18 March 2022

Tug-of-war amid thinner liquidity leaves market guessing on oil flat price direction
By Saket Vemprala

A volatile week saw crude prices tumble to a two-week low mid-week before regaining lost ground. As at 1200 London time on Friday 18 March, ICE Brent front-month futures were trading around $107/b, having settled around $98/b two days earlier and above $112/b a week earlier.

Volatility has risen amid thinner liquidity: the ICE and CME exchanges have increased margin requirements for key contracts including Brent crude and US heating oil, discouraging participation, and reducing open interest on futures contracts. Amidst the volatility, a trade association representing Europe’s largest energy traders have called for emergency assistance from central banks, as access to cash gets squeezed. One well-known Swiss trading house active in the Russian crude market has reportedly been sounding out deep-pocketed private equity firms for a cash injection.

Bulls, of course, have been supported by the Russian war in Ukraine, and the seeming reluctance of OPEC members with spare capacity – chief among them Saudi Arabia – to compensate for reduced Russian crude exports in the short term. High-profile customers of Russian crude are shying away, while banks are reluctant to finance such transactions, complicating credit issues. Some non-Western buyers such as India are taking advantage of record low Russian crude prices (relative to the Brent benchmark). Russian crude exports to India are averaging 170,000 b/d in March, according to Kpler, compared to a 2021 average of 91,000 b/d. And crude continues to flow to Europe, as the EU has not instituted an outright ban on the importation of Russian oil.

But it is highly likely that despite increased buying from non-Western customers and the possibility of a developing secretive or semi-secretive trade in Russian-origin crude and refined products, Russia will have to cut upstream production. The International Energy Agency (IEA) clarified the stakes by estimating as much as 3mn b/d of Russian crude could be shut in, compared with pre-Ukraine crisis production of around 11mn b/d (crude and condensate combined).

And of course the Russia crisis extends beyond crude into refined products, particularly on diesel. At the European level, Russian-originating distillate cargoes accounted for on average 31% of total imports between 2017-2021, but this has risen to closer to 35% during the pandemic. So-called “self-sanctioning” by suppliers and Western governments’ economic sanctions complicating trade finance has not yet resulted in major disruption to actual trade flows. Kpler currently estimates March imports of distillate and jet at 700,000 b/d, down 21% on February. Although the import figure for March is likely to rise over the final two weeks of the month, there are reports diesel loading programmes from Primorsk – the top Russian origin for Europe-bound distillate – are being revised lower.

Any shortfall in fuel usually supplied by Russia will need to be substituted by drawing down stocks, other producers boosting refinery output, and the reorientation of trade flows. Global distillate and jet markets enter this crisis with inventories depleted, but the situation is particularly bleak in Europe. Stocks are more than 10% below the five-year average for OECD Europe, according to OilX. Refinery output in the region is higher than a year ago, but remains more than 2% below the five-year average. There is limited buffer of stocks to substitute reduced Russia flows and high natural gas prices have been a drag on refinery output growth recovery since the pandemic. Therefore, any additional diesel output is likely to be at the expense of jet, as refiners minimize the jet slate and maximise distillate output. Jet yields in Europe were lagging pre-pandemic levels before the Russia crisis. Assuming the global aviation demand recovery continues, any incremental rebalancing of jet/distillate yields will further erode regional jet production and be bullish for jet pricing (see below for our extended analysis on the Russia crisis' impact on jet fuel).

But back to bullish factors for crude: added to the Russia story is the absence thus far of a deal emerging from the Iran nuclear talks, despite much excitement in recent weeks that an agreement was imminent. The role of Russia as a spoiler in these negotiations has been much covered, but analysts also concede that any significant Iranian volumes would not re-enter the market until after the implementation period of an agreement.

Short-term physical tightness is pulling volumes out of both onshore and floating storage. On the latter, Kpler estimates that volumes that have been at sea for 20-90 days declined by around 5mn bl in the past week to their lowest since early January.

But while some analysts have been recently forecasting short-term price moves up to $200/b, there are demand-side reasons to expect prices will remain short of that threshold even with considerably less Russian oil making its way to the global market.

