Softer Crack Spreads Drag on North Sea Trade
- October North Sea crude exports are up 30% on the month to 775,000 b/d, which is 58,000 b/d lower on September 2021.
- Crude supply is not an issue right now, but the relative weakness in product margins is sending the wrong signals to refiners.
- The Brent price structure has deflated and is supportive of demand, but high volatility partly discourages forward hedging despite the looming EU embargo.
The product market remains extremely tight and is largely distorted by unabated Russian product flows. But when the EU oil embargo kicks in this winter and all Russian flows to Europe cease, the potential price rally could become extraordinary.
The crude volumes underlying the dated Brent spot price have rebounded in October, signaling the end of planned summer maintenance and upgrading work in the North Sea.
The five grades that make up the dated Brent pricing basket — Brent, Forties, Oseberg, Ekofisk, and Troll (BFOET) — will load an average 775,000 barrels per day in October, up nearly 30% b/d from 600,000 b/d in September.
As refiners head into maintenance, feedstock supply is not an issue. Prompt demand is abating, partly explaining the dip in physical differentials. Forties, which often sets the price of dated Brent, is trading flat to dated Brent after having reached a fever-pitch premium of $4.5 per barrel in late July.
But the lull may be temporary. Russian oil flows have remained largely uninterrupted, and this resilient supply continues to underpin global prices, including North Sea differentials. The current softness belies future product shortfalls. Diesel inventories are still way too low to meet the seasonal winter demand increase and extra demand from fuel switching.
|North Sea Loadings for October and September 2022|
|Total ('000 b/d)||--||--||775||--||600|
|Source: Energy Intelligence|
The end of the driving season in Europe is weighing on gasoline margins and imparting some weakness to the petroleum product complex. Gasoline benchmarks are under pressure, with the spread between Brent and gasoline falling from $16/bbl to $10/bbl, brokers said.
Forward gasoline contracts for October 2022 even dipped into negative territory, which, in theory, should stimulate demand. But the weakness is spreading. A large selloff in gasoil cracks is dragging down jet fuel prices.
“The liquidity remains incredibly thin in middle distillates. Gappy markets and large bid offer spreads discouraged participation, with the moves showing a clear dislocation from the physical market," said Ehsan Massah, head of research at Onyx Advisory.
If crude balances are slack, product fundamentals remain razor thin. Any price disconnect ahead of potential winter shortages is hence worrying as the prompt spreads should in principle reflect the physical market for products. “As we approach the winter months and live through the reality of the energy crisis, the last thing we need is discouraging margin levels for the refiners," Massah said.
Despite relatively steady volumes, Brent open interest has been declining since March 2021, showing that fewer investors want to hold an overnight position in a market that is prone to wild daily price swings.
Volatility has shooed away some market participants who used to keep positions opened for more than a single day — typically the refinery hedgers. In the US, the CBOE oil volatility index (OVX) hovers around 50%. For comparison, its 10-year average is 37.6%. In the Brent options market, implied volatility is close to 50%.
The Brent prompt premium to deliveries in six months coming off from a monthly average of $13.3/bbl in July to $5.90/bbl in August. The spot dated Brent price has sunk below the front-month future price for the first time since April, after blowing out to an $11/bbl in July.
Intraday ebbs and flows dragged Brent below its 200-day moving average, a key support level around which the benchmark has since been hovering.
|North Sea Loading Program for October 2022|
|Total BFOET*||24,000,000||774,194||40 cargoes||--|
|Total Johan Sverdrup||16,400,000||529,032||24 cargoes||--|
|Total BFOET Plus Johan Sverdrup||39,800,000||1,283,871||64 cargoes||--|
|*BFOET stands for the five North Sea benchmark streams: Brent, Forties, Oseberg, Ekofisk and Troll. Source: Energy Intelligence|