Asian influence grows in the North Sea crude market

The growth in Asian refining – particularly in China – has had significant implications for the global oil markets throughout the last decade. While the Northwest European crude markets were slow to respond to Asia’s rising influence in crude oil demand, crude shipments to Asia from the North Sea have accelerated dramatically over the last two years, boosted by cheap freight, favorable market dynamics, and a seemingly insatiable appetite to feed the Far East’s growing refining sector.

Nowhere is this trend more pronounced than in the UK’s Forties Blend, where large chunks of the loading program each month ultimately makes their way to refiners in South Korea, thanks to favorable terms under the South Korean Free Trade Agreement with the European Union, in force since 2011. But increasingly, while the arbitrage flow to Korea is steady and consistent, both the big Chinese and European majors have moved in to ship large quantities of both Forties Blend and, to a lesser extent Ekofisk, to smaller, independent refineries in China.

Most of the North Sea production is comprised of small, disparate crude grades that often ship from FPSOs in smaller parcel sizes, characteristics that make them decidedly unattractive for long voyages.

By North Sea standards, Forties Blend – which produces just shy of 450,000 b/d – and Ekofisk – 220,000 b/d – are large crude streams with the capacity to load larger crude vessels. Hound Point, the loading point for Forties, even has the ability to load VLCCs, a boost to the economies of scale in terms of arbitrage movements that has played a substantial role in the ow of oil eastwards.

The role that shipping has played in making the arbitrage not only possible but often preferable to shorter haul voyages, cannot be overstated as the global tanker eet has continued to grow.

In 2016 and 2017 the VLCC fleet saw a rapid increase in new deliveries and the fleet currently stands at 716 vessels, with 97 vessels hitting the water in the last two years alone. This trend looks set to continue with the current order book currently representing 13% of the total fleet.

This growth has led to a sharp increase in competition and contributed to a heavy drop in overall freight rates, making it increasingly economical to move oil – any oil – from one region to another. The Atlantic Basin freight market is heavily dependent on the extremely liquid West Africa to China VLCC route, basis 260,000 mt. Rates on the route peaked at $33.64/ mt in October 2015 but have dropped heavily since then.

The average freight rate on the route in 2015 was $25.09/ mt, before falling to $17.38/mt in 2016 and $13.31/mt in 2017, a 47% fall in two years, according to S&P Global Platts data.
Fixtures on the Hound Point-Far East route were reported at a lumpsum rate of over $9 million in December 2015, early 2018 fixtures have come at rates as low as $4.25 million.

Forties vs Ekofisk: Arbitrage dynamics

The crude arbitrage from the North Sea to Asia is largely driven by Forties Blend, currently the single largest crude stream in the North Sea and the biggest component of the basket of crudes that underpin the Dated Brent benchmark. Over the last four years, the market has transformed from one where most oil was refined within Europe to one where well over half of the program each month is shipped outside of the region, predominately to Korea and China.

Ekofisk and Forties first-destinations 2017

Forties accounted for about 36% of total BFOE loadings – including Troll – in 2017, and nearly two-thirds of the grade was ultimately absorbed into Asia. South Korea accounted for the largest share of this volume, attracting some 32% of the Forties volume loading directly out of Hound Point, with China coming in at a close second, taking more than a quarter of it.

And that is just accounting with the direct Hound Point to Asia flow. In addition to the VLCCs loading directly from Hound Point, some 17.5% of additional volume loaded at Hound Point on smaller Aframax cargoes ultimately wound up moving in that direction after transferring on to larger vessels via ship-to-ship transfer at special STS areas like Southwold, off the coast of eastern England.

Southwold itself serves as the first destination for nearly a third of the vessels that load at Hound Point, irrespective of size. While not all of these cargoes will eventually sell to Asia – some of them are reoffered in the local refining market – it is a fact that STS areas often act as staging grounds for barrels moving further east. Because these cargoes often transfer ownership and actual vessel multiple times, it can be difficult to determine how much of Forties – and, to a lesser extent, Ekofisk – is ultimately shipped to the Far East, either already sold in to an end-user destination or even still available for sale on a delivered basis in the Southeast Asian market.

In comparison to the heavy share of Forties going to the Far East in a given month, Ekofisk – the second-largest crude grade in the BFOE basket underpinning Dated Brent – is still predominately a Northwest European crude. The majority of Ekofisk loaded at Teesside in 2017 – some 57% – was sold directly into Northwest Europe. Despite this, Ekofisk flows to Asia, particularly to China, have begun to play an increasingly important role in the dynamics around Dated Brent and Northwest European refining.

