SINGAPORE (Dow Jones)--Falling freight rates have re-opened the West-to-East fuel oil arbitrage window after a hiatus in the early third quarter, but tight oil supply and strong bunker fuel demand could restrict the flow from Europe to Singapore.
The freight rate for a very large crude carrier has fallen to around $5.5 million this week on weak demand for crude shipments, a Singapore-based shipbroker said. High freight charges, which stopped the arbitrage flow since June, hit a peak of $10.5 million in early July.
Combined with a narrower viscosity spread for September at around $14 and an East-West spread of around $50, this has made arbitrage feasible on paper, but only one very large crude carrier has been fixed so far on the West-East route.
The East-West spread is the price difference between 380-centistoke barges in Europe and Singapore 180-centistoke swaps. Arbitrage barrels are usually 380-cst material, so the viscosity spread, or price gap between 180-cst and 380-cst, is used to convert the Eastern leg of the cargo to 380-cst.
The difficulty of finding the right oil and available ships in Europe, along with a strongly backwardated Asian market, are some of the reasons restricting arbitrage flow, traders said.
"Sharp backwardation may not have the economics working as you lose $10 (on the cargo) easily after 30-40 days voyage," a Singapore-based trader said.
This means the spread between the price paid for the oil and the value of the contract for the period in which it will be delivered is valued at a $10 discount.
In a backwardated market, the price in the front month is higher than in later months. The September-November spread in Asia was at $7.50/ton on Thursday.
The market may also need a wider East-West spread for arbitrage to work, the first trader said. The East-West spread has fallen to around $49 this week from $60 in May.
However, the rapid fall in freight rates has made some shipowners reluctant to lease their ships, traders said.
So far only one VLCC, Ghawar, has been fixed to load 270,000 metric tons of fuel oil in Rotterdam in early September. The vessel will arrive in Singapore in October.
Scramble For Oil
Four other cargoes between 100,000 and 130,000 tons are expected to arrive in Singapore in October, indicating that traders are keen to ship more oil from Europe.
But it has been an uphill task to find the right oil in Europe to fill up an entire VLCC.
"People are scrambling for oil. Filling up a VLCC is not going to be easy," a Western trader said.
Another Singapore-based trader said one would also have to examine the economics closely, such as the price of oil in Europe and blending values as unfinished cargoes are usually shipped and blended in Singapore.
In most cases, Singapore is the cheapest place to blend oil as it has enough tanks and plenty of different blendstocks and cutters, he added.
Fuel oil, or heavy residual oil, is mainly blended into bunker fuel for ships or burnt in power plants. Singapore, the world's largest bunker port, consumes nearly 3 million tons of fuel on average each month.
Supply in Europe has fallen over the past few months on scheduled refinery maintenance and cuts in crude runs on weaker margins at refineries, traders said.
More refineries, including those owned by Royal Dutch Shell (RDSA) in the Netherlands, StatoilHydro ASA (STO) in Norway and Galp Energia SGPS S/A (GALP.LB) in Portugal, are headed for turnarounds in September.
In addition, the military conflict between Georgia and Russia may have caused stocks to fall in the Baltic region - an outlet for Russian crude and products into world energy markets, traders said.
This could boost demand at the Northwest Europe oil hub of Amsterdam, Rotterdam and Antwerp, or ARA, they added.
Falling bunker fuel prices have also boosted demand in the ARA, traders said.
Bunker firms in the Mediterranean are expected to cover any fuel shortage, caused by turnarounds in the region by sourcing material from the more liquid ARA market, a fuel oil trader based in Greece said.
Asia Supply To Stay Tight
In Singapore, supply of on-spec bunker fuel - oil that meets specifications on viscosity, sulfur content and density - may remain tight in August and September at least as fuel oil imports are likely to fall by a third in August from the monthly average of 3 million tons. Only around 1.7 million tons will arrive in September.
Middle Eastern producers have also cut back exports, channeling fuel oil for domestic use as summer power demand surged.
"Fuel oil is short everywhere. So it's unlikely (more cargoes can arrive) till November," the first trader said.
Tight supply has already pushed the Asian market into steep backwardation and raised premiums.
"Until we get resupplied, we will see fairly thin trade," the third trader said.