Oil Products: Industries Fundamentals Suggest Easing Prices


BMI View: Prices of most oil products held steady in the first quarter of 2013, thanks to a rally in crude prices in January and February. However, the rest of the year could see prices fall back as early gains in crude prices start to roll back amidst revived concerns about global economic growth as problems in the eurozone return to the limelight and optimism about US economic growth winds down. Downward pressure on fuel prices will likely persist as competition in the global refining sector heats up, and as the emergence of alternative fuels challenges the stronghold of oil-based fuels in the transport sector. Notwithstanding the downtrend in fuel prices, crude prices in the US$90 - US$100 per barrel range will continue to support oil products prices at historically high levels.

Methodology

Our refined products forecasts methodology is based on estimating the future spreads between each product - gasoline, gasoil/diesel, naphtha, jet fuel/kerosene, bunker fuel 180 and 380 - and its regional benchmark: WTI for products sold at New York, Brent for Rotterdam and Dubai for Singapore. In other words, changes in crude prices (and our crude price forecasts) will automatically trigger movements in our forecasts for oil product prices.

Our estimates of the spread between crude prices and individual oil products are determined by the following:

  • Supply: This will be affected by changes in regional and global refining capacity.

  • Demand: This is partly a function of our expectations of the trajectory of the global economy. With regard to customers, we have identified the four main markets using the products they each utilise most often: kerosene/jet fuel in the aviation sector, gasoline and diesel for retail users and land freight operators, naphtha in the petrochemicals industry (a gauge for industrial activity) and bunker fuel for the shipping sector. In our outlook for demand we therefore incorporate forecasts and the views of BMI's Shipping, Freight Transport, Autos and Petrochemicals industry analysis, as well as the assumptions and forecasts from BMI's Country Risk analysts, in an effort to incorporate a wide-range of industry data.

Crude Price Forecasts

In early March w e revised our forecast for Brent and WTI for 2013. We now expect Brent to average US$110 per barrel ( bbl ) and WTI US$93.50/bbl. Our forecast for Dubai, which takes into account the estimated spread between Dubai and Brent as part of its methodology, is US$107/bbl (see BMI 's Oil Price Outlook - Forecasts Revised On Early Rally, But Fundamentals To Take Prices Lower , 1 March 2013) .

BMI's Oil Price Forecasts, Average Price (US$/bbl)
2011 2012 2013f 2014f 2015f 2016f 2017f
f = forecast. Source: BMI, Bloomberg
Crude Benchmarks
Brent 111.05 111.68 110.00 105.00 102.50 101.00 99.00
WTI 95.05 94.15 93.50 91.00 91.00 92.00 93.00
Dubai 106.15 108.88 107.00 103.00 100.00 98.00 95.50

Early Rally Turns Into Run-Off

2013 opened with a strong rally in prices of all oil products we consider in our forecasts. This is both a function of gains in crude prices (by February 19, Brent and WTI had risen 5.3% and 3.8% since the start of the year) a nd bullish economic growth sentiments that translated into higher expectations for oil product demand. However, renewed economic fears in the eurozone, as well as sombre economic data from the US and China , have seen this rally unwind for both crude oil and oil products.

Crude Rally Loses Steam…
Front Month Price Of Brent & WTI, August 2012-Present (US$/bbl)
… And Oil Products Follow Suit
Prices Of Selected Oil Products In Rotterdam, New York & Singapore

We expect oil product s prices to even out over the year as economic concerns are likely to linger. Barring any supply shocks to the market caused by the eruption of tensions in the Middle East and in the Korean peninsula , or major refinery outages, fuel demand should remai n relatively subdued in 2013 . We highlight emerging markets such as China, India, Brazil and Indonesia as significant growth markets, but the effect of this growth will likely be tempered by weak consumption in the developed countries - a product of a slower global economy and increased fuel efficiency. Hence, our short-term forecast for 2013 - which we have revised this quarter - shows a year-on-year (y-o-y) decrease in prices across all products.

In the longer term, we expect prices to stay at levels above those in 2010 through to the end of our forecast period in 2017 as a result of high crude prices . Nonetheless, a cross all products, the uptrend in prices since 2009 appears to have reversed into a downtrend from 2012. This change is particularly pronounced in the bunker fuels market, for both 180 and 380 fuel grades.

In addition to a slight fall in crude prices that underpins our fuel price forecast, we also expect crack spreads to narrow due to the following long-term developments: an increase in global refining capacity, whose impact would be especially strong in the Asian market; increased fuel efficiency; and the beginning of a switch to alternative fuels.

Although this fall in prices will occur globally, regional discrepancies do exist. As such, broad generalisations should be taken with caution.

