MNI Commodity Weekly: Russian Oil Product Flows Begin Longer Voyage Trend

Executive Summary:

• Russian Oil Product Flows Strong Post Feb 5 - but Voyages Far Longer: Shortly after the Feb 5 EU ban on Russian oil products, flows are diverting to a host of new markets as Asia steps in as a key initial buyer. Similarly to crude however, the increased distances the oil products have to travel is putting more flows onto the water and raises questions about Russia's ability to sustain it's current export pace, especially from its Baltic and Black Sea ports.
• EU Industrial Gas Demand Return Tentative on Price Risks: European gas benchmark prices have seen a steady decline since their peak last August, supporting a rebound in gas demand from European industries. But gas-intensive European industries are still cautious given the price uncertainty amid China’s economic reopening and the future of Russian gas flows.
• Oil Market: Economic slowdown concerns in focus with US Fed rate tightening weighing on crude prices. Crude drifting lower with downsides limited by Chinese demand optimism for the year.
• Gas Market: European gas finding support with a cool end to the winter and Asian buying interest maintaining LNG supply risks. US Natgas continues to trend lower due to comfortable supplies despite only a gradual return of Freeport LNG so far.

Russian Oil Product Flows Strong Post Feb 5 - but Voyages Far Longer

Russia has maintained solid oil product exports after EU sanctions and the G7 price cap were enforced February 5. Russian oil exports impacted by the December 5 ban serve as a proxy for the potential outcome of Russian oil product flows to an extent – notably the logistical issues involved with moving volumes further afield.

• As flows have moved away from Europe, Russian oil products are finding a new home in Asia and the Middle East according to Refinitiv, while Vortexa has tracked cargoes towards Brazil and West Africa.
• Similarly to crude, Russia is finding demand for its oil products by offering them with significant discounts. Russian diesel is understood to be selling at about $35/bbl less than non-Russian diesel according to Argus pricing.
• According to Vortexa, in the first half of February, shipments of diesel type fuels from Russia’s ports averaged more than 1 million bpd, down around 150,000 bpd from January, but still well above the 2022 daily average.
• It has tracked overall clean product flows above 1.7mn bpd over the same period, a decline of less than 200kbd from January.
• Even as Russian oil product exports remain resilient, there are signs that longer journeys will take their toll on Russia’s ability to keep the pace longer term.
• Like Russian crude exports post-sanctions, Russia is using ship-to-ship transfers offshore Kalamata Greece and Ceuta, North Africa to shuttle oil products from Baltic and Black Sea ports to larger tankers bound for Asia.
• According to Refinitiv, Russia's diesel exports in February from its Baltic and Black Sea ports involving STS near the port of Kalamata in Greece have almost doubled month on month to more than 300,000 tonnes.
• China is pulling in Russian fuel oil at a record pace in February, with an expected 5.62 million barrels this month according to Kpler – far higher than Decembers prior record of 3.89 million barrels. Chinese refiners are pulling the fuel oil in to upgrade into lighter ends like diesel and gasoline to fuel its economic rebound post lockdowns.
• Saudi and the UAE have also increased their imports of Russian fuel oil which can be used as direct burn for power generation.
• As for other emerging product trends, India has surfaced as a buyer of Russian naphtha – it rarely bought any prior to sanctions. It can be used as a gasoline blending component.
• Even though Russia clean product exports remain high, imports of Russian clean products are expected to fall in February because of journey times. Vortexa forecast Russian clean product imports could drop 600 kbd as a whole in Feb as a result (see bars in chart below).
• Russian diesel at sea holds currently at about 24 million barrels, up 150% from average historical levels and more than 4-fold from historical low points according to Kpler.
• Vessel tracking shows that the vast majority of Russian oil product at sea is moving and not floating, indicating that most of it has a buyer at present. Signs of that changing to floating in the months ahead may be a sign that Russia will be forced into production cuts with the fleet unable to hold up against the logistical constraints.

Russian Clean Product Exports (red line) vs Expected Arrivals (bars) - source: Vortexa

EU Industrial Gas Demand Return Tentative on Price Risks:

Prior to last year’s soaring gas prices, European industrial gas consumption had already seen demand destruction going back to September 2021 as European benchmark natural gas prices started rising to unprecedented levels. Russia’s invasion of Ukraine last year added further weight - pressuring Europe’s industry. Since its peak in August 2022, natural gas prices have come off significantly in the region amid healthy gas storage levels, high LNG imports and demand destruction. Looking ahead, price volatility because of the uncertainty of the Chinese gas demand recovery and Russian supplies keeps industry gas buying cautious of returning.

