Analysis: Naphtha markets enter August weakening across Europe, Asia on global economic contraction

The European naphtha market is set to enter August amid expectations of constrained demand across the grades, with weaker demand in Asia further reducing motivation for product flow.

Macroeconomic data released July 30 pointing to significant contraction pushed global financial and physical markets into steep downward corrections, including the naphtha market, particularly through its price correlation with the crude oil complex.

The US economy shrunk 9.5% in the second quarter, the steepest quarter-on-quarter since the government first published the data 70 years ago, while Germany reported losing roughly 10 years of GDP growth.

"All commodities collapsed today and naphtha seemed too strong recently to begin with anyway," a European market source said.

In Asia, prices have tumbled over the past two weeks during trading for the H1 September delivery cycle, led by a resumption of Western arbitrage flows, the use of LPG as alternative feedstock and weaker demand for heavy full range naphtha grades as splitters found condensate a more economical feedstock.

The Asian market has seen more demand for lighter naphtha grades, but not enough to significantly support arbitrage flow from Europe. The August East-West spread -- the CFR Japan premium to the CIF NWE equivalent - was assessed at $14.25/mt at the European close July 30, a sluggish increase of 7.5% week on week.

"In Asia it's a matter of cracker demand, which has a maximum swing of about 20% to LPG as feedstock [and is] likely at 10% now, which is around 300,000 mt. However, there isn't a price incentive to use LPG at the moment," an Asian market source said.

The recent new wave of coronavirus infections has also seen the market take a dive as it has dampened gasoline demand, which market participants said would free up more naphtha cargoes from Europe and the US.

Reflecting the softer sentiment, the August-September Mean of Platts Japan naphtha swap timespread narrowed its backwardated structure $2/mt day on day to 25 cents/mt at the July 30 Asian close, a two-month low. The spread was last at this level June 4 at minus 25 cents/mt.

EUROPEAN DEMAND UNDER PRESSURE

The structure in the European market was also flattening, tracking at least partially a steepening contango in the crude oil complex. Naphtha CIF NWE August against the equivalent September contract closed at $1.50/mt in backwardation July 30, narrowing 70% from the week before.

However, the most significant pressure point for European naphtha was the loss of demand for gasoline blending, with the mogas-naphtha spread remaining uneconomically narrow. The gasoline Eurobob FOB ARA August contract premium against the naphtha CIF NWE equivalent closed at $9.50/mt July 30 and has averaged $21.74/mt in July to date. The differential averaged $127.37/mt in July 2019.

Under regular market conditions, the premium averaged $116.70/mt for the more expensive summer gasoline grades in 2019, ranging from $77/mt to $173.50/mt over March 31-September 30 in the year. The average differential for March 31 to date in 2020 is $29.37/mt and range from $4.75/mt to $52.50/mt.

This supports the argument that not much demand is expected in August for naphtha heavy grades to be treated in catalytic reformers before being added into the gasoline blending pool. This had also led to heavy grades that are higher in aromatics being discounted against the lighter, more paraffinic grades preferred by petrochemical producers as feedstock.

The feedstock market outlook in Europe was unlike that in Asia in key aspects. An economic incentive to utilize more LPG against naphtha was firmly present, with the naphtha CIF NWE August contract against propane CIF NWE equivalent closing at a $66.25/mt premium July 30, up 3.1% on week and within the typical petrochemicals producers' switching range of around $60/mt.

"Europe has a 1 million mt swing to use propane as feedstock, so the impact is more important and European petrochemical makers are taking propane," another Asian source said.

European petrochemical producers will continue maximizing LPG utilization rates in August when possible, but only the minority of crackers could take advantage of the accommodative propane-naphtha spread, while the rest would support naphtha feedstock grades.

In addition, since the price differential between the feedstocks has remained wide for several weeks, all market participants that could take advantage of the pricing difference have likely already switched. This could signify that any increase in petrochemical producers' demand in August would be largely covered by naphtha. However, length in the European ethylene market could cap any further naphtha support.