Storage operators could ultimately lose out as they work within a challenging environment despite the recent major trading play according to Yaw Yan Chong, director of Thomson Reuters Oil Research and Forecasts
For the second time in two years, Asia’s fuel oil market saw a major trading play which ended up with its key players expending massive capital only to yield modest returns even for those on the right side of the buy-sell divide.
Worse, the play – the largest the fuel oil market has ever seen in terms of volumes exchanging hands – again saw severe logistical issues as players stretched their infrastructural capabilities to breaking point in their efforts to squeeze that extra dollar. So much so that some of the main participants had to abruptly drop out midway.
Not quite the ‘super-normal’ profits that the architects of such trading plays are used to.
The primary reason for this is a fundamental lack of liquidity in the product’s derivatives market that resulted from severe cutbacks by many investment banks in terms of speculative trading volumes amid increasingly tighter regulations.
This is in the face of a tepid demand environment. The Asia marine fuels market has remained stagnant with no growth for the past four years, thinning demand from China’s small, private refiners who have turned to cheaper alternative feedstocks such as bitumen mix and drastically falling imports of power-generation fuel into Japan as the country turns to cheaper alternatives.
The latest play – who won?
This June, fuel oil’s main players returned with a vengeance – mounting the largest play the market has ever seen, with a record volume of nearly 6 million mega tonnes (mt) of physical fuel oil cargoes changing hands in the daily pricing window. In the first three sessions alone, a total of 1.85 million mt were traded, culminating in a record daily high of 726,000 mt on the third day involving 28 deals.
The spark stemmed from the increased liquidity in the derivatives market from around Q4 2014, in part due to an abrupt collapse in global crude benchmarks which saw front-month Brent lose over half its value, plunging from above $110/bbl last June to below $50/bbl in January this year.
The increased liquidity had in turn provided the much-needed paper-physical leverage.
And so the battles lines were drawn with Glencore, PetroChina, Mercuria and BP on the buy side, while Litasco and Totsa were the main protagonists on the sell side, with other trading elites such as Vitol and Shell in the supporting cast.
Most players were on the sell side as that’s where they perceive value to be. After all, demand has been pervasively poor, though some short-term support was provided by China’s teapot refiners buying up large volumes of bitumen mix as feedstock.
Thomson Reuters Oil Research and Forecasts believe that the bulls on the other hand felt perhaps that they have to take a contrarian market position to generate the liquidity that they needed to create sufficient paper-to-physical leverage.
That they ended up buying nearly 6 million mt of physical oil, mostly of the 380-cst grade, would put their cumulative paper positions roughly at 18 million mt based on a 1:3 ratio. At a rough estimate of $360/mt as the average transaction price for all of the trades, that’s a staggering $2.16 billion outlay for the entire physical volumes.
And if that’s not enough, the bulls also appear to have uncharacteristically telegraphed their intentions well in advance by snapping the June/July 180-cst intermonth timespread out of the market’s steeply contango structure in H2 March – almost three whole months before the contract’s pricing in the calendar month of June.
Infrastructure vs oil volumes
Ultimately, it boils down to whether the bulls will have the sufficient infrastructure back-up in the shape of both landed and floating storages to house the inevitably large volumes that they will have to absorb; or whether the sellers have sufficient volumes to offload to the buyers and that their storage terminals can handle these expectedly large off-takes.
In addition to using their storage capacities already on long-term lease in the Singapore trading hub, the bulls have also had to sub-lease both short-term, shore-based capacities from friendly allies that are not maximising them, as well as time-chartering 15-20 tankers, mostly 80,000-mt aframaxes as floating storages for one to three months.
That demand for storages drove up spot charter rates to levels unseen since 2008.
The irony is that, in ordinary times, the market is oversupplied in terms of storage capacities, particularly for fuel oil, so much so that operators have slashed rates to $5-$6/mt from its peak of $8-$9/mt for long-term lease of onshore tanks in the Singapore trading hub.
Before even the June pricing-out month commenced, the June/July timespreads for both the 180-cst and 380-cst grades were lifted to double-digit backwardation, peaking at $16.50/mt and $15/mt respectively before even they became prompt, from the steep contango of $1-2/mt for both spreads in H2 March.
