Sea during winter months have switched to LR1 tankers as a result of loading restrictions on LR2 tankers. The move in the first quarter of next year should ease pressure on LR2 freight rates between the Mediterranean and Japan, which in December reached their highest level in two years at around $2.65mn, according to Argus data. A fall in freight rates on the eastbound route could help support flows to Asia-Pacific from Mediterranean outlets such as Skikda.

Weak fundamentals in Europe have already caused prices to fall sharply relative to crude from mid-August 2018, culminating in a $9.79/bl discount to North Sea Dated on 9 November. Falling prices in the region prompted a high level of eastbound arbitrage fixtures, hitting a peak of 1.58mn t in October against a monthly average-to-date of around 850,000t. Naphtha flows from Europe to Asia-Pacific when price differentials between the two regions rise above the cost of freight, with Asia-Pacific serving as the main pressure valve for excess European supply.

But demand for gasoline, and naphtha for blending purposes, is faltering in the Asia-Pacific region too, which is likely to continue pressuring prices in Europe. Asian gasoline refining margins fell to a two-year low in November 2018 as production units in the Mideast Gulf returned to service after unscheduled turnarounds.

Scheduled maintenance at a 150,000 b/d crude distillation unit at state-owned IOC's 300,000 b/d Panipat refinery in Northern India for 20 days of scheduled maintenance in February 2019 should tighten the supply of gasoline in India, affecting eastbound exports and supporting demand in Asia-Pacific for European naphtha for use in gasoline blending.

Key naphtha and condensate import market South Korea was granted a waiver for US sanctions on Iran, but ceased taking Iranian product in October. Imports from elsewhere, particularly other Mideast Gulf countries, have risen to meet demand, so sanctions are unlikely to change flows of European naphtha to South Korea in the first half of 2019.

Some support will come from west Africa, as demand from gasoline blenders, in Nigeria especially, will continue to stimulate buying interest in naphtha in the first half of 2019. Nigeria suffered from acute gasoline shortages in winter 2017-18 and the government is likely to seek to maintain healthy inventory levels this winter, especially ahead of February's general election. December 2018 gasoline stocks reached record highs of 2.6bn litres, or 52 days of use at an average consumption rate of 50mn l/d, according to Nigeria's state-owned NNPC.

Northwest European naphtha spent just nine trading days at a premium to North Sea Dated during 2018, and with so few bullish signals to be seen there is little reason to expect a reversal of this pattern during the first half 2019.