BMI's Refined Products Forecasts, US$/bbl
2011 2012 2013f 2014f 2015f 2016f 2017f
f = forecast. Source: BMI, Bloomberg
Jet Fuel
Rotterdam 127.91 130.12 127.87 122.33 119.31 117.31 114.82
New York 128.24 130.74 128.69 121.19 119.19 118.19 115.19
Singapore 125.67 127.01 126.04 120.71 116.47 114.14 111.16
Global Average 127.27 129.29 127.54 121.41 118.33 116.55 113.72
Gasoil/Diesel
Rotterdam 125.80 128.64 126.09 120.29 117.02 114.80 112.11
New York 124.72 128.24 127.74 120.24 118.24 115.24 112.24
Singapore 126.26 128.08 126.55 122.00 118.00 115.00 112.50
Global Average 125.59 128.32 126.79 120.84 117.75 115.01 112.28
Gasoline
Rotterdam 114.47 120.77 118.44 112.88 109.86 107.87 105.42
New York 119.30 124.79 122.78 115.28 113.28 112.28 111.28
Singapore 119.91 123.41 121.53 116.08 111.77 108.59 105.57
Global Average 117.89 122.99 120.92 114.75 111.64 109.58 107.42
Naphtha
Rotterdam 106.07 106.75 105.15 101.61 101.50 100.10 98.19
Singapore 102.46 102.96 101.68 100.34 97.00 95.30 93.07
Global Average 104.26 104.86 103.42 100.97 99.25 97.70 95.63
Bunker Fuel 180
Rotterdam 97.27 101.52 94.73 91.26 90.13 89.87 88.98
New York 101.09 104.65 100.31 92.81 90.81 89.81 88.81
Singapore 100.14 101.96 97.32 92.84 90.86 89.77 88.09
Global Average 99.50 102.71 97.46 92.30 90.60 89.82 88.63
Bunker Fuel 380
Rotterdam 94.03 97.47 92.13 88.56 85.83 83.87 81.48
New York 97.13 100.29 97.00 89.50 87.50 86.50 85.50
Singapore 98.94 101.08 96.22 91.74 89.96 88.87 87.19
Global Average 96.70 99.61 95.12 89.93 87.76 86.41 84.72
Bunker Fuel Average
Rotterdam 95.65 99.50 93.43 89.91 87.98 86.87 85.23
New York 99.11 102.47 98.65 91.15 89.15 88.15 87.15
Singapore 99.54 101.52 96.77 92.29 90.41 89.32 87.64
Global Average 98.10 101.16 96.29 91.12 89.18 88.11 86.68

Consumers will be grateful for falling diesel and gasoline prices over the coming years. Falling prices may delay the rise of alternative fuels, however, including some early movement towards liquefied natural gas (LNG) and biofuels in transportation, which we have seen in the shipping and air freight industries. This could in turn taper the downward trend in fuel prices.

Supply: Refining Capacity Expansion Sets Tone

Expansion Meeting Growth Needs
Global Refining Capacity And Oil Consumption, 2010-2017 ('000b/d)

The geography of expansion is highly uneven. Emerging markets in Asia, the Middle East and Africa are building up their capacity. However, developed economies such as Japan and Europe will see more refinery closures, which will in turn negate some of the loosening of the global fuels market that the former should have brought about.

Emerging Markets

Africa will see the fastest rate of regional refining capacity growth at 30%. However, the most significant growth in absolute volume will come from the Middle East - where Saudi Aramco has at least three large 300,000 barrels per day (b/d) refineries set to come online - and in Asia - where expansions continue apace in China and India, while Indonesia considers at least four large newbuild refinery projects. Meanwhile, Russia's refinery modernisation programme will see its plants continue to serve the market to make up for expected closures in Central Europe. Turkey - the fastest- growing market for oil in Europe - will also see significant refinery expansion.

Supporting Domestic Needs With Internal Expansion
Refining Capacity Of Emerging Markets, 2010-2017 ('000b/d)

This means that most of these markets are prepared to meet an expected increase in local fuel demand and will have spare capacity for export. This is particularly so for the Middle East and Russia. Even China, which is set to overtake the US as the world's largest oil consumer, is on its way to becoming a net fuel exporter owing to a continued increase in its domestic refining capacity. This will loosen some pressure on global supplies and in turn prices, particularly in the Singapore market.

Developed Markets

Among developed markets, the outlook is brightest for US refiners which are amply supplied by cheaper crude feedstock available in the North American markets, thanks to a production boom in the US and Canada. However, due to fragmentation of the US refined fuels market, where supplies are concentrated in the refining heartlands of the Midwest and Gulf Coast, prices in import-dependent New York (East Coast) are expected to remain elevated and follow international trends. This will create an uneven market with prices that can vary vastly from region to region, to reflect differences in the crude baskets refiners have access to.

