If oil prices are going to start moving in reaction to IMO 2020, the last two weeks may have been the time with the first signs of that occurring.
There were enough movements in the market – except for the overall outright price – that could at least lead market observers to speculate that something was starting to happen as a result of the January 1 rule that will require ships to burn lower-sulfur fuel. And here at FreightWaves, we can’t know for sure. But we’ll point out some of the numbers that were posted this week as showing clear signs of diesel market strength, and then we’ll engage in speculation about what it all means.
First of all, to get to the finished price for diesel, you start with the price of crude. For the week, the global benchmark crude, Brent from the U.K. sector of the North Sea, was down. Pulled lower by continuing weak fundamentals, sagging equity and financial markets and a stronger dollar, the price of Brent over the course of the past week declined to $58.37/barrel (b) from $61.91/b at the close of the prior week. Meanwhile, the price of ultra low sulfur diesel (ULSD) on CME also fell over the course of the week, to $1.8945/gallon at the week’s close from a settlement a week earlier of $1.9416/g. (The week’s low settlement was $1.8736.) But the smaller rate of decline for ULSD meant that the spread between CME ULSD and Brent widened to $21.20/barrel from $19.63 at the close of the prior week.
That spread (or differential if you prefer) is the most simple one available to observe the strength of diesel relative to crude. For the first half of the year, it averaged about $16.45/b. For the period between July 1 until the last day before the September 14 attacks on Saudi facilities, it averaged about $17.22. But this past week, it moved solidly above $20/b on its way to the $21.20/b level. And yes, it could be refinery maintenance. But maintenance hits gasoline also, and that market is showing no signs of the type of strength that the Brent-ULSD crack is exhibiting.
It needs to be said that even if IMO 2020 were to force up the price of diesel relative to crude, a collapsing crude oil price could produce an odd result. Forecasts of a diesel squeeze as a result of IMO 2020 might be correct, given the strengthening spreads. But forecasts of “it won’t be a big deal” will be right too because of low outright prices. (One big unknown though – how much will a strong diesel price pull up an otherwise weak crude price?)
The movement in the diesel market these past two weeks may have nothing to do with IMO 2020. The refining sector is in the middle of maintenance season, when various units at plants are taken down or cut back to perform regularly scheduled work. (Some of these projects involve bringing in dozens or hundreds of contractors to get the work done.) You can see the impact of maintenance season in the Energy Information Administration data that came out Wednesday showing crude inputs into refineries were down to about 16 million barrels per day (b/d) from 17.7 million b/d in early August. A decline like that is to be expected during maintenance season, and it may have worked to tighten up the diesel market.
Then we turn to physical markets, and that is where things get interesting. The leading supplier of prices from physical markets – what they call assessments – is S&P Global Platts; its numbers are available only to subscribers. FreightWaves does have access to those assessments and while we can’t be too specific about the precise assessments Platts is producing, we can show where its numbers told an interesting story.
The market for many of the low sulfur marine fuels (no more than 0.5% sulfur) that are expected to replace the high sulfur bunker fuel that now powers ships (up to 3.5% sulfur) actually weakened slightly this past week relative to dated Brent, the physical “version” of the Brent contract on the CME and ICE. But that wasn’t across the board. Some were stronger.
Those low sulfur marine products are tied to the diesel market in two ways. First, a product known as marine gasoil (MGO) is essentially a diesel product manufactured specifically to meet the needs of the marine industry. It is not a new product. Its molecules are structurally the same as those you find in diesel.
Second, a new blend of product called very low sulfur fuel oil, or VLSFO, (among other names) is not technically considered a diesel product. But it might as well be; it is produced with a significant amount of an intermediate product called vacuum gasoil (VGO). And before VLSFO was created to deal with IMO 2020, VGO was blended into the process to make gasoline or diesel.
A quick review of the last two weeks of S&P Global Platts’ data shows that the spread between dated Brent and both MGO and the new grades of VLSFO widened in favor of MGO/VLSFO… except where it didn’t. There is no clear pattern, with some types of products growing stronger relative to Brent and other grades getting weaker. The movements are not dramatic enough and certainly not consistent enough to declare a trend.
But in various markets for the diesel products used over the road, the direction is clear – higher. The spread between dated Brent and ULSD on the Gulf Coast delivered into the key Colonial Pipeline, according to Platts’ data, moved up to $19.73/b at the close of last week from $17.95/b on September 23 (and had been higher earlier this past week). In Chicago, the movement went to $19.75/b from $17.25/b; it too had been higher earlier in the week. The spread for a barge in New York harbor also widened, but less dramatically, to $20.84/b from $19.50/b. (Many of the physical spreads did narrow Friday even as the Brent-ULSD spread on CME widened).
One theory as we choose to speculate – refiners are making good on their promises that supplies of marine fuels will be adequate. The coverage of IMO 2020 in the shipping press inevitably surrounds the question of whether there will be adequate supplies to meet the new standard. Companies invariably answer “yes” when asked that. As a result, the price of those marine fuels is not consistently stronger relative to crude markets.
But in order to ensure those supplies of marine fuels, some diesel molecules need to move from traditional uses (like VGO as a feedstock for gasoline and diesel) to make the new fuels like VLSFO, or more molecules need to be produced in a form that already existed but which will require more supply (MGO). The strength in the ULSD market alongside the mixed picture for those new and existing marine-specific fuels could be the first sign that is happening.
Shipowners were expected to start cleaning out their tanks in September and replacing non-compliant fuel with compliant fuel. Here in early October, the market may be signaling the first signs of a reaction to that activity.