Viewpoint: European naphtha robust into 2021

Low supply and firm demand from key export markets will keep European naphtha refining margins firm relative to previous years in 2021, despite a lack of interest from European gasoline blenders early in the new year.

Robust pricing is likely to continue into the early part of 2021, as a result of strong demand from the petrochemical sector in Europe and in the key Asia-Pacific export market. Naphtha is usually in higher demand in winter because consumption of LPG — a competing petrochemical feedstock — increases for domestic heating. This seasonal effect will be enhanced in winter 2020-21 by particularly high demand for the co-products that are generated by using naphtha in ethylene production. European petrochemical units are operating steadily at high rates, supported by firm production margins and buoyant polymers demand, particularly from the packaging and construction sectors.

Demand from the petrochemical sector will soften towards spring as scheduled maintenance starts. At least 3pc of Europe's ethylene cracking capacity is scheduled to be offline at some point next year, close to the all-time high of 3.85pc recorded in 2019. And the 2021 figure may rise to 7.1pc if one of northwest Europe's largest crackers remains out of service into the new year.

While firm petrochemical demand has been the principal factor supporting European naphtha prices during the second half of 2020 and into the new year, ebbing of that demand in spring 2021 is not likely to lead to a dramatic weakening of refining margins. Consumer demand for European gasoline is likely to rise in spring 2021 as Covid-19 vaccines begin to enable more recovery in economic activity and travel. And demand from blenders typically firms heading into the summer as a result of higher export demand from the US ahead of the driving season. Naphtha is favoured as a blending component in summer grade gasoline because of its low evaporability relative to lighter alternatives.

The naphtha market had one of its weakest years on record in 2019, trading at a discount to the underlying North Sea Dated crude contract for the entire year for the first time since 2013. There was little reason at the start of 2020 to expect any significant increase in naphtha values, and then the spread of the Covid-19 virus in Europe sent naphtha prices plummeting to their lowest in 21 years at just $102.75/t on 21 April.

But the heavy fall in outright prices had the effect of rekindling demand for the limited supply of European naphtha that was available, and refining margins recorded their highest second-half average since 2017 with a discount to North Sea Dated of 42¢/bl during July-December.

European naphtha subsequently emerged as an unlikely outperformer during 2020, avoiding the extremes of oversupply that plagued most other oil product markets. Buying interest from petrochemical end-users was robust for most of the year, while any excess European supply was typically able to find a ready home in Asia-Pacific. And the fall in European refinery utilisation to 30-year lows of just 67pc in June, from around 85pc in January, meant that prompt supply was tight at times — even with minimal demand from the gasoline blending sector.

Recovering road fuel demand means that European refinery utilisation rates are likely to rise by around 10-15 percentage points over the course of 2021, increasing the level of European naphtha supply. The return to the Mediterranean market of Libyan crude cargoes will also support light naphtha balances. But interest from east of Suez should keep supply in the European naphtha market balanced in 2021, as it did this year, maintaining refining margins above the double-digit discounts recorded in previous years.

By Thomas Warner