Viewpoint: Naphtha exposed to the elements

European naphtha prices are finishing the year high relative to crude and gasoline, but are at the mercy of powerful forces as the market heads into 2022.

European naphtha margins to crude hit six-year highs of around $5/bl in mid-December, as low imports from elsewhere combined with robust demand from gasoline producers to support prices. European gasoline consumption has proven resilient against the new Omicron variant wave of Covid-19, as key European markets have not so far had the kind of restrictions on freedom of movement that characterised previous waves of the pandemic.

The extent of Covid restrictions in the first half of 2020 is unknowable but crucial to forecasting the immediate future of the European naphtha market. Other variables are equally significant, and just as difficult to assess. The dramatic rise in natural gas costs during the second half of 2020 has had a direct effect on naphtha, as LPG has been drawn out of the petrochemical cracking pool and into power generation at European refineries. Natural gas costs could easily rise further during the first quarter, drawing more naphtha into the petrochemical sector to replace the LPG lost to refinery fuel generation. But if the northern hemisphere winter proves to be milder than the market anticipates, then LPG prices will fall heavily, displacing naphtha.

Also critical in determining the fate of the naphtha market in the next six months is the balance of supply and demand in Asia-Pacific. Naphtha prices in Europe have been supported during the second half of 2021 by the relative ease of clearing excess cargoes to Asia-Pacific. But with naphtha demand in Asia closely connected with the state of the Chinese manufacturing sector, European naphtha exports are highly exposed to economic fluctuations east of Suez. The impact of the Omicron variant on Asian economies is as uncertain as it is in Europe.

There are so many important variables heading into 2022 that some participants in the swaps markets have been heard drawing down their long-term positions until the outlook is clearer. With that in mind, there appears little utility in making firm predictions about what is in store for the European naphtha market out to the end of the second quarter. Overall it has been clear since the beginning of the pandemic that naphtha prices have tended to be well-supported relative to other refined products when the pandemic's effects have been most severe. This is because the fall in demand for transport fuels causes run cuts at European refineries, reducing the amount of naphtha produced, while demand for naphtha as a petrochemical feedstock remains buoyant as people continue to consume plastics.

Naphtha refining margins are more likely to stay at the elevated levels recorded in mid-December if the Omicron wave causes lockdowns to be imposed in key European markets. They will probably be elevated further if the winter proves to be notably cold, as LPG prices will rise and make naphtha the obvious choice of feedstock for petrochemical producers. Naphtha refining margins, measured by the premium to North Sea Dated crude, are typically steady during the first quarter, varying little from month to month before summer-grade gasoline blending starts in the second quarter and supports naphtha demand. If refining margins stay steady during the first quarter at around the December average of $4/bl, it would be the strongest start to the year by that measure since at least 2011. The average refining margin for the first quarter of 2016 was the highest since 2011 at around $2/bl, after the monthly average for the previous December was close to the $4/bl recorded this year, suggesting a potential direction as the market moves into 2022.

By Thomas Warner