Q4 ULSD arbs into Europe deeply closed despite low stocks, reduced runs and no clear source of resupply, Q4 E/W too narrow?

Europe

All arbitrage opportunities to Europe currently appear extremely closed along the entire curve, a surprising turn given the strength in ICE GO (gasoil) spreads and cracks in the past week. 

Red Sea refineries have reclaimed their position as the most advantageous arbitrage option into Europe, primarily due to increasing US Gulf Coast (USGC) differentials and freight rates. 

The European market’s positive outlook is attributed to factors such as stocks remaining below seasonal averages, reduced refinery runs due to operational challenges from having run hard for an extended period, light crude slates posing CDU space issues, and heat-related challenges.

Additionally, substantial investments from funds and investors have contributed to the bullish sentiment.

However, there are indications that this bullish sentiment may be excessive. Sources in the Mediterranean (MED) report ample availability of diesel at present, suggesting no immediate shortage.

Market sources predict a less tight situation by the second half of August, with more US ULSD becoming available with July’s US exports to Europe reportedly at their highest levels for 4.5 years. However, the upcoming seasonal European maintenance period in October adds further uncertainty.

The transition to winter diesel will play an important role in how the market develops but more importantly the performance of non-Russian refineries will play critical roles in stabilizing prices and minimizing volatility in the fourth quarter of 2023.

Consequently, spreads and cracks should be approached with caution at current levels. Q4 E/W (East to West) ULSD is currently undervalued, as Europe will surely have to pull from EoS (East of Suez) to partially replenish persistently low supplies.

Americas

The USGC continues to assert its dominance over other barrels heading to Brazil and West Coast South America (WCSAM), capitalising on a narrow E/W and rising Asian FOB prices.

By contrast, the situation into Argentina is more mixed, with low Asia to Latin America MR (Medium Range) freight rates playing a significant role. 

Notably, three MR fixtures from US Atlantic Coast (USAC) Transatlantic (TA) have also been observed this week, attracting traders seeking to capitalize on the current backwardation by offering short-voyage volumes.

Low US distillate stocks, much like in Europe, have captured the attention of bullish funds, resulting in considerable gains in US Heating Oil (HO) cracks and spreads over the previous week.

However, we would caution against buying HO cracks and spreads at these elevated levels. In the short term, during the rest of Q3, the pressure on HOGOs (Heating Oil vs Gas Oil) will be to narrow as Europe continues to look for resupply from the US (or EoS).

The outlook should shift into Q4, as growing US demand contrasts with the ongoing sluggishness of Europe’s demand. This disparity is anticipated to widen the HOGOs in Q4 2023.

Singapore and East Asia

Despite increasing FOB prices in West Coast India (WCI), it has maintained its position as the primary arbitrage route into Singapore, thanks to its relatively slower FOB price growth compared to East Asian prices.

With WCI FOB prices expected to decline soon due to reduced demand during the monsoon season, this trend is anticipated to continue.

Both WCI and Arabian Gulf (AG) arbs are currently oriented toward East Asia rather than Europe, driven by rapidly rising sales prices in Singapore and a narrow E/W spread. A number of fixtures, loading early August, have been noted to perform this route.

The surge in Singapore sales prices is attributed to exceptionally low seasonal stocks, particularly in ULSD compared to jet fuel.

Similar to Europe and the US, bullish funds have been drawn to the low stocks in Singapore, leading to considerable gains in Sing 10 cracks and spreads in recent weeks.

The upcoming announcement of new Chinese gasoil export quotas is expected to bolster Chinese gasoil exports, August’s exports already expected to be approx. 600KT. Q2 2023 Chinese gasoil exports having averaged 500KT per month.

As East Asia’s turnaround period ends and Europe’s begins, the contrast in demand is set to exert widening pressure on the E/W arbitrage into the fourth quarter of 2023.

Jet

Over the previous week, the next two months of arrivals have seen their arbs open from all the major Asian jet sources apart from South Korea.

Recent increases in diesel spreads have boosted NWE Jet premiums, with LR2 premia rising significantly from +$1 to +$8/mt versus Platts NWE since the beginning of June. As a result, the August jet E/W spread has widened substantially from -$40 to -$60/mt over the last week. 

August Singapore Regrade has widened partially due to anticipated new Chinese export quotas, and Chinese international flight numbers remain at only 51% of pre-COVID levels according to the OAG (Official Aviation Guide of the Airways).

These factors have contributed to a weak East Asian jet market, leading to potential exports to Europe and the Transpacific soon. Consequently, the European jet market is predicted to weaken by the end of August, confirmed also by our NWE jet sources, correlating with seasonally reducing demand.

Expectations are of downward pressure on NWE Jet CIF differentials and regrade in the short to medium term.

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James Noel-Beswick is Commodity Owner for Sparta. Before joining Sparta, James worked as an analyst for likes of BP and Shell, and leads our continued development of the distillate product vertical.

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