Commentary summary:

• Europe’s naphtha prompt timespread dives into deep contango.

• Physical market premiums turn negative in Asia and Europe.

• Arbitrage opportunities expand from Europe to Asia via Cape of Good Hope.

• Short-term challenges persist, but Q1 outlook shows recovery potential.

The naphtha market continued its free fall for yet another week, with Europe’s prompt timespread plunging deeply into contango. Both the Asian and European markets have experienced a sharp four-week correction.

Cracks also traded lower again, and the threat of contango now extends to the January/February timespreads, which, although still in backwardation, have dropped by over $5/mt since early November.

(The European naphtha market fell into contango, while the MOPJ edged closer to it)

In the physical market, the correction has been even more severe, with negative premiums in the Asian market for the first time since Q2 of this year, and the European OSN also trading in negative territory since the start of the week.

The contango in paper markets and discounts in the physical market clearly reflect a recently weak market. This comes despite naphtha being the best-performing crack in percentage terms across the barrel from Q1 through mid-Q4, with steady increases for six consecutive months.

(Continuous M1 cracks contracts highlight the two major turning points in the naphtha market this year)

The main fundamentals driving the global naphtha market downturn at the end of the year are an increase in supply in both regions.

Russian product is leading the surge in the East, with Tuapse ramping up production towards the end of November. Meanwhile, in Europe, the restart of the Pernis and Fawley refineries has contributed to the supply rise.

This increase in product has been compounded by European destocking efforts, as companies reduce petrochemical industry inventories ahead of year-end.

This has translated into lower activity in NWE and negative petrochemical margins, which have primarily impacted the Asian market, reduced recent naphtha demand and added further downward pressure on the market.

(MED physical correction accumulates $5/mt during last two weeks)

But not all news is negative in the naphtha market. The sharp corrections in premiums, coupled with a rising East/West (E/W) spread, have significantly opened the arbitrage from Europe to Asia, both for HFRN and OSN cargoes.

Despite the continued declines in Asian cash differentials, European weakness and the E/W spread have been enough to improve arbitrage margins via the Cape of Good Hope by $10/mt over the past two weeks.

We may need to wait for February deliveries in Asia to trade before seeing a market rebound, but the improved arbitrage outlook substantially enhances the perspective we’ve had since the start of the month.

Once Europe moves past its destocking phase and the first additional arbitrage cargoes are confirmed, given the strong margins, the Western market could rebound or at least find support following the recent correction.

(Med to Asia arbitrage margin keep rising on strong E/W and weaker FOB prices)

The arbitrage outlook is not only improved by the push of barrels to Asia but also by the strengthening intra-European arbitrage. TC6 rates hit new annual lows again this week, enhancing the economics of cross-MED and MED-to-NWE arbitrages.

This is putting additional pressure on European cash differentials, which have plunged into discount territory, making at the same time the market more competitive for exports to Asia.

(TC6 Correction keep MED to NWE arb open despite lower cash diffs in the north)

In summary, the short-term outlook remains challenging, but arbitrage opportunities are expanding for the start of the next year, which could support the global naphtha market.

This comes at a time when heating demand reduces propane’s competitiveness in steam cracker demand. Therefore, our global outlook cautiously points to a market rebound towards the end of this month and a much more supported market during Q1 of next year.

Source: Sparta Commodities