Shortages send fuel oil price soaring

In oil industry jargon, fuel oil is the bottom of the barrel. Fuel oil, used to fire power stations and ships, has lived up to its moniker: for years it was cheap compared with other refined oil products such as petrol and diesel. Now an acute shortage of fuel oil has sent prices soaring.

The price of fuel oil and marine fuel, known as bunker fuel, has risen to within a whisker of the record high set in 2008. A combination of low supplies as refiners shift output towards diesel and petrol and strong demand for electricity generation in Japan has pushed prices higher.
Although fuel oil’s importance has declined since the 1970s as electricity generators and heavy industries have burned more natural gas, it remains an important influence on the profitability of the shipping industry.

Benchmark 380 centistokes high-sulphur fuel oil hit $720 a tonne last week in Singapore, just 5 per cent below the record high of $759 a tonne set in July 2008. By contrast, other energy commodities, from Brent crude to diesel, are trading at 20-30 per cent below their 2008 peaks.

“Prices may go up a little more,” says a London-based oil dealer, whose company is a top fuel oil trader. Another leading fuel oil trader adds: “The price risk is skewed to the upside.”

Expectations of higher prices are anchored firmly in a strong physical market for the commodity. The premium to secure fuel oil cargoes for immediate delivery over that of later cargoes jumped on Friday to a record high of $21 a tonne, compared with the peak of $11 in mid-2008, a sign of extreme tightness.

The surge in fuel oil prices has encouraged trading activity in Singapore, the global hub for the commodity, where oil companies such as BP and Royal Dutch Shell, global traders including Vitol, Trafigura and Glencore, and local houses such as Brightoil and Hin Leong, are particularly active.

The jump in prices is largely the result of a substantial drop in supplies as refineries cut back the amount of fuel oil they produce from each barrel of crude they process. Soozhana Choi, oil analyst at Deutsche Bank in Singapore, says refiners have over the past decade made “significant” investment in upgrading capacity that allows them to transform fuel oil, which for years was abundant and cheap, into more expensive refined products, including diesel and petrol.

“Consequently, the global fuel oil yield has declined sharply in the past decade while light products yields have gained,” she says.

Ms Choi estimates that the fuel oil yield – the percentage of each crude oil barrel transformed into fuel – has dropped from almost 15 per cent in 2002 to about 10 per cent last year. In the US, one of the few countries to provide official data on refineries’ yields, the reduction has been marked, the yield falling to a low of 3.2 per cent in late 2011 from more than 6.5 per cent in the early 1990s.

This structural fall in fuel oil output was exacerbated last year by a fire at the 500,000 barrels a day Royal Dutch Shell Pulau Bukom refinery in Singapore, which depressed supplies. Singapore is the world’s biggest marine refuelling centre and, as such, a big consumer of fuel oil. Production problems disrupted other regional refineries, among them Taiwan’s 540,000 b/d Formosa refinery and PetroChina’s 400,000 b/d Dalian plant.

Russia, a big exporter of fuel oil to Asia, has cut shipments because of a big increase in domestic demand, further tightening the regional market, traders say.

At the same time, fuel oil demand, after years of decline, has suddenly picked up. The closure of nuclear power plants in Japan following the March 2011 tsunami and earthquake is forcing utilities to run fuel oil-fired power plants instead. The International Energy Agency estimates that residual fuel oil demand is running nearly 50 per cent above the previous year’s levels owing to demand from utilities.

“Demand for fuel oil-generated electricity in the Far East has been strong,” says an oil trader.

If, or when, the nuclear crisis in Japan ends, the structural changes in the refinery industry mean fuel oil supplies are likely to stay low, keeping prices well supported, traders say.

FT