European margins claw back some gains

Commentary summary:

• Brent-linked vs WTI-linked competitiveness is at least starting to narrow, albeit still miles apart in all regions with Americas crude very cheap.

• Weakness in US physical premiums continues with Mars particularly suffering, as SPR “supply” accelerates.

• If the Europe-US combined oil system can run smoothly enough and get added SPR supply of crude and products, we still need E/W signals to push oil of all types East, with WTI & LatAm the main target of that for now for the foreseeable.

Ekofisk, Forties, Johan Sverdrup diffs have dropped $11.0, $8.0, $2.0 per barrel w-o-w, with another steep decline on Friday associated with the paper sell-off on risk-off headlines that afternoon (messaging which has since reversed course).

At this point in time, European cracking margins look substantially better and workable on a larger variety of North Sea, WAF, Black Sea grades. Med margins on local grades like Saharan and CPC are also OK.

Some refiners/traders that perhaps hadn’t shifted some of their exposure away from prompt Brent (and were facing awful margins) might have been re-selling cargoes. But the fact is the complex was simply too strong given the implicit signal that Europe basically couldn’t refine much except WTI.

This I had flagged as a problem. Where do European grades look roughly fair value? It could be around here (discounting the scenario for now that an extreme rally in ICE Brent spreads could/would filter into physical; and equally an extreme sell-off is still possible if peace talks succeed).

We do need margins on Brent-linked crude in Europe to be roughly borderline I would say. Europe gets first dibs on local barrels, while Asia has been quiet in Brent-linked, preferring (far cheaper) WTI for now.

It seems fair that European refiners are put under some pressure by crude premiums as some European volumes (presumably mostly Med/Black Sea) should go East at some point down the line, as is historically normal to see.

But freight risk & margins might need to be lower before that happens en masse.

Meanwhile, SPR release of products in Europe – mostly gasoil – as well as a lack of strong run cuts in Europe seen so far, might also mean that fair value ICE GO cracks – as a proxy for products’ implied pull/drag on European margins/utilisation – are not going to be that high until perhaps May or June, assuming SoH remains closed.

Rather, most of the problem remains in Asia where the E/W diesel spread needs to be stronger than the current -$40/tonne on average, to pull diesel cargoes.

Jet in Europe will be a different story and possibly the reverse of the NWE/Asia gasoil story in terms of required E/W values.

(WTI cheap in Asia, and in Europe)

The strength of Chinese buying in the Brent and WAF market could be flat price dependent as is also historical. Chinese buying will be increasingly influenced by SPR releases which are simply going to be cheaper and involve less risk of all sorts.

There seems to be more willingness from Chinese authorities to make use of SPR now.

The US embargo on Iranian barrels is a further problem for those teapot/independet refiners dependent historically on cheap sanctioned barrels, so expensive Nigerian crude might not be the solution despite more import quotas (and threats to remove quotas if independents cut runs even if they are loss-making).

And India now gets another reprieve from the need to source increasingly from Europe/WAF, with Russian barrels getting a waiver extension after-all (this by the way, doesn’t give a confident message about lasting peace).

But Asian buying on WTI looks set to stay very high and should really test US export capacity limits. Asia might also steal some WTI market share away from Europe over the coming weeks and months, forcing all else equal more crude inventory draw on the old continent.

Certainly, it looks like more Brazilian and Guyanan has headed East (China) at the cost of flows to Europe, though WTI flow to Europe looks to have been somewhat stable thus far.

Asia’s pull on LatAm may increase given the relative lengthening in the USG sour crude market. Mars diffs have collapsed with SPR adding last week some 600 KBD of “supply” (mostly sour), plus the increased availability of Venezuela barrels in the USG.

EIA data showing combined preliminary US imports of Ecuador, Colombia, Brazil, Mexico crude, plus Libya, Nigeria, is showing a 500 KBD y-o-y drop over the last 4 weeks.

So, what to trade here? Well, I still don’t see too much to recommend with certainty on crude yet. I mentioned last week the possibility of deferred WTI/Brent spreads narrowing on the back of future rapid draws in US crude stocks.

July WTI/Brent futures widened $1/bbl since then, but mostly due to a TD25 rally in spite of a very long Afra list in the USG.

We are only just getting started of course on US draws, and assuming SoH flow remains low or closed for longer, US inventory (SPR + commercial) will need to keep drawing rapidly to feed Asia in particular.

Afra rates should come under pressure if Asia draws more WTI market share.

Cushing is already drawing now, and PADD-2 intake is yet to rebound seasonally. So WTI/Brent will need to narrow to reflect the US’s growing need to protect its own stocks, just as with the HOGO going forward in my view.

Tail risk is of course any rash decision making on US oil export policy, as well as all the headline risk around Iran in general. Not easy times at all.