Viewpoint: European VGO market in line for shake-up

The International Maritime Organisation's (IMO) 2020 global marine fuel sulphur cap — which will limit the permitted sulphur content of marine fuels globally to 0.5pc as of 1 January — will be a key determining factor in VGO price movements next year. The soon-to-start regulations have already contributed to a sharp widening of the spread between high-sulphur and low-sulphur VGO in northwest Europe since November. Demand for low-sulphur VGO from the marine fuel pool has been firm, while gasoil margins have been depressed partly because of slower-than-expected uptake of marine gasoil (MGO).

Low-sulphur VGO is being increasingly used as a blending component in the creation of 0.5pc sulphur fuel oil. This has depleted availability on the spot market and has, in turn, lifted prices to the highest since Argus assessments began. The recent rise in low-sulphur VGO prices has come despite seasonally weak gasoline margins, which have traditionally been a driving factor of VGO values. The detachment could be linked to weaker gasoline margins coinciding with burgeoning marine fuel demand, but it may not last. Low-sulphur VGO pricing could become a balancing act between fluid catalytic cracking (FCC) economics and 0.5 sulphur fuel oil demand by spring, when gasoline consumption will pick up ahead of the summer driving season and VGO markets could be tight from several months of diversions into the marine fuel pool.

High-sulphur VGO demand in 2020 could partly be influenced by the extent to which MGO takes off as an IMO-compliant fuel. A slower-than-expected uptake of MGO — contrary to initial market expectations of a gasoil supply crunch in 2020 — drove high-sulphur VGO values last month to their lowest since April.

But there are other potential roles that IMO 2020 could play in the high-sulphur VGO market. Refineries switching to lighter, sweeter crudes in the latter stages of this year in preparation for the new regulations has boosted demand for high-sulphur intermediary feedstocks as refiners seek a balanced product yield. And extremely wide high-sulphur fuel oil (HSFO) cracks against key European crude stream Urals has prompted crude run cuts in recent weeks, which could well continue into next year as the HSFO market continues to shrink. This could boost high-sulphur intermediary feedstock demand to meet refineries' road fuel production requirements.

Go with the flow

Less VGO could be available in Europe next year. Russia is the principal exporter of the product to Europe and the Mediterranean, but exports from the country are set to decrease over time as refinery upgrades and secondary processing capacity expansions mean more VGO and straight-run fuel oil is used domestically. A total of around 11.3mn t of VGO was exported from the former Soviet Union region in January-October this year, down by over 9pc from the same period of 2018.

Outside of Europe, Russian VGO traditionally finds a home in the US, which is structurally short of alternative feedstocks for secondary processing units. The deficit in the US will see transatlantic flows continue in 2020, but the rate could be hampered early next year by eroded US gasoline margins — which led to run cuts on the US Gulf coast last year — and multi-year high transatlantic freight rates since US sanctions were imposed on subsidiaries of China's Cosco Shipping. Demand for heavier feedstocks in the US is likely to persist as long as sanctions on Venezuela's oil industry curb access to sour crude and fuel oil.

Otherwise, IMO 2020 could lead to demand surfacing for low-sulphur VGO in Singapore next year — as it has already for low-sulphur straight-run fuel oil — as Asia-Pacific's main bunkering hub seeks blending components for 0.5pc sulphur fuel oil. This demand has yet to take off, with no shipments of VGO from Europe to Singapore recorded by oil analytics firm Vortexa in the July-November period this year.

By Robert Harvey