NWE physical hi-lo fuel oil spread dives to all-time low

The hi-lo fuel oil spread -- or premium for 1%S FOB NWE cargoes over the 3.5%S FOB Rotterdam barges -- has dropped to an all-time low of minus $19.25/mt, as strengthening HSFO markets continue to subvert traditional quality spreads.

The spread first dropped to $19.25/mt on Aug. 2, and dropped to the same level Aug. 8 as global sour crude tightness has continued to spur an HSFO rally.

The spread, which would typically reflect a premium for the higher-quality 1%S fuel grade, first inverted in June 2023, and has since fallen to hitherto unprecedented levels.

Previously, the differential had not turned negative since September 2019, when it dropped below zero for one day. Prior to 2023, the lowest level on record was minus $7/mt in September 2015.

"Really we shouldn't see these levels go below zero," said one 1%S supplier, noting the unprecedented relative strength in the HSFO market.

On average, 1%S cargoes were assessed $91.44/mt higher than HSFO barges in 2022, and $61.27/mt higher in 2021.

HSFO tightness prevails

HSFO storage levels in the Amsterdam-Rotterdam-Antwerp region are reported to be at half of 2022 levels as the shift away from Russian Urals sour crude has dented high sulfur residual fuels output from European refineries, which are increasingly running sweeter crude substitutes.

Meanwhile, production cuts by Saudi Arabia and Russia into September are expected to disproportionately impact heavier crude grades, while seasonal demand drivers such as Saudi power generation demand have kept markets tight.

Consequently, HSFO cracks have steadily increased throughout the year, trending closer to parity with Brent crude prices and steadily eroding margins for lower sulfur (0.5%S and 1%S) fuel grades.

Muted 1%S activity

In contrast, while 1%S markets have strengthened in recent months, demand has remained stable on the year.

Sources in both Northwest Europe and the Mediterranean noted steady demand volumes from the utilities markets on the month despite the price moves.

Utilities demand has contracted on the year, however, weighing on LSFO markets as cheaper natural gas prices caused many countries to switch back to gas-powered operations in H2 2022.

In addition, traders did not expect large discounts for the 1%S market to persist, as previously product has been blended into the HSFO pool in larger volumes in 2023 as prices for the two grades have converged.

Despite HSFO demand stickiness on the year given the mass-scrubber investment post-IMO 2020, analysts have also expected narrowing sulfur spreads to incentivize switching to lower sulfur fuel grades in the months to come.

Francisco Blanch, a Commodity & Derivatives Strategist at BofA Europe, said in an industry report that narrowing spreads make "VLSFO increasingly attractive for bunkering vs HSFO and for upgrading, while challenging the economics of HSFO desulfurization."

Paper market lag

The trend of severely narrowing European hi-lo spreads in the physical spot market has not been fully reflected in the paper curve, where the differential remains in positive territory

Platts, part of S&P Global Commodity Insights, last assessed the paper Northwest European hi-lo front-month differential at $19.50/mt Aug. 7 as it strengthened for two consecutive sessions.

Overall, the paper hi-lo had been seeing significant pressure over summer, however. The front-month hi-lo differential reached under $20/mt on June 13 and has mostly remained under that level since with one exception on Aug. 1.

The last time that the paper hi-lo front-month was trading at under $20/mt was in the summer of 2020.