Ekofisk exports to Asia in 2017 were not on the same scale as Forties, but China imported nearly 16.5% of the total volume loading directly out of Teesside, with a further 18.5% heading towards Southwold.

What makes the arbitrage from one region to another viable depends heavily on a myriad of factors, many of which are unique to individual companies. In the North Sea, however, the number of market participants who routinely work arbitrage for both Forties and Ekofisk either direct to refiners or into storage in the Far East has grown over the last several years.

While global majors like Shell and trading companies like Glencore and Trafigura have been consistent players in the arbitrage markets in past years, the growing presence of China has seen Petroineos – a joint-venture between Petrochina and upstream company Ineos – and Unipec move in to the market as well. Even Norway’s state-owned Statoil, the largest single upstream producer of BFOE crude, has moved oil out of Northwest Europe and into Asia.

China vs South Korea

While calculating the arbitrage is complicated, ultimately, pulling it off successfully depends on the relative value of three primary factors: the local value of crude, the value of crude at destination and freight.

But what that means in terms of actual numbers can differ from grade-to-grade and participant-to-participant. Nowhere is this more evident than when looking at Forties flows to Asia, particularly to South Korea.

The signing of the EU-South Korea free trade agreement in July 2011 helped create a new West-East oil trade route, with South Korean refiners gaining access to tariff-free imports of Forties – previously taxed at 3% – along with a tax rebate on refined product exports, and later, a reported 90% rebate on the additional freight cost of shipping Forties from the North Sea, versus shipping a Middle-Eastern crude from the Persian Gulf.

Forties VLCCS by destination

North Sea Arbitrage vs EFS

These terms and conditions, valid only for grades loading in the EU – to which Norway does not belong – meant that Forties suddenly became a lot more attractive to refiners in South Korea, largely independent of many of the other costs associated with driving arbitrage. While the terms of the trade agreement have evolved over time, North Sea traders say that much of the original agreement is still intact, and that South Korean refiners currently put the net value of the FTA at around 30-50 cents/b. In practice, this means that the Northwest European refining market is often priced out of the Forties market entirely.

Tracking by cFlow, Platts trade flow software, shows that in 2013-15, South Korea was, single-handedly and some distance, the largest importer of Forties. South Korea imported and re ned more Forties than the whole of Europe in the wake of the FTA and over that period about 66% of VLCCs loaded out of Hound Point headed to South Korea.

However, Chinese imports of North Sea crude quickly ramped up after 2015 when the Chinese government moved to liberalize crude sourcing for its smaller, independent refiners. Chinese crude buying boomed, starting first with Forties already on its way to Asia, and then later, as the Brent’s premium over Dubai began to narrow, toward Ekofisk.

Prior to 2015, independent refineries – or “teapot” refineries, also they’re also known – used to rely on fuel oil and domestic crude for feedstock. Chinese teapots account for approximately 25% of China’s total refining capacity of around 16 million b/d, according to Platts estimates. China’s independent refineries imported a total of around 93 million mt of crude oil in 2017, according to according to S&P Global Platts estimates. This represented around 22% of China’s total imports of 420 million mt in 2017.

In 2016, China overtook South Korea as the number one importer of Forties, draining almost 55% of VLCCs leaving Hound Point, against 24% for South Korea. In 2017, imports were fairly equally divided between the two countries, while arbitrage volumes out of Hound Point continued to swell. More than 78 million barrels of Forties were thus sent to Asia last year.

Both Forties and Ekofisk are likely to be spotted en route to Asia in a given year. However, the Forties arbitrage is characterized by a sustained stream of VLCCs moving east, while Ekofisk moves are more scarce and tend to be triggered by a pull from Asia, rather than a push from Europe.

While several months passed without a single ship taking Ekofisk to Asia in 2016-17, at least one VLCC of Forties per month was seen steaming east of Suez. In 2017 alone, an average 3.25 VLCCs left Hound Point directly for Asia each month, with a peak at five in May 2017.

Volumes of Ekofisk moving to Asia were less consistent and more markedly driven by the relative value of the benchmarks underpinning the European and Asian markets.

As such, Ekofisk exports to Asia distinctly peaked between March-August 2017 when the Brent/Dubai exchange of Futures for Swaps (EFS) dipped below $1.50/b. A narrower EFS conducts a greater competitiveness for crude grades pricing against the Brent benchmark relative to Dubai-related grades, thus favoring arbitrage economics from the Atlantic Basin to Asia.

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