Narrow gasoline-naphtha spread sets bearish tone for blending components into August

The European gasoline demand outlook into August remains weaker than required to push prices to a workable premium over naphtha, leaving naphtha and its octane boosting complements outside of the blending pool.

Poor blending margins and concerns over rising coronavirus cases have eroded the demand recovery outlook for gasoline in the European market. Sources had previously expected a more robust demand-side recovery in August.

The weakening market outlook has been reflected in a much steeper contango between gasoline Eurobob FOB ARA August swap against the September equivalent, signalling weaker prompt demand, while deterring producers from storing excess gasoline stocks. Although Northwest Europe provided a possible outlet for the right grades or premium unleaded gasoline, unfavorable blending economics have also softened demand from Nigeria, traditionally a key outlet for Northwest European gasoline producers.

The Eurobob FOB ARA crack spread against ICE Brent crude oil front-month futures also declined 65.1% week on week, despite the hit that crude oil prices took the week before from a weaker macroeconomic outlook.

Naphtha seen correcting lower

The outlook for the naphtha complex entering August was also bearish, with the crack spread against the ICE Brent crude front-month futures contract falling 218% week on week, showing a significantly deteriorated weaker margin to distill naphtha. A flip to contango on July 31 also showed weakening prompt demand. Heavy naphtha grades, mainly used as gasoline blending components, were seen at a discount to lighter grades, sought by petrochemicals producers, driving prices higher across the naphtha complex. However, as naphtha prices saw strength earlier in the month, petrochemicals producers maximized propane utilization rates, taking a significant market share from naphtha. Naphtha prices took their time to react but eventually began to recede.

"There are [naphtha] cargoes on offer in [the Amsterdam-Rotterdam-Antwerp hub], but there is not much buying [and] there is not much demand in the Mediterranean either," a source said.

Blenders were showing no interest for naphtha into August, due to an uneconomical gasoline to naphtha premium; however, petrochemicals producers were expected to show steady support, albeit it still low.

"August doesn't look great, it feels wobbly," another source said.

The gasoline Eurobob FOB ARA front-month swap premium over the naphtha CIF NWE equivalent was assessed at $15.5/mt on August 3, with the average differential, however, declining 31.4% week on week despite a weakening naphtha complex, showing greater weakness in relative terms in the gasoline market. The differential in fact was closer to the one seen historically between winter (cheaper) gasoline grades against naphtha than during the summer, averaging $21.33/mt in July compared with $127.37 in July 2019.

Naphtha grades, both light and heavier, are lower than required to fit the gasoline specifications in octane numbers, therefore incurring octane enhancement costs during blending. Heavy grades incur catalytic reforming costs, while light grades are commonly mixed with octane boosters. As naphtha prices increase against gasoline, fewer volumes will be taken into the pool, while octane boosters as complements will also see less demand. The price relationship between naphtha and octane-boosting costs is therefore inversely associated.

Bearish economics for blending components

As gasoline weakened against naphtha, it became less profitable for gasoline blenders to use naphtha as a blending component, signifying also less need for octane boosters such as MTBE and aromatics.

Gasoline blendstock MTBE's premium over the Eurobob gasoline front-month swap kicked off the month at $56.50 on August 3, significantly below the $188.75/mt seen on August 1, 2019.

MTBE, a high octane and low RVP component, is typically preferred for summer gasoline blending, but the weak gasoline market kept the premium under pressure.

"The mood in the market is not as expected for July; it feels like January or December," a producer said.

On the sell side, MTBE traders were offering from their stocks due to the bearish blending economics, but term demand was still quite strong, another producer said.

European toluene, an aromatic with high octane numbers, also fell victim to expensive naphtha and poor blending margins, with the premium over the gasoline Eurobob FOB ARA front-month contract hitting an all-time low at $14.55/mt on July 31. There was some buying interest for mixed xylenes at the end of July, only to fizzle out at the beginning of this week.

"There is hardly any demand for octanes," a trader said.

Indicatively, the gasoline Eurobob FOB ARA front-month swap against the naphtha equivalent priced at a 105% premium on average in July, compared with a 124% premium of the equivalent month in 2019. Comparatively, the MTBE July average against gasoline the Eurobob FOB ARA front-month stood at 115% (or a factor of 1.147) against 126% (or a factor of 1.257) in 2019, toluene at 109% against 118%, and mixed xylenes at 110% against 116%, respectively.