INSIGHT: Why Europe naphtha crack spread is set to stay negative

24 October 2011 16:02  [Source: ICIS news]

By Jo Pitches

LONDON (ICIS)--Having remained consistently in negative territory for more than nine months, a combination of high Brent crude oil values and poor demand for European naphtha are set to keep the European naphtha crack spread negative for the foreseeable future.

The European economic crisis is a major factor behind the weak interest in naphtha, with growing fears for the global economy exacerbating the situation.

Furthermore, new refining capacity in Asia, the US Gulf and South America is exerting additional pressure on European refining margins.

The crack spread refers to the margin a refiner attains from purchasing crude oil and selling the resulting products.

ICIS data shows that the naphtha crack spread has been consistently negative since January 2011.

On 4 January 2011, the crack spread was at plus $3.70/bbl, with front-month Brent crude oil trading at $93.53/bbl. This resulted in a naphtha cargo range assessed at $857–865/tonne CIF (cost, insurance & freight) NWE (northwest Europe).

However, by 12 January, the spread had turned negative, softening to minus $1.30/bbl. Front-month Brent was at $97.90/bbl, and naphtha prices assessed at $854–862/tonne CIF NWE.

Despite having fluctuated since then, the crack spread has remained firmly negative, falling as low as minus $10.60/bbl on 24 October. At the same time, front-month Brent was trading at $110.31/bbl, with the naphtha range assessed at $879–887/tonne CIF NWE.

“[The price of] Crude is still high, demand [for naphtha] is weak…” a trader said when asked to explain why the crack spread has been negative for so long.

Despite fluctuating, Brent crude oil values have remained elevated for much of this year, driven upwards in February on fears of supply shortages stemming from the political unrest in North Africa.

ICIS data shows that front-month North Sea Brent prices have almost consistently remained over $100/bbl since 14 February, when it traded at $103.04/bbl.

“When crude’s up and naphtha demand is poor, the crack is lower to offset the [naphtha] flat price impact,” the trader explained.

A weakening crack spread will have a dampening effect on flat prices, while a strengthening spread will exert upward pressure. With interest in naphtha already poor, in the absence of any counterbalancing measure, crude oil-driven naphtha price hikes could further disrupt demand for naphtha.

Participants involved in the naphtha market for several years have noted a general weakening of the crack spread since the 2008 economic crisis.

“Seasonality plays a part, but prior to the 2008 recession it was usually possible for naphtha to break even, or at least for the crack to be a bit positive,” an analyst said.

The consensus is that the situation has worsened this year as fears for the global economy grow. According to a trader, Europe is now around a million tonnes long every month. This is despite refinery run cuts in September.

“The naphtha market is always long, so cracks are always negative. The average of the last couple of years shows they’re rarely positive,” the trader added.

Europe has an overcapacity, there’s a structural surplus of naphtha and gasoline,” the analyst said.

Demand from the gasoline sector has been weak this year, partly due to a reduced demand for gasoline itself.

“The driving season in the US has been weak, demand for gasoline is down this year,” the analyst said. “It’s due to the poor economic outlook. Less trade means less commercial driving. Fewer people are taking holidays.”

Demand from the petrochemical industry has also been disrupted by the economic crisis.

“Petchems is underperforming. Demand for polymers is falling because of the recession,” a second trader said.

A producer added: “Demand from petchem buyers is dwindling, the financial crisis means people don’t need as much plastic.”

Poor demand for end products resulted in European cracker operating rates being reduced to around 80% in September, and it is thought that further cuts may follow.

Furthermore, low prices for rival feedstock propane have for many months been encouraging petrochemical buyers to opt for LPG instead of naphtha wherever possible. A seasonal switch to naphtha normally occurs in September, but this has not yet been witnessed.

The consensus is that the naphtha crack spread will likely remain negative for the foreseeable future.

Possible short-term solutions include arbitrages opening, further refinery run cuts or a move away from LPG use to naphtha.

However, comparatively fleeting changes may not be sufficient to turn the crack spread positive for long, because of growing refining competition from other continents.

While around 15 European refineries have been closed, sold, or put up for sale as a result of consistently poor margins, refining capacity in Asia, the US Gulf and South America is expanding. This will likely further pressurise European refining margins.

In the US, a $2.2bn (€1.58bn) expansion project at Marathon Petroleum Corporation’s refinery in Detroit, Michigan, is expected to be complete by the fourth quarter of 2012 and will increase refining capacity by 13,000 bbl/day. Also planned for completion in 2012, Shell/Motiva’s Port Arthur refinery in Texas should increase throughput to 600,000 bbl/day. Marathon’s Garyville refinery in Louisiana increased output to 436,000 bbl/day in 2010, and has received approval from regulators to boost capacity to 545,000 bbl/day.

In Asia, numerous refinery projects are expected to come on line during 2012, with China adding around 25% of the total, at around 600,000 bbl/day. There are tentative plans for further expansions after 2015 at a number of Chinese refineries. India is also planning new refineries.

In South America, it is thought that Argentina has plans for around 14 refinery expansion projects, which will enable the country to reduce fuel imports.

“Refineries in Asia and the US are efficient, Europe can’t compete,” the analyst said.

The consensus is that the outlook is bleak, for European naphtha crack spreads and European refining margins in general.

“I don’t see the situation improving,” the analyst explained. “We can only hope that growth is strong in Asia and the Middle East so they’ll use all the products they produce and not send them to Europe.”

($1 = €0.72)

Additional reporting by Sheena Martin and James Dennis

By: Jo Pitches
+44 208 652 3214

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