Singapore: A glut in Asian diesel supply could develop as early as the third quarter this year, as high refining runs and the onset of new capacities are compounded by fewer opportunities to move excess cargoes to Europe.
For most of last year, traders were able to ship surplus barrels from Asia to Europe, but the trading margins of such arbitrage movements evaporated in the fourth quarter.
Future East-West shipments look even more remote with the gas oil (diesel) Exchange of Futures for Swaps (EFS) values turning positive on Tuesday.
Gas oil EFS spreads — the price difference between Asia’s benchmark 0.5% sulphur grade and levels on London’s Intercontinental Exchange — measure East-West trading opportunities, and together with prevailing freight rates, reflect an open or shut arbitrage window.
“There is no question that a supply overhang in the Asian diesel market could develop later this year, probably after spring maintenance is over, as there will be plenty of capacity coming out of Japan, Korea and China,” said Victor Shum, an analyst at energy consultancy Purvin & Gertz.
“Some opportunities could open up for Asian diesel looking for a home in Europe, if the European economy picks up in the next few months, as a lot of gas oil demand comes from the commercial transportation sector.”
But such Asian trades would likely be few and far between, as Russia has a logistical edge in supplying to Europe, Shum said.
“So any potential moves of Asian diesel to Europe would be limited, and not likely to set a trend,” he added.
The May EFS swung to a premium of 90 cents a barrel on Tuesday, from a small discount of 3 cents on Monday and a discount of 7 cents last Friday, Reuters data showed. It had traded between a premium of $1.68 and $3.58 during February.
On the over-the-counter (OTC) market, the EFS traded between a premium of $1.00 a barrel and $2.50 a barrel on Tuesday. Late on Wednesday, it was bid at $2.25 and offered at $3.00.
The EFS had sunk to a low of a discount of $2.85 on 1 April after staying negative for most of March, Reuters data showed, offering some hope it could deepen and prise open the arbitrage.
But traders said the EFS needs to be in the range of a discount of $9 to $15 a barrel for an East-West arbitrage trade to break even, taking into account estimated freight rates for a Long-Range (LR) tanker sailing from Asia to Europe.
Even though rates for LR tankers sailing from South Korea to the UK Continent (Western Europe) have dipped to around $1.75 million, from $2.0 million three months ago, the East-West arbitrage trade is still out of the money.
“Freight is only one factor. Physical cargo values play a big part and in Europe, there’s still an excess of gas oil,” said a ship broker. “Freight must be very low for this trade to work.”
However, one rare arbitrage voyage was seen last week on the “Stena Polaris”, fixed to carry 65,000 tonnes of South Korean gas oil to Europe on 22 April.
For now, traders prefer to tap arbitrage voyages from South Korea to Chile, due to firm diesel demand from the Latin American country after an earthquake damaged its refineries.
But these outlets for Asian gas oil could dry up once Chile’s larger refinery resumes output in June and reaches full capacity in the third quarter. Its smaller plant had re-started in March.
Coupled with China’s excess exports, Asia could face an oversupply later this year, said traders. This could flip the EFS back into the negative, but may still not be deep enough to open the arbitrage to Europe.
“It’s hard to be bullish on Asian gas oil when we are getting all this surplus from China,” said an Asian trader. “Spot demand from Vietnam and Indonesia is but a drop in the ocean compared to the excess volumes coming out of China.”
With China adding at least half a million barrels per day (bpd) of crude processing units each year until 2015, it is producing diesel faster than the economy’s double-digit growth can absorb. The surplus could double this year to 120,000 bpd and most of it is likely to stay in the region.
India’s Reliance Industries will also run the world’s largest refining complex above its 1.24 million-bpd capacity this year, flooding global markets with the full force of diesel and gasoline supplies for the first time since its new plant started in 2008.
“There’s going to be a lot of barrels chasing limited demand outlets,” said another trader with an Asian refiner.
Refining output will also be restored once spring maintenance in Europe and Asia wraps up, and new capacity comes online.
European refiners are slated to shut at least 1.3 million bpd of capacity this month, or 8% of the continent’s combined 16 million-bpd capacity. The April figure is heavier than the offline capacity of 0.9-1.2 million bpd in February and March, and is expected to ease to about 600,000 bpd in May.
Asian refiners will shut almost 3.4 million bpd of capacity for second-quarter maintenance, cutting 11% off total capacity, though about a quarter less than last year. The closures are set to peak over the May to June period.
A total 724,000 bpd of new refining capacity is expected to start up from the second half of this year, with India leading with 247,000 bpd, while the rest of Asia is forecast to add 57,000 bpd, data from research firm Wood Mackenzie showed. This is on top of the 1.65 million bpd that came online last year.
Traders who are more optimistic argue that European appetite for Asian barrels could surprise on the upside, as the economic recovery gathers pace, excess inventories show signs of easing, and more refineries shut operations on poor margins.
Distillate stocks — stored on ships located mostly off the Mediterranean and UK — are being drawn down gradually, helped by higher heating demand over the cold winter.
Oil products in floating storages have fallen to 52-55 million barrels as of end-March, from 85-90 million barrels in early January, according to data from the International Energy Agency (IEA) and ship broker ICAP.
No new Asian cargoes are moving into floating storages, as the narrowing diesel contango in Europe has made this option — aimed at earning better prices in the forward market — an unprofitable one. The contango shrank to $3.25 a tonne on Wednesday from a low of $12.25 a tonne on 25 January, as the prompt market improved.
But demand from Asian economies should not be overlooked.
Indonesia’s state utility expects diesel consumption to rise this year due to lower natural gas supply to power plants, while Vietnam’s only refinery is struggling with operating glitches.
India is seeking to import low-sulphur grades as it rolls out its clean fuels programme this month.
“Emerging markets demand in the region should not be underestimated,” said a derivatives trader with a bank.
“There’s steady imports from India, and regular spot demand from Vietnam and Indonesia — one refinery or another tends to go down and they will have to come to the market to buy.”