Lower runs and refinery closures in developed markets outside of the US will be the main factor propping up prices despite capacity expansion in emerging markets. At a time of high crude feedstock prices, crude import-dependent refiners in developed Europe and Japan will see their refining margins pressed. Weaker domestic demand (the cause of which will be further elaborated) also makes them dependent on external markets for support. However, their export competitiveness will be challenged by the smaller scale of their plants relative to newbuild and sophisticated facilities in emerging markets, and cheaper fuel exports coming out from the US Gulf Coast.

Struggling Against The New Challengers
Refining Capacity In Western Europe & Japan, 2010-2017 ('000b/d)

This is already taking shape. For instance, Platts reports that Japanese refiners will most likely lower their runs in view of weak refining margins. At least three Japanese refineries - Sakaide, Tokuyama and Muroran - will end processing operations in 2014 on the back of a weak domestic market and legislation forcing the rationalisation and modernisation of refining operations. A Bloomberg survey underscores similar woes facing European refiners, showing that executives interviewed expect at least 10 plants in the region to permanently shut down by 2020.

Losses in capacity in these traditional refining markets will limit the scale of global refining expansion, such that the global fuel markets will not be oversupplied and significantly force prices down. Slower demand growth - owing to an expected rise in fuel efficiency, tougher environmental rules, rollback of fuel subsidies and alternatives to oil products - explains the extent to which individual oil product prices will fall.

Naphtha: Global Economic Outlook Weighs On Prices

Weak growth in some of the world's most industrialised economies will affect demand and its effect seems to be particularly pronounced for naphtha. Although the rally between January and February 2013 saw naphtha prices pick up 10.7% on average in Rotterdam and Singapore, the fall in oil products prices across the board thereafter saw naphtha fell 16.9% from its mid-February peak at the time of writing - the greatest decline observed among all oil p roduct grades and above the 12.4% decrease in the price of Brent over the same period.

As the fall in oil product prices has been precipitated by renewed growth fears , particularly in the eurozone, it suggests that naphtha - a feedstock for the petrochemicals industry - is especially sensitive to macroeconomics.

With the exception of the US, we expect tepid growth in key industrialised countries - growth in the eurozone and Japan is projected to average 1.2% and 1.1% respectively between 20 13 and 2017. China's growth is also expected to slow down from an average of 9.2% between 2008 and 2012 to 6.4% between 2013 and 2017. This will keep prices of naphtha subdued.

We forecast an average price of US$103.42/bbl for naphtha in 2013 - a 1% fall from 2012 when economic prospects were equally bleak. Over the longer term the fall in crude prices , alongside slow growth in key countries , will see naphtha fall by an average of 1.76% between 2013 and 2017. An exacerbation of the eurozone crisis or economic shocks elsewhere pose s downside risk to this forecast.

Gasoline And Gasoil/Diesel: The Green Effect

Gasoline and gasoil/diesel - key for the land transport sector - will also be affected by a weak global economic outlook. Complicating demand for gasoline and gasoil/diesel are green measures; fuel-efficient vehicles and green legislation limiting emissions will further limit growth in consumption of these fuels in developed countries. Oil-based fuels could also see a growing challenge from alternative power sources such as batteries or natural gas - LNG and compressed natural gas (CNG) - as the preferred choice in the transport sector towards the tail-end of our forecast period, both in emerging and developed markets.

For example, Indonesia, the Philippines and Pakistan are pushing their countries towards CNG for transportation, while China has already started a pilot programme to run public buses and taxis on LNG in selected cities. A rollback of fuel subsidies or price controls on fuel - which China has attempted and many emerging countries could enforce under budgetary pressures - would also slow demand growth significantly in these markets.

Meanwhile, in the US, major freight player UPS is deploying more gas-powered trucks in its fleet. Other major transport companies could follow suit, given the low price of domestic gas in the US and under a small but growing shift towards green policies. Meanwhile, Volkswagen's Scirocco R-Cup - a car race that will pit cars powered by CNG against each other - could also indicate a growing embrace of gas-powered cars at the household level. The challenge posed by gas to oil-based fuels will likely grow, especially if supported by a further fall in gas prices globally.

Our average global gasoline price for 2013 is US$120.92/bbl, compared to an average of US$122.99/bbl in 2012. Over the longer term, we see an average fall of about 2% per annum between 2013 and 2017. The fall is expected to be greatest in Rotterdam, where the fall in gasoline demand is expected to be greatest, followed by Singapore as competition among refiners heats up alongside an expansion of refining capacity in the region.