The first is inflation-induced demand destruction. The wave of ever-higher commodity prices started in 2H 2021 in the natural gas, coal, electricity, metals and fertiliser markets, before the Ukraine crisis inevitably pushed up crude prices. The price spike has now definitively made its way to the end-user refined products markets, with retail gasoline and diesel prices in the US and UK recently hitting record highs. Amid a high-inflation environment, consumers are cutting back – something being actively encouraged by the IEA, which has issued a 10-point plan to cut oil use. Some governments – France, Japan and several US states, for example – have sought to ameliorate the demand destruction with subsidy payments, rebates or fuel tax reductions. The IEA has cut its forecast for global oil demand during 2Q-4Q this year by 1.3mn b/d.

The second is the latest Covid-19 outbreak in the world’s second-largest oil consumer, China, which had to recently lock down the 17 million-strong city and manufacturing hub of Shenzen. China’s zero-Covid strategy comes at a high economic cost, and locking down major economic centres will have a knock-on effect for both global supply chains and Chinese oil demand. Goldman Sachs has reduced its 2Q22 Chinese oil demand forecast by 700,000 b/d to reflect the latest Covid-19 outbreak, but notes that the effective demand destruction coincides with the loss of Russian volumes, which helps to restrain the price rises otherwise needed to balance supply and demand.

When diesel sneezes, jet fuel catches a cold
By David Elward

We were asked this week to offer an opinion to one major European airline on the likely impact of the Russia crisis on jet fuel market. So we're reproducing a version of it here for our readers.

- Macro: Global jet fuel/kerosene (jet) supply chains are far less directly exposed to Russia than diesel/gasoil (distillate) markets. However, the proximity of jet to distillate in the oil refining pathway means, to coin a phrase, when diesel sneezes, jet fuel catches a cold. Jet’s fortunes are intertwined with the rest of the middle distillates complex, so the indirect impact on jet fuel is likely to be disproportionate to the aviation industry’s low dependence on Russian supply.

- Price Reaction: General Index data shows jet prices usually closely track diesel, a trend which has continued through the Russia crisis. Short-lived extreme pricing in the build-up to the last monthly ICE LSGO futures expiry (March-2022 contract) resulted in spot prices for jet and diesel spiking in the run-up to 9 March, before subsequently falling back sharply. But crack spreads have climbed again this week (there's no expiry imminent to blame this time!) and remain elevated above prior to when Russia invaded Ukraine on 24 February. The General Index Jet NWE FOB Barge crack spread to Brent futures was 164% higher on 17 March than pre-war, while the General Index ULSD NWE FOB Barge crack spread to Brent futures was 152% higher.

- Russia’s supply role: Jet importers are far less exposed to Russian than distillate importers. At the global level, Russian-originating distillate cargoes accounted on average for 13% of total world imports between 2017-2021, according to Kpler tanker tracking of seaborne cargoes. Jet from Russia accounted for less than 0.02% of total world imports during this period. At the European level, Russian-originating distillate cargoes accounted for on average 31% of total imports between 2017-2021, but this has risen to closer to 35% during the pandemic. Jet imported into Europe from Russia accounted for approx. 0.04% of total imports during this period.

- Limited flows impact so far: So-called “self-sanctioning” by suppliers and Western governments’ economic sanctions complicating trade finance has not yet resulted in major disruption to actual trade flows. There has not been a substantial decline in Russian diesel exports to Europe thus far. Kpler currently estimates March-2022 imports of distillate and jet at 700,000 b/d. While this is a 21% decrease on February-2022 the import figure for March is likely to rise over the final two weeks of the month. Looking further ahead, there are reports loading programmes for diesel exported from Primorsk, the largest origin point for Russian distillates sent into Northwest Europe, are being revised lower and expectation in the market is this could soon be seen in reduced export volumes. Some of the Russian oil arriving in the last week or two would have been paid for some time ago, so the payment problems will also likely gradually build up.

- Substituting Russia supply: Any shortfall in fuel usually supplied by Russia will need to be substituted by drawing down stocks, other producers boosting refinery output, and the reorientation of trade flows. Global distillate and jet markets enter this crisis with inventories depleted, but the situation is particularly bleak in Europe. Stocks are more than 10% below the five-year average for OECD Europe, according to OilX. Refinery output in the region is higher than a year ago, but remains more than 2% below the five-year average. There is limited buffer of stocks to substitute reduced Russia flows and high natural gas prices have been a drag on refinery output growth recovery since the pandemic.

