Surging Saudi Arabian demand for high sulphur fuel oil (HSFO) will create a uniquely strong regional market in the Mideast Gulf next year, putting pressure on pricing mechanisms and having consequences for medium sour crude.
Global demand for HSFO is likely to fall precipitously as a result of the International Maritime Organisation (IMO) 0.5pc sulphur cap on marine fuels that comes into force in 2020. But Saudi Arabia will see the consequent lower absolute prices for HSFO as a chance to accelerate its programme of reducing the direct burn of crude for power generation and free up more of its crude for export.
Relative values will change too — globally, the spread between HSFO and IMO-compliant fuels such as 0.5pc sulphur fuel oil and gasoil will blow out dramatically over the course of next year as IMO 2020 approaches — but HSFO differentials in the Mideast Gulf will find support from Saudi demand and a shift in supply balances.
Saudi Arabia's fuel oil imports rose markedly during the first eight months of 2018 — up by nearly 60pc year on year to 291,000 b/d according to the Joint Organizations Data Initiative (Jodi). Imports were 425,000 b/d in June, just ahead of peak demand, compared with 187,000 b/d in June 2017 and 151,000 b/d in June 2016. On the regional supply side, Iran will find it difficult to find an outlet for its around 185,000 b/d of fuel oil exports that typically remain within the region, when US sanctions take full effect. The completion of Kuwait's Clean Fuels Project (CFP) next year will end the country's fuel oil exports until its 615,000 b/d al-Zour greenfield refinery comes online at the end of 2020.
These dynamics will lead to a detachment of the regional market from the pricing hub at Singapore, and may support the development of an independent Mideast Gulf fuel oil assessment. The region looks to Singapore for its fixed price —the Singapore price minus the cost of freight — and for the forward curve. But while the global HSFO market is likely to develop a wide contango as IMO 2020 approaches, a theoretical independent Mideast Gulf forward curve for HSFO would likely show backwardation ahead of summer 2020.
Higher fuel oil imports by Saudi Arabia could free up more of its mostly medium sour crude for export. This in turn could have a knock-on effect on values — demand for similar grades will already be reduced as refiners seek to minimise fuel oil output, resulting in a wider discount to crudes with a lower yield of heavy distillates.
Saudi Arabia's direct crude burn typically peaks in July and August because of harsh summer heat. Direct burn was 580,000 b/d and 490,000 b/d respectively in July and August this year. But it is falling by design — this year was lower than the 657,000 b/d and 659,000 b/d in July and August 2017 and the 697,000 b/d and 739,000 b/d in July and August 2016.
