Weaker gasoline, healthy VLSFO output may limit NWE Hi-5 growth this winter

The 0.5%/3.5% sulfur fuel oil spread at Rotterdam fell to unprecedented lows in September, signaling less incentive to buy high sulfur fuel oil, and expectations for its near-term recovery may be overstated, according to analysts.

Platts assessed the physical Rotterdam barges Hi-5, as the spread is known, at $20/mt Sept. 9, a multiyear low and down from $228.75/mt a year previously, according to S&P Global Commodity Insights data.

A large part of that was due to tight supply of HSFO (3.5%S), as production cuts from Saudi Arabia and Russia earlier in the year primarily affected sour crude, thereby limiting the resulting cut available to refiners wishing to manufacture HSFO for bunker sales to scrubber-equipped ships.

Summertime pressures on supply of HSFO are easing, and the Hi-5 has grown as a result. Platts assessed the physical Hi-5 FOB Rotterdam barge spread at $72.25/mt on Sept. 29. Paper market structure indicates the spread recovering even further into 2024, as Platts assessed the paper Hi-5 Fob Rotterdam barge spread at $78/mt in October and $84/mt in January 2024, according to Sept. 29 swaps assessments.

Questions about growth potential

However, some analysts have questioned the growth potential.

"The forward curve is too optimistic," Arne Anders Lohmann Rasmussen, chief analyst at hedging company Global Risk Management, said. "I see HSFO staying expensive and VLSFO under pressure."

Calculations from analysts at S&P Global found the Rotterdam Hi-5 growing from $64.10/mt in September to $71.60/mt in October and then decreasing as winter wears on, falling to $64.40/mt in February.

Russian exports of HSFO to Rotterdam, previously a mainstay of bunker markets at the European bunker hub and in the surrounding region, have been off-limits since G7 and EU embargoes came into effect around the start of 2022.

These geopolitics-induced factors were exacerbated by seasonal increases over the summer in HSFO demand from air-conditioning units in the Middle East and as road construction and repairs in the Northern Hemisphere diverted output toward bitumen production instead of fuel oil.

While seasonal limitations to HSFO will dissipate as summer passes and present scope for the Hi-5 to widen, there are factors on the other side of the equation that limit its upside potential.

Increasing VLSFO supply

Improving availability and blendstock for very low sulfur (0.5%S) fuel oil may blunt growth prospects for the Hi-5, according to analysts.

As such, that curbs the cost advantage that ships equipped with scrubbers -- more formally known as exhaust gas cleaning systems -- derive from buying HSFO instead of pricier VLSFO, which complies with international rule for sulfur content in marine fuel.

While economics vary between ship types, market watchers calculate that a Hi-5 of less than $100/mt puts the payback time to recoup scrubber installation costs at over two years and makes investing in them a more questionable prospect.

Gasoline stock builds in the US and Singapore contribute to a better-supplied global picture and should ease prices, Rebeka Foley, senior analyst, oil markets, pricing & trade Flow at S&P Global, said.

The support that gasoline cracks received from strong summer mobility looks to fade in Q4, 2023 and projections for 2024 "remain negative in the large Western European economies," S&P Global analysts said in their October outlook for refined products in Europe.

While they said that tightness in gasoline stocks from earlier in 2023 could persist, cracks are coming down.

S&P Global forecasts NWE gasoline versus delivered Forties crude falling from above $20/b in September to around $10/b in the new year.

When gasoline demand is low as is the case today and likely for the coming months -- because of low demand after the driving season and abundant inventories -- its blending components remain available for the production of VLSFO and this applies bearish pressure to the fuel oil grade, GRM said in a research note Oct. 2.

Scrubber-fitted vessels rose from about 5,000 ships in 2021, accounting for around 2 million b/d of HSFO, and these numbers look broadly stable until 2029, according to S&P Global's Freight Markets Bunker Forecast Sept. 7.

That is, unless carbon capture technology takes off, in which case there will be a continued rise to just under 7,000 vessels, accounting for around 3.4 million b/d of HSFO.