The buying momentum was maintained till June 19, with the main players soaking up an average of about 376,500 mt per daily session, while the value of the 380-cst cash differential averaged at $8.02/mt.
Then, abruptly, the buying spree lost steam; first, with PetroChina disappearing from the buy side triggering an easing in the buying appetite, dipping to an average of 100,000 mt/day by the month’s end.
By the last two trading sessions of the month, none of the buyers were seen picking up any cargoes; with one of them, Mercuria, actually turned seller.
This downward momentum intensified after the bears led by Litasco and Totsa took the opportunity to sell down the market to discounts of $4-$5/mt following the bulls’ exit.
Post-play, the bulls were stuck with the record-high volumes bought at high prices, but had counted on the market’s contango structure, as well as the expectation of significantly tighter inflows in August and September to mitigate their physical losses.
But, that was when global crude benchmarks started to retreat and eventually plunged in July, driven largely by the expectation of more supply into an already pressured market.
Given the new scenario, fuel oil prices plummeted with levels for the 380-cst grade averaging at $307.74/mt for the month – which translated into a staggering loss of about $45-$50/mt to the estimated average price of $360/mt that the bulls had paid for their nearly 6 million mt of cargoes. On paper, these losses can be as high as $100-$200 million, depending on the inventories being held and hedging levels.
The upshot is another bout of selling that saw the grade’s Aug/Sept weakening to a contango of $4-$5/mt, pressured by some players selling ex-wharf bunkers at below-market levels.
The jury is still out in terms of what the final outcome of the play will be, but it will be safe to assume that the returns were underwhelming in comparison to the capital expended.
In simple terms, probably no one really won.
Regardless the outcome of what has been dubbed the ‘mother of all trading plays’, the market’s fundamentals remain the same – that is, a tepid demand environment with poor derivative liquidity in the medium/long-term that is insufficient to generate the required paper-physical leverage to yield the super-normal profits of the past.
Despite the trading play that generated huge volumes of derivative trades in the daily pricing window, the year’s average volumes up till June was 3.25 million mt/month or below 2013 levels.
In the short-term it is unlikely that another such play will be mounted, given the collateral damage to profit-and-loss (P&L) positions of the prime movers.
The Chinese refining sector has brought some cheer through March-June as its smaller, private refiners bought large volumes of feedstock averaging 1.5-2.0 million mt/month during the period.
However, the demand had not been for conventional straight-run fuel oil (SRFO), which would normally be refined into diesel and gasoline for the domestic market which had remained poor averaging at all-time lows of 1.48-1.49 million mt/month for the past two years, but rather a different grade known as bitumen-mix.
Meanwhile, third demand bastion for residues –the Japanese utility market has remained lacklustre and does not look likely to rebound as its government moves away from fossil fuels as a power-generation source including the restoration of the country’s nuclear reactors mothballed since the Fukushima disaster in April 2011.
With the outlook poor for both baseload demand and prospects of more trading plays dim, one casualty could well be the storage operators – which have thrived in Singapore’s past 20 years as Asia’s primary oil-trading hub and seen capacities grow to nearly 15 million m3 on both sides of the Johor Straits.
Since 2007, when large additional capacities, including the giant 2.3 million m3 Universal Terminals, Asia’s largest commercial facility, came online; the total commercial storage capacity onshore at 7-8 million m3 has well exceeded baseload demand, which has fallen to 6.5-7.0 million mt/month in the past two years.
In the current challenging environment, several mid-sized players have either exited the fuel oil market or opted not to incur expensive, long-term storage costs.
Thomson Reuters Oil Research and Forecasts believe that the environment has become increasingly challenging for storage operators, as much as it has been for the fuel oil trading community.
A year ago, we said that the fuel oil market is headed for a fundamental change in the way that it trades and makes money. We are more reinforced in this belief after the lessons of this June.
- Yaw will be speaking on the first day of Tank Storage Asia’s conference at Marina Bay Sands on September 29 and 30 about the effect of the new sulphur emissions regulations on the marine fuel market. For more information click here