This year has started with bang as a sustained rally in oil prices has propelled marine fuel prices to their highest levels since 1 January 2020, when the majority of the world’s fleet switched to lower sulphur fuel. This week, we present our outlook for crude and marine fuel prices and discuss whether higher marine fuel prices, and wider spreads between low sulphur and high sulphur fuels, are here to stay.
Crude prices hit eight-year highs
Crude prices have surged to eight-year highs since the start of the year after being stoked by a combination of a relatively tight physical crude market, oil inventories in several major consumer languishing at low levels, tightening global middle distillates markets and simmering geopolitical tensions between Ukraine and Russia so that front month ICE Brent and NYMEX WTI are currently oscillating around $93/bbl and $91/bbl, respectively. Furthermore, although these factors largely impact prompt factors, they have also succeeded in dragging prices for future delivery higher.
Where next for crude prices?
In our opinion, crude prices stand at a crossroads. Market bulls are claiming that it is only a matter of time until crude prices breach the $100/bbl barrier and then the sky is the limit. This is based on the premise that oil demand is significantly stronger than currently estimated by benchmark forecasters and that geopolitical tensions will remain at fever pitch across 2022. On the other hand, the slightly lonelier bears, suggest that the oil demand rebound is decelerating while oil supply growth is accelerating which indicates that markets are now oversupplied. Furthermore, they attribute some of the recent upward momentum to paper markets which suggests that the rally could soon run out of steam. Ceteris paribus, this implies that prices should also move lower. We stand in the bears camp, since our forecast of global oil demand growth in 2022 (3.1 mb/d) stands towards the low end of the range among forecasters. Meanwhile we project record supply growth of 5.3 mb/d in 2021 with inventories being projected to soar by 1.1 mb/d.
That being said, we acknowledge the upside risks to prices coming from any potential incursion of Russian forces into Ukraine while our global balance does not suggest, although they will rebound, OECD commercial oil inventories will not stand above average by end-2022. All told, we project that crude prices will ease later this year on slightly looser oil market fundamentals which should see crude move back down towards $80/bbl. Accordingly, we project that front month ICE Brent will average $83/bbl in 2022. The big downside risk is from the return of Iran. However, for the moment we have not factored in the timing of its return, but we consider that it has the potential to move prices below $80/bbl upon the easing of US sanctions. Moving across the medium-term, we project that the rate of price increase will decelerate but that prices will remain supported due to lower OPEC spare production capacity, notably as its West African members struggle.
Marine fuel prices to weaken from current highs.
The main question is how will the above impact marine fuel prices?Considering our expectations on where crude prices are heading, this suggests that absolute marine fuel prices should eventually come off their recent highs. However, this is only part of the picture since one reason for the current strength in 0.5% very low sulphur fuel oil (VLSFO) and marine gasoil (MGO) prices is that they remain supported by a tight global gasoil market. Indeed, many VLSFO grades are a blend of fuel oil and lower sulphur middle distillates. Looking across the short-term, we do not expect that gasoil markets will loosen significantly as we project global gasoil demand to remain strong. This will not only be led by the ongoing global economic rebound, but as small-scale diesel generators are increasingly being used in Asia to combat soaring electricity prices and increasingly unreliable national grid networks. All told, this suggests that, in the even of crude prices softening, VLSFO and MGO prices could remain supported other marine fuels.
380 prices to weaken?
To a certain extent, global high sulphur fuel oil (HSFO, sold into the bunker pool as 380 Cst) markets are also being supported by similar factors to those supporting lower sulphur fuels and today’s marine fuel futures prices suggest that VLSFO and MGO will strengthen versus 380 Cst. However, we believe that there remains plenty of scope for the opposite to occur. Global high sulphur fuel demand currently remains supported by the switch of some natural gas-fired power generation capacity, especially in the Northern Hemisphere, to fuel oil. This has occurred as natural gas prices have soared with recent data suggesting that, on a barrel of oil equivalent basis, European natural gas prices recently an eyewatering $350/bbl. However, natural gas prices should weaken once the Northern Hemisphere exits peak winter demand season which should also see fuel oil demand weaken. Furthermore, as OPEC+ continues to unwind its production cuts, this should see global sour crude production steadily rise. As more sour crude is processed by refiners this ‘organically’ boosts the output of HSFO and most of our oil supply growth this year is either very light crude (especially from the US) or sour, neither of which will help simple refiners ‘organically’ increase their production of the demanded-for middle of the barrel products.
So how will the drybulk fleet react to higher bunker prices?
With bunker expenses creeping up quickly, does this meant shipowners will slow-steam, which will subsequently tighten tonnage availability, enjoying low bunker expenses since 2020?
Laden Speed.
We can observe that fluctuations in laden speed are more influenced by real-time freight developments. As C5TC collapse from Oct-21, the CAPE laden speed adjusted swiftly from 11.8 knts to 10.8 knts by end Jan-21. This decline was further accelerated with increasing bunker expenses. On the other hand, Panamax & Supramax’s laden speeds continue to push upward since beg-22 in response to the strong showing in P5TC & S10TC, shrugging off the impact of rallying bunker prices. Moving ahead, if the drybulk market took off 2Q22, the likely scenario would be a speed up in the fleet despite bunker prices staying at elevated levels...
Ballast Speed.
On the contrary, when it comes to the ballast leg, all 3 major vessel sizes opt to heed the signal from the bunkers market and start to slow steam from Oct-21. So, there’s a dual approach adopted by Shipowners to strike a balance between responding to rising freight rates & bunker prices at the same time. However, this might change, heading into 2023, when compliance to EEXI & CII takes precedence to freight economics...