- Jet already at low production base: We expect any additional diesel output will come at the expense of jet, as refiners blend more jet into the diesel pool. Jet yields in Europe were lagging pre-pandemic levels before the Russia crisis, whereas distillate yields have been rising seasonally. OilX data puts distillate yields at close to 40% for OECD Europe’s refiners in March-2022, more than 1% above the five-year average for this time of year. By contrast, jet yields are 1% under the five-year average at around 6.5%. The inability of regional producers to quickly and sufficiently raise diesel output is already visible. Shell announced it would limit sales of heating oil in Germany. Amrita Sen, Director of Research at Energy Aspects, told a UK Parliament committee this week that diesel rationing could come as soon as the end of the month in Germany. Assuming the global aviation demand recovery continues, any incremental rebalancing of jet/distillate yields will further erode regional jet production and be bullish for jet pricing.

- Early warning signs: Perhaps one of the best indicators of blending adjustments is the relative price of jet vs distillate on a crack spread basis. Each refiner will be different, but they will have a sliding scale model where for every $/tonne change in the spread you find another X kbd switch from the market. The S&D Balance is another useful indicator to track. OilX sees the jet balance for OECD Europe short by 484,000 b/d for March, compared to net long 103,000 b/d in January, which seems to match-up with the broader view of tightness and bullishness in jet.

- Strong summer headwind: Airlines are anticipating the first normal summer since the coronavirus pandemic. But they are flying into a strong headwind of spiralling fuel costs and volatile pricing. While some European airlines can rely on well-worn hedging strategies to safeguard them from unpredicted higher fuel bills, the same can't be said for all. Three major US airlines are unhedged, as per their standard strategy. The pandemic, despite its historic demand destruction, resulted in surprisingly few major casualties among the airlines, as taxpayer support helped to keep the industry afloat. However, Russia's invasion of Ukraine has triggered a whole new crisis for a sector where fuel is the single-biggest cost. The aviation industry is not out of the woods yet.

PADD 2 refinery runs slide to 5-month low on turnarounds
By Jeffrey Bair

Refinery runs in the midsection of the US have dipped to a low point since last fall because of maintenance work that is expected to last well into April.

The Valero refinery in western Tennessee and the Phillips 66-operated refinery along the Mississippi River in Illinois both recently started turnarounds on key fuel units. Both sites saw work on catalytic reformers, instrumental to gasoline production.

The projects helped cut PADD 2 refinery utilization, representing the Midwest, by 2.2 percentage points last week to 87.6%, the lowest since 8 October. Refiners in that region are running much less hard than those in the nearby Gulf Coast in the US refining hub.

Wild fluctuations as European LPG buffeted by Ukraine fallout
By Virginia Bridgewater and Arran Brodie

European LPG prices have fluctuated wildly alongside extreme crude moves since last week, with Propane CIF NWE Large Cargo values spiking then plummeting by more than $250/MT in less than 10 days.

Overall, propane and butane large cargo values dropped back to pre-Russia/Ukraine war levels this week. Propane CIF NWE values, which had previously peaked at $995.25/MT on 8 March, fell back sharply, reaching $754/MT on 16 Mar. Physical propane also weakened against April, down to +$8/MT on 16 March compared with a premium of more than +$40/MT on 15 March. Prompt tightness continues while further out true values are harder to gauge in light of market volatility and general uncertainty.

The propane-naphtha swaps values also came in following highs of around $-200/MT last week before falling back to the low $-140s/MT by 16 March.

The heat has largely come out of the market for now, despite a speculative propane offer based on 89% of April naphtha which was valued at around +$55/MT to April paper. This was not expected to find a seller, despite North Sea April loading programmes announcing less availability than expected. Not only is more product going into Equinor’s downstream but with natural gas prices still at record highs, LPG is still being used to spike natural gas streams.

The announcement came just after an unmet Equinor offer for later in April brought the butane value against naphtha to the mid-low 90s as a percentage of naphtha from 96%.

While outright butane values have leapt far beyond $1,000/MT in the weeks since the Ukraine invasion, this is due to naphtha volatility rather than butane’s. Europe relies far more heavily on naphtha from Russia than LPG and is feeling the pinch as the war continues.