Slow death of fuel oil gets quicker thanks to gas

By Emma Farge – Analysis

LONDON (BestGrowthStock) – Refining margins for fuel oil look set to fall deeper into the red as traditional demand sources dry up due to fuel switching.

Sinking profit margins are particularly bad news for simple refiners, lacking the capacity to upgrade the sludgy substance to lighter transport fuels for which demand is bouncing back.

Fuel oil fundamentals have been under siege for years, especially in the developed world, because of stricter environmental legislation in shipping and power generation.

But more recently, the divergence of oil and gas prices due mainly to the abundance of new gas supplies, including shale gas, has accelerated the pace of demand substitution.

U.S. gas futures fell below $4 per mmBtu this week, continuing their slide from near $6 at the beginning of January while crude futures hovered near 18-month highs at around $86 a barrel.

This trend could erode fuel oil demand for years to come and is likely to be irreversible, analysts said.

“There are very weak prices of natural gas and it looks to stay that way for a few years. This will affect the substitution potential in power generation,” said David Wech of JBC Energy.

And while demand is fading fast, global fuel oil supplies have risen sharply due to lower OPEC quota compliance, now around 50 percent, placing additional pressure on margins. Higher OPEC output consisting mainly of heavy crude grades from the Middle East boosts refinery fuel oil yields relative to other products.

Refiners in Europe and the United States are also starting to crank up output to exploit relatively buoyant gasoline and diesel margins, weighing further on fuel oil prices.

“Last year, fuel oil was strong because of OPEC and because of low refinery throughputs. Now the reverse is happening,” said Wech. “Fuel oil will definitely weaken further in the course of the year.”

European margins for the benchmark high-sulphur grade neared positive territory and rose to a six-year high of minus $2 a barrel in January, according to Reuters data.

But prices have since slumped to a new fifteen-month low of below $13 a barrel in early April, helped also by abundant Russian exports.

Singapore has traditionally been the obvious dumping ground for growing fuel oil surpluses in Europe and Africa — also a big exporter due to limited refinery complexity. But even this demand hub is nearing saturation with stocks at record highs near 25 million barrels on 8 April.

“Tanks are full. Too many cargoes are going into Singapore,” said a London-based fuel oil trader. Still, trade sources estimate that western exports to Asia will top 4 million tonnes in April because of a lack of alternative outlets.

Shrinking Chinese demand is a key factor behind rising Asian stocks, traders said.

“The recent weakness has been largely down to demand in Asia and switching there,” said head of energy research at Societe Generale, Michael Wittner, adding that he is neutral on the fuel oil crack in the short term given this year’s dive.

“For the big picture, the trend should be the same way in terms of utilities shifting away from fuel oil in Asia. They are just a few years behind Europe.”

Most of China’s utilities use coal for power generation, but those that still run on fuel oil are gradually starting to introduce gas.

China’s fuel oil consumption is set to fall nearly 13 percent in 2010 from last year to 508,000 barrels a day versus a rise in all other oil products, according to the International Energy Association’s latest monthly report.

Plans to shutdown China’s small refineries known as “teapots” — which use fuel oil as a feedstock — could further diminish demand, analysts said.

(Reporting by Emma Farge; editing by William Hardy)

Slow death of fuel oil gets quicker thanks to gas