Nov 26 2022
The European physical gasoil market, already showing signs of tightness, could strengthen further on reduced supply from Russia due to the EU's February 5, 2023 sanctions, according to analysts and traders, but economic weakness will likely provide shock absorbers.
Russia has long been Europe's key gasoil supplier and many analysts believe EU sanctions banning Russian product imports will cause volumes to Europe to collapse.
The CIF Mediterranean 0.1%S Gasoil cargo cash differential versus the front month ICE low sulfur gasoil future strengthened $2.75/mt on the week to Nov.24, to a discount of $5.75/mt below the ICE LSGO. On an outright basis, the CIF Med 0.1% gasoil price is $913.75/mt – its highest level in a week as seasonal winter demand rises.
In Northwest Europe, although CIF Northwest Europe 0.1%S gasoil cash differentials strengthened $2/mt on the week to Nov.24 to a discount of $28.25/mt below the ICE LSGO as traders report that the market is strengthening.
"[NWE 0.1%S] swaps have been heading up for a while," one trader said. "Mediterranean [gasoil] prints [the physical outright price published by Platts] have been holding despite the [strong] backwardation [in ICE LSGO futures]."
Traders highlighted that differentials had a lot of potential to increase in the following months as a result of EU-Russian sanctions and fewer flows, in general, coming to the region.
"Next year differentials are rating quite strongly," a second trader said, adding that with no flows from Russia, the principal users of gasoil in Europe will have to look for different sources of supply. Russian product made up around 14% of European gasoil demand in 2021, according to the latest outlook from S&P Global Commodity Insights analysis.
"The pressure to cover lost Russian cargoes at a time of existing global tightness are bullish for prices in coming months and in early 2023," said Rebeka Foley, an analyst at S&P Global.
However, she adds that global economic weakness will temper demand, "providing a reprieve to supply concerns."
S&P Global forecasts global gasoil demand to rise 380,000 b/d on the year in 2023, compared to 520,000 /d in 2022, with Europe set to contract in this current quarter and the first half of 2023.
The main European demand hubs for 0.1%S gasoil in the Mediterranean have traditionally been Greece, Spain, and Italy. In Europe as a whole, France is the largest demand center for 0.1%S gasoil for use as a heating oil.
Market participants suggested that European gasoil demand could be fulfilled by refineries, primarily in the UK and Rotterdam, through increases in production. A third trader also suggested that supply could come from reducing exports from the Amsterdam-Rotterdam-Antwerp hub to West Africa. Due to the lower restrictions on Russian product exercised by African nations, flows could potentially go directly from Russian Baltic ports to West Africa, a fourth trader said.
"Europe exports a lot of the heavier grades to Africa," the third trader said, "so the lack of Russian products will eat into that source."
European refinery capacity has also recently increased following the end of outages due to French refinery strikes at the end of October which at its height took out four of the country's six refineries. Nevertheless, strikes that began in BP's Rotterdam refinery Nov.22 and at Pembroke Docks serving the Valero Energy refinery in the UK on Nov.16 may see refining capacity reduced again.
On top of this, European refineries continue to prioritize the production of diesel over gasoil due to favorable cracks and the large sulfur spreads between the 10ppm ultra-low diesel cargo prices and the 0.1%S gasoil cargo prices.
Platts, a part of S&P Global Commodity Insights, assessed that 10ppm ULSD FOB ARA vs Brent crack at $39.95/bl compared to the 0.1%S Gasoil FOB ARA vs Brent crack at $35.69/bl. According to the latest outlook from S&P Global CI Analystics, ARA distillate cracks are expected to average well about the 5-year range, at $43/b in the first half of 2023 and $40/b in H2 2023.
The incentive for desulfurization remains strong on the back of a $59.75/mt spread between 10ppm CIF Med cargoes and 0.1%S CIF Med cargoes prices, assessed Nov.24. The NWE sulfur spread was assessed at $85/mt on Nov.24.
"For refineries, once they have the feedstock, desulfurization costs [very little]," the second trader said. "To bring gasoil to the market or convince refineries to make it, it has to be well-bid." They continued that once demand hit from falling temperatures, cash differentials would strengthen significantly.
Analysts have added that supply into the European gasoil complex could be supplemented by flows coming from the US and the Persian Gulf. That said, US flows would likely be diesel.
New refineries built in Saudi Arabia could allow Middle Eastern gasoil flows to help replace Russian volumes, market participants have said.