The recent actions by OPEC to increase production will increase crude availability and lower feedstock costs for refiners. Perhaps more importantly, the increase in medium sour crude production could impact product quality and yields. Sanctions on Venezuela and Iran as well as OPEC restraint have limited heavy and medium sour crude production in recent quarters. The oversupply of crude will entice higher refinery throughput in the near-term, with refiners preferring higher sulfur feedstocks given wider light sweet-medium sour differentials. Some of the crude will end up in storage, but surging tanker rates will limit the appeal of floating storage. As onshore crude stores rise, refiners are likely to increase throughput, and by extension, product supply.
Coronavirus has put a ceiling on demand in the first half of the year, however, and will limit lower prices from spurring additional consumption in the near term. As a result, ESAI Energy expects higher throughput to result in a significant build in petroleum product stocks during the second quarter. These surplus product stocks will weigh on prices when demand recovers later this year. For the IMO bunker transition, these changes have several likely consequences. First, shipowners can take a breath. Tanker charterers can expect higher rates over the next few months as Saudi ships more crude. Even for the other shipping sectors still suffering from lower demand depressed by COVID-19, the lower crude price means lower bunker prices as well, both for HSFO and VLSFO. Revenues are low, but so are costs. By the second half of the year, when we expect supply chains to be snapping back, all shipping sectors – cargo, tanker, container, and bulk – should see a significant boost in demand. The tanker sector will sustain its current gains, though demand may begin to shift on the margin from crude tankers toward product tankers, as the inventories built in the first half of the year begin to reach market.
Second, weaker HSFO discounts are likely in the second half of the year. Running more heavily-discounted medium sours from Saudi Arabia and other Arab Gulf countries will increase the production of HSFO relative to LSFO. The chart below shows the change in component yields by replacing a barrel of Brent crude with an average barrel of Middle East medium sour crude. As an example, if refiners were to replace 500,000 b/d of Brent with medium sour, production of high sulfur fuel oil components would rise by 250,000 b/d while low sulfur components would fall by 170,000 b/d. These additional crude runs are also likely to reduce the increased volumes of HSFO that refiners have been running directly. Together, these factors should contribute to a looser HSFO market. Third, refiners may be hard pressed to find sufficient LSFO to meet bunker demand once the recovery begins. If bunker demand rises to the levels we expect in the second half of the year, constrained LSFO supply could help more gasoil to enter the bunker pool. Refiners’ first choice to meet demand will be VGO, but this may be in short supply as gasoline demand strengthens seasonally. A final consequence could be that diesel finds additional support in the second half of the year.