Red Sea arb too much for current European naphtha demand

European physical premiums finally came off at the end of last week and have remained low throughout the week. The drop in crack and time spreads from previous weeks has finally translated into the physical market, changing the outlook of the global market for Q2 to a more bearish market, and altering the current arbitrage flows, where new options open up in light of the strong European decline. 

Physical prices in Europe following time spreads’ drop. (Sparta Live Curves)

The end of Q1 showed a very strong European market, being the main highlight since mid-February.

The closed arbitrage to Asia for spot barrels through the Suez Canal or Cape of Good Hope has been the norm for the last two months with a strong rebound in European petrochemical demand stimulated by low inventories at the start of the year.

However, as we move into Q2, it becomes clear that Europe will not need to maintain such high premiums to keep its product on the continent. 

 That said, the opening of the reverse arbitrage from the East has been one of the main factors for the current drop in the European market.

With the appreciation of the European market, clearly an exporter, and the prolonged drop in Asia, both in paper and physical markets, the arbitrage opened for a few days at the beginning of April.

The arrival of cargoes from the Red Sea to Europe, with the arbitrage working to the Med and NWE, has led to an excess of supply.  

Red Sea arb to Europe opened, pointing to an oversupply in NWE and closing again quickly. (Sparta Global ARBS – Pricing Centre)

The demand for naphtha remains sustained in Europe due to stronger-than-expected petrochemical demand and a wide gas-nap that ensures strong blending margins, enough to retain cargoes that would traditionally go to Asia.

However, the demand is not strong enough to absorb the product that could come from the Red Sea and premiums of $15/mt, which is why we have seen the OSN in NWE drop more than $10/mt within a week. 

As such, the Q2 outlook has changed radically in the last few sessions. The options from the Red Sea have worsened significantly and no longer pose a threat to flood the NWE market with light naphtha.

However, Med prices have moderately held up against the fall, worsening the northbound economics and creating a misalignment between European prices. Therefore, we may likely see further falls in Med prices or in TC6 to ensure resupply to ARA. 

Cross-European arb has closed after recent NWE weakness; there is room for a potential correction in Med prices to open this arb again. (Sparta Global ARBS – Pricing Centre)

On the gasoline side, we find the most support against new drops as gas-nap remains at historical highs and blending in Europe continues to show good margins, thus sustaining the drop in blending naphthas caused by petrochemicals. 

Lastly, despite this week’s correction, the arbitrage from the USGC remains open to Europe despite the drop in NWE prices, as US FOB prices have also gradually decreased in the last few weeks, opening up the arbitrage for C5′ from the USGC to NWE. 

Gas-nap keeping blending naphtha strong despite petrochemical correction. (Sparta Historical Forwards)