Analysis: Higher naphtha demand in Europe shuts arbitrage window to Asia despite lower freight

Singapore — Strength in the European naphtha complex has crunched the East-West spread even as freight costs tumble to a near 10-month low, exacerbating the tight supply situation in Asia.

The July East/West spread - the premium of the CFR Japan naphtha cargo swap over the CIF NWE equivalent - was assessed at $12.50/mt at the Asian close June 26, 32.4% narrower than it was just two weeks ago on June 15, when it was $18.50/mt, S&P Global Platts data showed.

Although both European and Asian naphtha prices gained in value during the period, Europe showed more strength at the prompt as restricted supply and increasing demand tightened market fundamentals.

"The arbitrage is closed because Europe is so strong at this point; the structure is stronger than in Asia, so it closed the arbitrage window," a Singapore-based naphtha trader said.

The front month June/July Mean of Platts Japan naphtha swap timespread was assessed at $7.75/mt at the June 26 Asian close, and the backwardation structure had widened by $5.25/mt since June 15, Platts data showed.

The backwardation in the European segment was steeper as the June/July CIF NWE naphtha swap timespread was assessed at $10.50/mt on June 26, with the structure wider by $7.75 since June 15, showed Platts data.

Recent chartering activity to arbitrage naphtha into Asia was thin, with only three Long Range II tankers slated to load 240,000 mt of cargo for voyages in the first decade of July so far, sources said. In comparison, the first decade of June had at least 525,000 mt of naphtha loaded for the East-bound arbitrage, S&P Global Platts cFlow data showed.

The key Long Range II Mediterranean to Japan voyage was assessed at $1.9 million June 26, down $400,000 since June 15, Platts data showed. Freight was last lower September 4, 2019 at $1.8 million, Platts data showed.

ASIAN SUPPLY TIGHT

The Asian naphtha market has faced tight supply for the July and August delivery cycles as refinery run cuts and rising gasoline demand curbed cargo availability not just from arbitrage, but also from key exporters and domestic producers in the East of Suez, sources said.

Since trading activity began for the H1 August delivery cycle in Asia, cash differentials for spot paraffinic naphtha parcels have more than doubled to plus $18/mt June 26 from just $8.50/mt June 16 against the benchmark Mean of Platts Japan naphtha physical, on a CFR Japan basis, Platts data showed.

Market participants said the supply squeeze was expected to last into the H2 August delivery cycle, as it would take time for refineries to recover production levels.

Moreover, demand in the region was robust as healthy petrochemical margins for olefins keep naphtha-fed steam crackers running at maximum or close to maximum levels, sources said.

Reflecting firmer sentiment, the CFR Japan naphtha physical crack spread against front-month ICE Brent crude futures hit a four-month high of $75.175/mt at the June 24 Asian close, before edging back to $67.65/mt at the Asian close June 29 on the back of a mid-week downturn in the gasoline complex, Platts data showed.

EUROPEAN MARKETS UP

Although some European refineries could be restarting in July, several others have further reduced or halted operations due to high costs surpassing profits, an imbalance imposed by demand destruction across the refined products spectrum from the coronavirus pandemic, sources said.

Gunvor Group has halted operations at its Antwerp refinery in Belgium, Spain's Repsol refineries have suspended production until mid-July, while the Milazzo refinery in Italy has postponed its end-June FCC unit restart. Several other European refineries remain operating at decreased rates. Reduced production levels are necessary to reduce oversupply of refined products like jet fuel, however naphtha saw tightening fundamentals on stronger demand, sources said.

A fall in propane prices is expected to lead to a loss in naphtha demand, as the CIF NWE July propane contract closed at a $68.25/mt discount to the naphtha CIF NWE July contract June 26, decreasing 111% since June 15 and below the $60/mt typical threshold for switching to propane. Yet, the demand switch was heard marginal so far, and gasoline demand for naphtha blendstock grades was also increasing, sources said.

"The market is getting definitely tighter,” a European source said.

This could set European naphtha apart from other refined products and motivate refiners to maximize light distillates yields. While crude oil prices also rallied on a backwardated structure, gasoil 0.1%S CIF NWE fell 4%, jet CIF NWE plunged 82%, the ULSD 10 ppm CIF NWE crack spread against ICE Brent crude oil July futures weakened 4%, while naphtha CIF NWE has seen its crack spread against the same metric strengthen 35% since June 15, Platts data showed.