Asia VLSFO supply set to remain tight despite China hiking export quotas

China's higher export quotas are likely to have little impact on tight regional availability of low sulfur fuel oil as high gas prices raise the cost of production and other factors offset the expected incremental output increase in China, industry sources told S&P Global Platts.

LNG prices surged in 2021 from the year before, with the JKM averaging $15.03/MMBtu over the year and the daily physical assessment hitting an all-time high of $56.33/MMBtu on Oct. 6 as Asia and Europe competed for supplies ahead of winter.

S&P Global Platts Analytics earlier this month said it expects the JKM to average more than $30.00/MMBtu for deliveries in Q1 due to severe cold temperatures and a tight global gas market, especially in Europe where storage inventories remain well below historic norms.

"Refinery margins will remain generally healthy for those refiners not exposed to high natural gas prices. But those refiners who need to buy expensive natural gas for fuel or to make hydrogen are seeing up to $3-$4/b higher operating costs and thus weak margins, particularly in Europe," Platts Analytics said in a report earlier in February.

Even as record high gas prices have meant increased use of fuel oil for industrial and power generation needs, refiners have also apparently cut back on desulfurization, which entails high usage of hydrogen and natural gas.

As such, the volume of low sulfur fuel oil expected to move from the West to the East is likely to remain constrained in the near term, industry sources said.

Crude, Australian premiums

Very low sulfur fuel oil prices have also remained elevated in recent weeks, reflecting high crude prices. Dated Brent -- used to price more than half of the world's crude -- touched $100.795/b in intraday trade Feb. 16, the first time since Sept. 4, 2014, that prices have breached the symbolic triple-digit mark, Platts data showed.

This has prompted oil traders to scramble for whatever light sweet crudes they can get, while betting on whether the staggering backwardation in the crude forward curve will last.

A specification change for cargoes loading from March for Australian heavy sweet crude grade Vincent, which previously found homes almost entirely in the LSFO pool, was likely to make the product unusable in the LSFO pool, limiting supply further, sources said.

Australian heavy sweet grades including Vincent, Pyrenees and Van Gogh are widely seen as ideal for blending into low sulfur marine fuels due to the grades' rich fuel oil yield, very low sulfur content and unique specifications such as low pour point and high flash point.

Woodside highlighted in its latest annual report released Feb. 17 that it achieved record premiums for three crude oil grades including Vincent crude produced from the Ngujima-Yin FPSO, which targeted LSFO blenders rather than traditional refineries.

Meanwhile a bunker industry source said: "LSFO bunker demand was quite soft in Singapore [last month] but then again, we've had more demand come out of North Asia." He added that "people are not incentivized to sit on large inventories," all of which supports the VLSFO crack.

The focus is now on geopolitical risks, particularly the Russia-Ukraine situation, for further cues, he said.

Reflecting the current tight supply of marine fuel 0.5% globally, the front-month backwardation of the Singapore marine fuel 0.5% swaps widened to $20/mt Feb. 17, according to Platts data.

This was also cited as a factor in fewer arbitrage volumes from the West being due to arrive in Singapore in March, even as VLSFO floating storage units off the coast of Malaysia, in use since the onset of the IMO-2020 mandate, were returned, or were in the process of being returned, as storage becomes less viable.

China's quota boost

China's Ministry of Commerce in early January issued 6.5 million mt of fuel oil export quotas to CNPC, Sinopec, CNOOC, Sinochem and Zhejiang Petroleum & Chemical, Platts reported.

Despite the total quota allocation rising about 30% year on year, China is unlikely to increase supply in the seaborne market as the quotas only allow the companies to send tax-free domestically-produced barrels for bonded bunkering at Chinese ports.

The higher quota allocation has also been counterbalanced by the tight international market, with the increased volumes allotted to Chinese refiners for export mostly shrugged off by traders in Singapore.

"At the most, this increase, if it takes effect, would see a maximum of 150,000-200,000 mt/month more production from domestic refiners, and it's geared more toward meeting demand at Zhoushan, to make the prices there more competitive than Singapore," a trader said.

"I doubt we will see exports [from China] any time soon; if anything we'll see a reduction in the volumes imported [by China] from Singapore; I doubt much or any cargo will be exported," a second trader in Singapore said.