Demand in the European fuel oil market has failed to gain traction as countries around the globe emerge from coronavirus-induced lockdowns, resulting in spreads between high and low sulfur fuel oil grades to remain narrow.

“It's a lack of demand everywhere, volumes are down,” a Northwest Europe-based trader said. “The soft contango keeps offer side sitting and buyers need sharp numbers in this calmer bunker market,” the trader said.

The market is currently plagued by ample supply of very low sulfur fuel oil, or VLSFO, alongside a weakening contango structure putting pressure on storage economics.

HSFO, on the other hand, has seen limited production following IMO 2020, with OPEC+ oil production cuts supporting prices.

Analysts have warned about the OPEC+ production cuts being dominated by Middle Eastern producers. As a result, HSFO could become scarcer as these crudes typically yield a higher percentage of the product.

Shortly after the implementation of IMO 2020, the spread between 0.5%S FOB Rotterdam barges and 3.5%S FOB Rotterdam barges hit $321.50/mt on January 3. However, the spread has narrowed to $60.50/mt on July 27, a decline of 81% from the beginning of the year.

The spread averaged $246.52/mt throughout January, posting steady declines on monthly averages throughout the year as coronavirus weakens market fundamentals. The average through June was $53.39/mt, which narrowed further following the major demand fall out seen in April and May on the pandemic to $76.01/mt and $58.17/mt, respectively.

Following the International Maritime Organization's sulfur cap on January 1 cutting sulfur burnt on the high seas from 3.5%S to 0.5%S, there were expectations of wide spreads between the two products. However, following the coronavirus pandemic, all expectations have been blown out the water as sulfur spreads in fuel oil remain narrow.

VLSFO has dominated as the fuel oil of choice, which led to many storing the product on availability fears at the start of the year. However, a demand decline due to coronavirus has led to large stock builds through April and May.

Combined stocks of fuel oil in the Amsterdam-Rotterdam-Antwerp hub rose 11.7% to 1.456 million mt in the seven days to July 22, according to data from Insights Global. This was only down 16% from highs seen both at the beginning of May and June of 1.745 million mt.

Bunkers

The narrow pricing difference has trickled down to the end-user bunkers market, impacting shipowners' decisions regarding installation of scrubbers on ships to burn the cheaper 3.5%S fuel oil.

With estimates of about $2 million per ship, the pace of scrubber fittings has decelerated due to coronavirus-related slowdowns at shipyards, a reluctance to set aside capital during a global financial downturn, as well as a decrease in payback economics, according to market sources.

The pricing difference between 0.5%S and 3.5%S delivered bunkers averaged $55.25/mt in July so far, hovering around the $50/mt mark since April, Platts data showed. This extends the payback time for a scrubber from 1-2 years to 4-5 years, according to some market estimates.

S&P Global Platts Analytics has also lowered its projection for installations at the start of 2021 to 3,100 from 3,500.

Any recovery for economies in the coming weeks as they emerge from lockdowns suggests higher uptake of light end products such as gasoline. Regardless of demand from bunkers, this may provide a floor for VLSFO bunker prices.

“The nature of VLSFO typically as a blend means that as demand for gasoil/diesel, jet and gasoline increases, so the price of these products relative to crude will rise and this will also ‘pull-up’ the relative price of VLSFO to crude,” Steve Christy, director of strategic communications at Navig8 Group, said in a research note.

"Demand for middle distillates is more closely linked to industrial use and, amid regulatory changes in fuel specifications, demand here has been more questionable than that for personal vehicle use,” Alexander Black, a trader at hedging company Global Risk Management said.

0.5%S FO availability

The ample stocks of 0.5%S fuel oil have weakened demand for low sulfur feedstocks, such as low sulfur straight run and vacuum gasoil, as blending components in the bunker pool, causing downward pressure on LSSR and LSVGO prices, sources said. As early as February 2020, sources estimated that 70%-100% of European LSSR was going into the 0.5%S bunker pool.

In addition, LSSR and LSVGO prices have weakened further due to poor refining margins in fluid catalytic cracking units, sources said. However, margins in hydrocracker units that process HSVGO have been better, which has lent some support to the high-sulfur feedstock, according to sources.

The spread between CIF NWE 2%S and 0.5-0.6%S VGO has followed a similar direction to that of high and low sulfur fuel oil more recently, narrowing from $11.50/mt on June 3 to $2.75/mt on July 27.