• As an example of the weight of recent higher gas prices, Europe’s fertiliser industry has been hit severely. Producer Yara cut urea and ammonia output to 45% of capacity in Europe last March. In August, the producer was running its ammonia production at 35% of capacity in the region.
• According to the IEA, all industries in the EU, which use gas either as a feedstock or as an energy source, covered nearly half of the region’s consumption cuts last year. Overall gas use in the EU plunged by 19.3% in August-January compared with the five-year average for the same period.
• So far, large reductions in industrial gas demand have not been accompanied by dramatic drops in industrial output, suggesting good substitute options. The IEA estimates that, of the industrial gas demand reduction in 2022, around half was achieved by fuel switching. As an example, German industrial gas offtake was 30% below that expected for 2022, but total manufacturing output was flat. Germany’s industrial gas consumption in January remained 22.3% below the 2018-21 average, not adjusted for temperatures, suggesting European industrial gas demand has yet to recover.
• Looking ahead, waning wholesale energy prices have improved the outlook for European manufacturers, while economists believe the sector will now likely avoid a deep contraction. Lower gas prices could spur some industrial demand, while unprecedented levels of European carbon allowances also suggest a rebound in energy use by industries. The EU’s carbon price (EU ETS) Dec 23 has climbed to over $100/t CO2e for the first time on 21 Feb.
• Yet despite easing costs for energy, manufacturers continue to struggle to plan ahead. The outlook for natural gas prices is still too volatile for Europe’s industry to fully resume use of the fuel — despite a significant drop since last summer. The TTF front-month contract last traded just under €50/MWh, the lowest level since Aug 2021.
• The IEA has warned that the continent faces a potential natural-gas shortfall of nearly 30bcm next winter, as China emerges from its pandemic cocoon to possibly suck up more energy supplies. Chinese demand looks set to ramp up at the same point Europe aims to refill its inventories ahead of next winter - aiming to do so heavily dependent on LNG that is in competition with Asia.

Oil Market:

Brent crude has seen a gradual decline over the last week weighed down by concerns for global oil demand growth to test the low point from last week at around 81.9$/bbl. Ongoing inflationary pressures and future central bank tightening are expected to restrict oil demand growth in the short term.

• So far this year, crude has held within a 10$/bbl range from approximately 78$/bbl to 88$/bbl with the economic slowdown offset by optimism for a recovery in demand from China. Indicators suggest an increase in Chinese travel, higher refinery run rates and increased crude imports from Russia, the Middle East, and the US. Record Russian fuel oil imports into China this month are also supportive of higher refining activity. Extra market uncertainty comes from the supply side with Russia due to cut production by 500kbpd in March.
• The concern for the US economy and the congress mandated 26mbbls SPR release expected this year is keeping WTI subdued with the spread to Brent widening out to -6.75$/bbl and the prompt WTI time spread still trading in contango.
• The options market volatility skew to the downside is gradually reducing with the Brent Dec23 25 delta call-put skew closing in from -8.3% back in November to around -5.3% near the end of Jan and up to -3.5% this week. Upside price risks in the second half of this year come from Chinese demand recovery and a possible end to central bank rate tightening - although some analysts including Goldman Sachs and Morgan Stanley have recently lowered forecasts for later this year from previous estimates.

Brent Dec23 Implied Options Volatility - 25 Delta Puts and Calls - source: Bloomberg

Gas Market:

The European gas market has been relatively stable over the last few days with the expectation of higher demand from a period of cooler weather at the end of February helping to provide support. TTF front month is however still down about 3€/MWh in the last week.

• High storage levels and steady LNG supplies have driven prices lower but competition from Asia for LNG supplies is an upside risk as Europe looks to restock storage over the summer months. Falling Northeast Asia prices are encouraging increased buying interest from price sensitive South Asian buyers. Current spreads favour US LNG flows to Europe over Asia this summer.
• US Natgas continues to trend lower with front month Henry Hub trading below 2$/bbl this week - its lowest since September 2020. Prices are weighed down by weak demand this winter, high production levels, recovering storage and the slow return of Freeport LNG exports.
• Freeport has been making steady progress towards a restart in recent weeks and has now been granted regulatory approval to restart one liquefaction train. The remaining two liquefaction trains are expected to return to operation in the coming weeks. Several ships are waiting outside the US Freeport LNG plant after four partial cargoes departed since 12 February - thought to be carrying storage tank volumes from before the fire in June. Pipeline feedgas into Freeport has reached around 0.45bcf/day this week compared to full production rates of around 2.1bcf/d when all three trains are fulling operational.

Oil Market Calendar