OUTLOOK ’17: Europe naphtha, gasoline fate hinges on tumultuous oil outlook

By Cuckoo James

LONDON (ICIS)–The outlook for European gasoline and naphtha markets continues to be heavily dependent on oil price forecasts, because of the price elasticity of gasoline in the key US export market and the potential impact of sharp shifts in crude oil prices on European refiners.

Prices for both gasoline and naphtha closely track that of upstream ICE Brent crude oil futures.

Lower oil prices will help keep the record high consumption of gasoline in the US going, while higher oil prices can soon put a damper on consumption.

European refiners are structurally at higher risk than their US counterparts of suffering a loss when oil prices rise sharply, as they have done in December 2016.

“Refiners will profit from higher prices in the beginning in case they have bought crude at lower prices but their margins will dip once high crude prices start trickling into their system,” said Ehsan Ul-Haq, senior oil consultant at KBC.

“EU refineries are under pressure as is and they will have even more issues trying to stay active while prices go against them. We still haven’t seen export demand nor regional demand prop up enough to keep EU refineries running behind the margins,” Carl Larry, principal oil and gas consultant at Frost and Sullivan said.

However, experts also believe Europe could exploit potential weaknesses in Latin American refineries, at least for a while.

“Demand for crude from European refineries should remain elevated into year-end and early 2017, as weakness in Latin American refining continues to reduce the availability of US product for European markets,” Olivia Schorah from Energy Aspects said.

OIL SUPPLY AND DEMAND

Crude oil markets are now expected to re-balance only in the second half of 2017 if the futures price curve is to be believed.

Brent futures time spreads are atypically wide for the first half of next year, but tightens for months further out in the curve. A wide spread in a contango market is code word for persistent oversupply.

OPEC and Russia are pumping oil at record high levels prior to their promised output cut, according to surveys.

Experts agree any action to cut supply from 1 January as promised at the OPEC summit in November – if it happens at all – might not be enough in view of this imbalance.

Countries represented in the second OPEC and non-OPEC pact in mid-December account for 60% of the world’s oil output, and could be impactful if the terms are complied with.

“A big risk persists with Nigeria and Libya. Having been affected by conflicts and supply outages, these are two countries with significant potential to increase production,” Natixis Economic Research analyst Abhishek Deshpande said in a note.

Another potentially bearish factor is Iran’s production reference level. This is the level from which it will decrease its output. Unlike for most others, it is not set at October 2016 but at 2005, a gloriously productive time in Iran’s oil history.

There are other dangers too. The prominent one being a potential increase in US tight oil production if prices start edging up.

Some US production companies had already increased investment, especially in the Permian Basin, when crude oil prices neared $50/bbl, the US Energy Information Administration (EIA) said.

“A price recovery above $50/b could contribute to supply growth in other U.S. tight oil regions and in other non-OPEC producing countries that do not participate in the OPEC-led  supply reductions,” the EIA said.

OIL PRICES

Oil prices could easily take any direction in the new year, and along with fundamentals, traders would be keeping a close eye on the US dollar as it is an influential factor.

A rise in the US dollar typically exerts downward pressure on oil prices. The pricing trajectory of the US dollar in turn is highly dependent on US monetary policy.

In January, oil and US dollar would be heavily influenced by the US Federal Open Market Committee meeting on 13-14 December, and traders will be watching out for the possibility of accelerated interest rate hikes in the near future which could push the dollar higher.

“If the US economy stays strong through the next month or two, it’s also likely that the chance of another rate hike comes sooner than later. Again, stronger USD playing against the oil rise,” Larry said.

GASOLINE, NAPHTHA SUPPLY AND DEMAND

Depending on the direction oil fundamentals and prices take, US gasoline demand growth in 2017 will either slow or rise above current estimates, up from a record high reached in 2016.

The EIA estimates lower oil prices in 2015-2016 ensured an increase of over 2% or 400,000 bbl/d in gasoline consumption in the US.

EIA also estimates US gasoline consumption will reach a record high of 9.31m bbl/d in 2016.

The organisation is currently forecasting gasoline consumption growth will slow to just 60,000 bbl/d in 2017.

The US is a key export destination for European gasoline and blendstock naphtha – much of the prospects for the two markets depend on the direction oil prices and US gasoline demand takes in the new year.

Europe is structurally long on both gasoline and naphtha, and has to export product to the US, West Africa and Asia to balance its stocks.

Both products are well placed to exploit global growth in the transport and petrochemical sectors, which continue to make the largest contributions to global oil demand growth.

Asian demand for European naphtha is here to stay, although arbitrage economics play a huge role in spot deals.

The International Energy Agency estimates naphtha, LPG and ethane use as petrochemical feedstocks in non-OECD countries will rise by around 6m bbl/d between 2015 and 2040.

West African demand in 2016 received a boost after Nigeria resumed the oil-for-products swaps programme, and this could continue into next year despite the country’s struggle for foreign reserves.

European petrochemical demand could be the stable factor next year in supporting naphtha demand, as it has done all through this year.