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LSFO struggles with supply overhang despite strong Urals market, bullish LSSR

London — The strength in demand for Russia's medium sour Urals crude has had a contrasting effect on the availability of low sulfur bottom-of-the-barrel products, dampening demand of low sulfur fuel oil but boosting that of low sulfur straight run.

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Typically running heavier sourer crudes would produce more high sulfur fuel oil, giving refineries more of an incentive to import lower sulfur oil products.

However, LSFO has come under pressure recently as refiners started processing a sweeter crude slate as a relatively wide Brent/WTI spread encouraged an influx of US sweet crude to Europe. The Brent-WTI was last assessed at $6.85/b Wednesday, compared with $4.58/b this time last year. LSFO is a byproduct of sweet crude when processed in the crude distillation unit.

Overall supply of US sweet crude imports has grown this year so far, with more refineries running grades such as WTI Midland as a base load crude, with expectations this will continue to encourage increased flows of US sweet crude into Europe going forward.

In recent months the 1% LSFO market has failed to maintain a strong premium over 3.5% fuel oil, due to the pressure of refiners running hefty volumes of low sulfur crude, increasing the production of 1% fuel oil, and supply has simply outweighed demand in the first quarter of 2019, a trend expected to continue into the second quarter.

The market has turned to 1% as a blendstock for the European 0.5% fuel oil market as refiners have begun to offer their 0.5% marine fuels to shipowners ahead of the International Maritime Organization's reduction of the sulfur cap for marine fuel from the current 3.5% sulfur to 0.5% due to come into force in 2020.

Sulfur value spreads in crude oil directly affect the fuel oil hi-lo spread, which measures the premium of HSFO over LSFO, an indicator used by refineries to set their run rates.

Demand in the LSFO market in Northwest Europe has remained fairly sluggish due to ample product availability in the region despite the surge in demand from refineries for heavier sourer crude slates, which would typically reduce the output of LSFO, and in turn strengthen its premium over HSFO.

Tight availability in the sour crude market since the start of the year stemmed from a confluence of factors, including OPEC production cuts and the reduction of Iranian and Venezuelan crude exports as a result of US sanctions.

Ample availability of LSFO depressed the physical hi-lo spread -- the premium of 1% FOB NWE cargoes over 3.5% FOB Rotterdam barges -- which was last assessed at $2.75/mt Wednesday, down from values seen in mid-March of $9.50/mt.

The refinery feedstock LSSR, on the other hand, has seen a typical drop-off in production due to the popularity of more sulfur-heavy crudes.

Refineries that run heavier sour crudes produce more high sulfur vacuum gasoil and high sulfur straight run residue, providing less incentive to purchase feedstocks to process in their secondary units.

Meanwhile, low sulfur feedstock premiums typically increase as refineries import more Urals, on the back of reduced availability of low sulfur oil products.

This comes at a time where demand for LSSR has been amplified on the back of global storage demand in the run-up to the IMO's sulfur cap, as blenders seek the product as a component to making compliant 0.5% bunker fuel, market sources said.

The cut in sulfur in bunker fuel from 3.5% is likely to boost the value of a whole range of blend components, including VGO and LSSR.

"The LSSR market is strong," a feedstock trader said. "People are storing ahead of IMO 2020." The trader noted that among other locations, companies were seeking storage in Scandinavia, Malta and Singapore.

FOB NWE LSSR cargoes were assessed at an 80 cents/b discount against June ICE Brent Futures Wednesday, compared with a $1.15/b discount March 1.

URALS AT FRESH HIGHS

Russia's medium Urals crude, basis CIF Rotterdam, hit a five-and-a-half-year high this week, supported by increased arbitrage flows out of the region in April amid a globally tight sour crude market. Urals has strengthened despite the April programs out of the Baltic ports of Primorsk and Ust-Luga being the largest in over a year and with the structure in the Dated Brent, which Urals prices off, still in backwardation.

Urals NWE was assessed at a 44 cents/b premium to the Mediterranean Dated strip on Tuesday and Wednesday, the highest value since August 19, 2013, S&P Global Platts data showed.

In the past six months, a tighter global sour market has kept Urals differentials pricing above Dated Brent at various points, which is unusual for the sour grade, as demand has been strong, with few sour alternatives to Urals available in Europe. Refinery margins have also been stronger for more fuel oil and distillate-rich grades, compared with light sweet grades.

All this has translated into stronger values for Urals. Additionally for April, more Urals NWE cargoes have left the region, with one or two VLCCs planned for China, and around eight or nine cargoes heading to Mediterranean refineries, sources said, tightening the availability of volume in NWE.

--Tamara Sleiman, tamara.sleiman@spglobal.com

--Gillian Carr, gillian.carr@spglobal.com

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

--Edited by Jonathan Loades-Carter, jonathan.carter@spglobal.com