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Thursday, March 7, 2019 

Bjarne Schieldrop, chief commodities analyst at SEB, the leading Nordic corporate bank, has commented on the impact of IMO 2020 regulations on Gasoil and Heavy Fuel Oil (HFO) 3.5%.

He says: “If the gasoline crack is zero or negative in Q4 2019, and H1 2020 and simultaneously the Heavy Fuel Oil (HFO) 3.5% crack is substantially negative due to IMO 2020 regulations, middle distillate cracks will need to carry the entire refinery margin. Inevitably, this will produce very strong Gasoil cracks, exacerbating the impact of IMO 2020 on Gasoil cracks versus HFO 3.5% cracks.

“In September/October 2018, the gasoline crack to Brent crude crashed to zero. Subsequently and most unusually, it has remained at or below this level. As refineries usually adapt fairly rapidly to such changes, their failure to do so after five months suggests their technical capacities have been fully utilised in the face of structural changes in global crude oil supply. We are likely going to get an intermezzo with a rebound in gasoline cracks as we move through spring and into the summer season before spot gasoline cracks again crashes to zero or below the September/ October 2018 level. In our opinion this is largely due to the ongoing boom in production of ultralight US shale oil crude, which comprises a large share of light products. Once again, this has led to a surplus of gasoline and naphtha. Consequently, gasoline and naphtha cracks have crashed either to or below zero.

“Refineries earn their largest earnings shares from middle distillates (Gasoil/Diesel/Jet) and light products (gasoline, naphtha, etc.). Typically, heavy-end products (HFO 3.5%) have made losses for refineries, as they are less versatile, their demand base is narrower, and very expensive upgrading units are required to transform HFO 3.5% to more valuable products like diesel. While individual product cracks are not necessarily crucial for refineries, the overall refining margin for all products combined less crude and processing costs is certainly important. Therefore, when the gasoline crack crashed to zero, refinery margins on remaining products had to rise, to provide enough overall economic incentive for refineries to continue in operation. Consequently, both middle distillate cracks and HFO 3.5% cracks strengthened significantly in September and October 2018. Subsequent very strong Gasoil and HFO 3.5% cracks have been at least partly the result of the crash in the gasoline crack.

“Clearly, over the past six to nine months heavy crude markets have tightened, strengthening HFO 3.5% and improving relative value pricing of medium to heavy versus light sweet crudes. One could however phrase it slightly differently and instead say that it is not so much a deficit in the supply of medium to heavy sour crudes, rather, there is currently a surplus and slack in the refinery capacity able to process such crudes. The large portion of heavy, sour elements in such crudes is normally their Achilles heel. At the moment however, due to surplus heavy-end upgrading refinery capacity, the economic handicap of medium sour crudes is unusually limited.”

“Come Q4 2019 and H1 2020, the economic handicap will likely re-emerge with force. The heavy-end products (HSFO) - which the global shipping fleet currently consumes - will then instead have to be upgraded to middle distillates in refinery deep conversion units. These units are then likely to max out leading to a stranded surplus of heavy-end products, again leading to a very large discount HSFO and crudes containing large portions of such elements. After gasoline cracks strengthen heading into spring and the summer driving season, we expect they will once again crash to zero or become even more negative than in September/ October 2018. From November/December 2019, the HFO 3.5% crack is also likely to become increasingly negative. At that point, middle distillate cracks will need to be very strong to compensate for losses on both heavy and light-end products.”

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