Jet Fuel: Freight Continues Slump

We forecast that jet fuel prices will fall steadily through to 2017, in line with our other fuel products forecasts. Between 2013 and 2017, prices are forecast to fall 12% in Singapore, 10.0% in Rot terdam and 10.0% in New York.

In terms of freight transport, we forecast European, North American and Asian air freight carriers will continue to be squeezed in 2013, by both the challenging global economic picture and the continued growth of Middle Eastern carriers and their new hubs in the Gulf, having knock-on effects on jet fuel demand. Indeed, the industry 's torrid run continues into 2013 with year-to-date (ytd) figures from IATA to the end of February showing a global decline in freight tonne-km (FTK) of 1.2%. The only bright spot remains the Middle East, which posted positive growth amid an otherwise negative sector.

The IATA did, however, continue to record an increase in passenger demand going into 2013 . A t the time of writing , passenger traffic for February 2013 (the mos t recent data available) saw 3.6 % y-o-y growth . Nonetheless, it warn ed that a decrease in consumer confidence owing to macroeconomic developments will affect this upward trend. Moreover, even at these higher levels load factors were at 77.1%, implying that spare capacity remains. Hence, it will take a significantly large increase in passenger traffic to translate into more flights and jet fuel demand. Thus we see little upside risk of this uplifting the weaker demand we see in the air freight segment and to our short-term jet fuel price forecast.

Total Air Freight & Passenger Volumes
Feb 2013 vs. Feb 2012 YTD 2013 vs. YTD 2012
RPK: Revenue-Passenger-Kilometres; FTK: Freight-Tonne-Kilometres. Source: IATA
RPK (% change y-o-y) FTK (% change y-o-y) RPK (% chg y-o-y) FTK (% chg y-o-y)
International 3.6 -6.9 3.6 -1.2
Domestic 3.9 -2.3 2.4 1.2
Total Market 3.7 -6.2 3.1 -0.8

Bunker Fuels: Efficiency Takes Hit On Demand

Our global average forecast for bunker fuel (the average of the 180 and 380 grades global price) stands at US$96.29/bbl in 2013, which is down 4.8% from the 2012 average of US$101.16 - the highest average price recorded over the last three years.

Of all the oil products, the downtrend in bunker fuel prices looks the most pronounced. 2012 saw a strong downward trend in bunker fuel prices, reversing a strong price rally that had taken off in 2009.

End Of The Uptrend
Price Of Bunker Fuel 380 (Top Chart) & Bunker Fuel 180 (Bottom Chart), 2008-Present (US$/Metric Tonne)

We have been highlighting two key risks to the global shipping industry, each of which will have a knock-on effect on bunker fuels demand. The first is that there is a high risk of global overcapacity, as new ships, and especially container ships, hit the market. In 2013, this issue will be especially true with new mega-vessel capacity, including Maersk Line's Triple E-Type 18,000 twenty-foot equivalent unit (TEU) vessel, the largest ship to date, coming online. Importantly, these ships are not just larger, but they are actually more fuel-efficient than those currently employed around the globe. Not only will they be able to carry more goods, but they will be able to do so with less fuel, therefore reducing bunker fuels demand.

These efficiency trends are also part of a broader push for an overall cleaner shipping industry, as demanded by both governments with forward-leaning environmental policies and major ports themselves. Hong Kong and Los Angeles - two of the largest ports in the world - are demanding that container ships utilise cleaner bunker fuels than today's standards.

Furthermore, we have previously highlighted a separate push to increase the utilisation of LNG as a shipping fuel, with several European ports investing in LNG shipping infrastructure to support this new industry. Det Norske Veritas (DNV), a ship classification bureau, estimates that 19-45% of ships will be powered using LNG by 2030. Meanwhile, Maersk Line wants to test biofuels and NYK Line is trialling a solar power-assisted car carrier. We believe that the most likely alternative to bunker fuel will ultimately be LNG. However, this remains a long-term prospect that will only kick in towards the end of our forecast period.

Our forecast for a decline in bunker fuel costs will offer shipping companies some short-term relief and take the pressure off their bottom lines in the coming years, although prices will remain elevated by historical standards. As such, we believe that companies will continue to slow steam in an effort to conserve fuel and cut expenditures, as well as embrace the push towards cleaner-burning fuels. All of this is to say that the overall trend for bunker fuels will be that of reduced demand over the medium term.

This article is tagged to:
Sector: Oil & Gas, Autos, Freight Transport, Petrochemicals, Shipping
Geography: Global, Global, Global