Surge in arbitrage margins fuels naphtha market rebound on physical premiums and timespreads.

Commentary summary:

– Europe’s correction in physical premiums has widened export opportunities to Asia, increasing demand for cargoes and boosting the paper market.

– Europe remains in contango for the Dec/Jan spread, raising the question of whether the rebound will continue into year-end.

– A decline in West to East freight, combined with a strong E/W trend, keep improving the arbitrage economics.

– US physical premiums are stabilising while Asia shows stronger margins for heavy naphtha cargoes.

The naphtha market has experienced a rebound over the past week, particularly notable in the prompt timespreads of the European and Asian markets.

As we mentioned last week, the sharp correction in physical premiums in Europe significantly widened export opportunities to Asia, boosting demand for cargoes and stimulating the paper market as well.

Europe remains in contango for the Dec/Jan spread despite the change in trend, and the question as we approach year-end is whether the rebound will hold or if we will see the market sink again, as it has since the beginning of November.

(Nap NWE and MOPJ spreads have risen over the past week, driven by the rebound in arbitrage activity to the East)

For the second consecutive week, the most prominent factor in the market is a widely open arbitrage to Asia from Europe.

Looking at the options for an OSN cargo this month, currently delivering in Jan H2 on an LR2 is about $10/mt more profitable than the alternative of an MR to NWE in the coming weeks.

This differential narrows to $6/mt when considering the alternative Cape of Good Hope route.

(Current arbitrage margins from MED point to LRs option to the East or Brazil, surpassing the MR margin to NWE)

Breaking down the components of the arbitrage, we can see that over the past month, all factors have aligned in the same direction.

A prolonged decline in TC5, combined with a strong E/W trend trading at 10-month highs, has progressively improved the arbitrage economics, reaching the margin differentials mentioned earlier.

Regarding physical premiums, as shown in the following chart, both markets have experienced a rebound after a sustained drop over the past month and a half, climbing back to positive levels for Asian OSN.

There is still significant room for premiums to trade higher, as current values remain near the annual lows marked last week. If more cargoes confirm the LR2 route to Asia, a stimulus to European physical premiums will be imminent.

(The strong E/W trend and the drop in freight to the East continue to boost arbitrage economics, while cash differentials in Asia and Europe are rebounding for the first time in the past month)

In the US market, physical premiums appear to be finding support after the recent decline, in line with the global naphtha market trend over the past month.

Meanwhile, RBOB and MBC5 paper indicators have been trending upward in recent sessions. Arbitrage options point to better economics for trading locally or staying within LATAM in the short term.

However, 2H January deliveries show stronger margins in Asia, particularly for heavy naphtha cargoes bound for Korea and Japan. This could help support the US naphtha market as we move into Q1 of the coming year.

(USGC export option improve for 2H Jan and FEB deliveries)

In summary, the rebound in global timespreads and physical premiums over the past week clearly reflects the increased global arbitrage opportunities we have been identifying.

This trend persists for another week, driven by the upward movement of the E/W and the expectation of arbitrage from the USGC. The NWE market remains deeply in contango in the prompt, with a significant discount in cash differentials compared to the swap.

However, the outlook for early Q1 points to higher cargo demand from the Middle East, which will have to compete with the Asian alternative. Therefore, we anticipate the rebound to continue in the coming weeks.

Source: Spart Commodities