Viewpoint: US demand to drive European HSFO margins

US refinery demand for heavy residual feedstocks will support European high-sulphur fuel oil (HSFO) prices in 2021, but developments in the Covid-19 pandemic, changes in US sanctions policy and in Opec+ production cuts may prompt changes in fuel oil trade routes.

European HSFO prices received strong support from US refinery demand in 2020, enabling margins to crude to remain above levels some had anticipated ahead of the International Maritime Organization (IMO) sulphur cap that came into force at the start of the year. The IMO lowered the maximum sulphur limit of marine fuels to 0.5pc, leading to some expectation that demand from the shipping industry would be sharply lower for the 3.5pc sulphur product.

But US refiners purchased a higher number of Russian high-sulphur residual cargoes in 2020, for processing as a substitute for heavy crude grades in their coking units to produce more road fuels. US plants also blend Russian high-sulphur straight-run (HSSR) fuel oil to run in crude distillation units (CDUs) instead of sour crudes, availability of which was sharply reduced in 2020 by Opec+ production cuts.

This unexpected transatlantic demand also softened the effects of a slowdown in European exports to Singapore, the world's leading bunkering hub and the largest buyer of heavy fuel oil until 2020.

But, US refinery demand could ease in 2021 if Covid-19 subsides and road fuels demand recovers. This would probably increase crude unit run rates in the US. Any change in US policy towards Iran and Venezuela under the incoming administration of president-elect Joe Biden could reduce the need for alternatives to those countries' sour crudes, but this is highly unlikely to materialise in the first half of 2021.

Increased crude production by Opec+ countries might lead to more heavy grades finding their way to refineries in Europe and the Americas, and consequently to higher HSFO production that lowers the need for Russian fuel oil imports. But, even with Covid-19 vaccines beginning to roll out it is unclear if and when road- and jet-fuel demand will recover to levels that would prompt higher refining run rates.

European HSFO margins will receive support in 2021 from power generation demand in Saudi Arabia, which is likely to continue a trend of higher HSFO imports to reduce direct crude burn. Lower production by Saudi refiners, driven by the same reasons as elsewhere, was another driver of the country's higher HSFO imports.

A greater number of ships installed with the exhaust-cleaning systems known as scrubbers, which can still burn HSFO, has increased demand for the 3.5pc product, and sales of HSFO topped 1mn t in Singapore in October for the first time in 2020. Scrubber-related demand could boost HSFO sales in the first half of 2021, but this is likely to ease towards the end of the year by when most installations will be completed. A narrow spread between HSFO and IMO-compliant fuels will probably discourage future scrubber installations.

Very-low 0.5pc sulphur fuel oil (VLSFO) will probably hold its position as the primary marine fuel globally in 2021, as uptake of 0.1pc marine gasoil (MGO) failed to reach substantial levels. MGO's share in global bunkering hubs dropped gradually until the end of 2020, as was just 13pc at Rotterdam in the third quarter. VLSFO stayed as the primary fuel at the European bunkering hub, with 46pc.

Robust VLSFO demand during the Covid-19 outbreak supported refining margins for the product at a time when road- and jet-fuel margins struggled to remain profitable. VLSFO kept its value until the end of 2020, making it one of the most valuable refinery products.

European VLSFO supply was sufficient to meet domestic demand in 2020, but export opportunities remained limited because of alternative suppliers for Singapore such as Algeria and Brazil. These exporters will likely continue supplying Singapore, which will curb European exports.

By Enes Tunagur