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Analysis: US HSVGO-LSVGO inversion ends on switch to summer gasoline

Houston — High sulfur VGO in the US has finally shifted back to pricing at a discount to its low sulfur counterpart, with the transition to summer-grade gasoline supporting FCC margins and stoking demand for low sulfur feedstocks.

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US Gulf Coast LSVGO was assessed flat to or below HSVGO from January 10 through March 7, which is highly unusual and the longest period that has ever occurred in S&P Global Platts data going back to 2008, when the assessment for HSVGO started.

Low sulfur products tend to trade at a premium to high sulfur products because they require less processing to make finished products such as gasoline or diesel fuel. However, LSVGO fed into an FCC unit also tends to produce more gasoline relative to HSVGO, which yields more middle distillates, which means that stronger diesel margins tend to encourage HSVGO usage whereas higher gasoline margins will favor LSVGO processing.

This has important implications for VGO prices because USGC gasoline cracking margins have been well below historic norms this year, briefly going into negative territory in January and early February while diesel margins have spent 2019 above historic norms.

This suggests that the unusual inversion in VGO spreads can be traced back to US refiners looking maximize production of diesel fuel, creating strong demand for HSVGO year to date.

"Gasoline crack spreads typically decline to their lowest levels of the year in the winter months, but this winter has seen some of the lowest crack spreads on record," the US Energy Information Administration said in a report issued this month.

On March 5, the EIA said the prior five-day moving average for the USGC Mars crude oil cracking spread was a shade under $5/b, compared with just under $20/b for diesel fuel.

S&P Global Platts data tells a similar story. The data show that in the first five days of March, a barrel of ultra-low sulfur diesel was assessed at an average $25.85/b premium to WTI crude oil, compared with an average $13.01/b for gasoline.

Weaker gasoline margins have come amid high stocks in the US and globally but the transition to summer grades, which are more expensive to produce than winter-spec material and consequently sell at premium, have given margins a boost.

Along the USGC, benchmark conventional grade gasoline and benchmark CBOB both switched to summer grade 9 RVP on March 6, while in the Midwest benchmark suboctane gasoline in Tulsa moved from 13.5 RVP to 8.5 RVP on March 1, coinciding with the improvement in gasoline cracking margins.

A USGC VGO source said this likely explains why LSVGO has climbed in value relative to HSVGO in March. "This past winter, gasoline was trading at a discount to heating oil," he said. Now that gasoline specs are moving to summer, "it's trading at decent premium to heating oil," he said, adding that because summer grades of gasoline can be sold for more than winter grades, "refineries usually try to max out gasoline production in summer, which should make LSVGO more valuable against HSVGO." A second US VGO source said he agreed with this take on the market.

EUROPE EYES THE ARB

Looking across the Atlantic, in Europe market sources said that better gasoline margins in the US are now the main factor supporting increased US demand for LSVGO, as refineries in the USGC look to optimize gasoline production, particularly out of their FCCs.

"Mogas cracks are exploding in the US and FCCs will run more, we'll see a call on the arb," a European feedstock trader said. "I am seeing more demand." Other European feedstock traders agreed the gasoline summer spec switch had caused demand for the feedstock to emerge.

"I think the US will need more VGO to get into balance with higher runs for gasoline," a European gasoline source said. "It is going to be interesting when they [US refineries] are out of turnaround how much more they will need from Europe."

Refining margins have also widened in Europe, which should lead to an increase in refinery utilization, according to market participants, contributing to further VGO demand.

The tanker Sakura Princess is in Northwest Europe is expected to load 80,000 mt of VGO Thursday for delivery to the US Gulf Coast region, set to discharge on April 4, data from S&P Global Platts trade flow software cFlow showed.

SUMMER MARGINS

Platts data also shows that the switchover to summer grade RVP has coincided with a sudden improvement in USGC cracking yields.

A cracking yield differs from a cracking margin in that it measures the value of a basket of refined products produced from a given barrel of crude.

Unlike a cracking margin, the crack yield does not take the cost of crude into account.

Platts data show the USGC cracking yield for Mars crude was reported at $66.70/b on February 12, when most US gasoline assessments were still at a winter grade. Since then, that same crack yield has rallied, hitting $71.80/b on March 12.

Philip Verleger, an energy economist, recently published a report putting the US gasoline cracking margin versus Brent crude oil at an average $6.93/b in the second week of March, up from negative $2.47/b for the same average in the second week of February.

Clearly, improved gasoline margins have had a net positive impact on cracking yields.

--Seth Clare, seth.clare@spglobal.com

--Solomon Lanitis, solomon.lanitis@spglobal.com

--Sarah-Jane Flaws, sarahjane.flaws@spglobal.com

--Edited by Alisdair Bowles, alisdair.bowles@spglobal.com