Just a month ago Dec EW was trading at $-7,5/bbl and arbs were flowing from AG and Far East into WAF and Latam. A month later the situation has reversed entirely. Western markets have started their winter hibernation period and US markets have already moved into Backwardation
USGC is now the cheapest source of supply globally. Not only it retains control of its natural markets in Latam (Mexico, Ecuador, Colombia etc.) by more than $10/bbl, but Arbs from USGC are now open into remote destinations such as Australia (on an LR1) by $3-4/bbl or landing at Parity to AG into Tanzania. It is also threatening the European market by landing into WAF at least $20/MT cheaper than ARA up until end of Jan arrival.
These arbs might be open, but export volumes will not be enough to compensate for weak internal demand. As a consequence, the US has been the first market to move into contango and start building stocks for next season.
Furthermore, it is worth noting that just before Thanksgiving cash diffs in the GC collapsed. As such, when looking at the blend composition of most destinations, the blends mainly consist of components. This is unusual in the US where A and M grade tend to trade below their bottom up blend value and become the main component for export grades.
Indeed, the move has been so strong that A and M grades now benefit from a blending margin vs. the swap. The last time this happened was in April when C5 collapsed. This is generally a good indicator of an oversupplied market and, unless we see a correction, it should set the tone for both ARA and Sing.
On the European side, cash diffs continue to come off, but unlike the USGC, finished grades such as E5 and E10 are still being maximised in blends. This has incentivised NWE wholesalers to prefer to buy E5 and E10 in the window rather than blending it themselves.
These window bids, although slim in volume, maintain the structure backwardated at least until Jan-23. This could all change if European cash diffs follow the US trend, especially now that all Arbs from ARA remain shut.
Furthermore, if Arbs from the USGC to WAF do materialise, this could hamper demand for ARA-origin volumes even more, and accelerate the bearishness on component cash diffs. Something to keep an eye on. Finally, the only glimmer of hope for European barrels at the moment is the East. ARA lands at parity to AG into Saudi. But that arb should open up at least 1-2 $/bbl more before materialising.
On the Asian front, the rebound experienced since the lows of early November now seems overdone. Eastern prices are now attracting barrels from USGC into places like Australia and all arbs out of the area are now shut.
Sing spreads are still in backwardation in the front month, mainly due to the large amount of cargoes Arb’d out of the region over the past month. But given the above-mentioned global scenario, this does seem short lived and we can see that on the deepening contango in Q1.
Overall, the US has lead the way towards winter hibernation and stock building. Perhaps the move has been too abrupt relative to Europe and Asia from a blending economics perspective. A short-lived rebound cannot be ruled out, but certainly remains under-priced relative to Europe and Asia right now.
In any case we have now entered winter hibernation mode and the market should be stock building for the next season. The key over the next weeks will be refining margins. With weak demand, this will determine how quickly and how steep the contango will be over the next months.
Felipe Elink Shuurman is CEO and Founder of Sparta. A former trader, Felipe drives strategic vision and growth at Sparta. Before Sparta, Felipe worked and traded for BP, Vertical and Gunvor.
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