European clean product flows are changing, but the clock is ticking

Europe remains highly dependent on Russian clean product exports, particularly gasoil/diesel. As we head towards the embargo, it was expected that reliance had fallen, not risen. The ban will, however, bring about a change in global trade patterns for both middle and light distillates.

Against all odds and all expectations, Russian clean product exports continue to surge. There was a long period in the second and third quarters, from March to October, when the volume exported fell, with most of the reduction being caused by a fall in flows to Europe. This was in line with restrictions that some major importers and traders imposed on themselves in the wake of the Russian invasion of Ukraine. And yet, heading into the end of 2022 and the start of 2023, the totals in November and December are on par with those seen before the invasion.

This defies expectation as an embargo on Russian refined product imports takes effect on February 5th, and by now, there was a sense that Europe would have sought alternative sources for its supply needs. Or perhaps this is the last hurrah before things change more formally, the last chance to buy from the nearest large source, keeping freight costs down compared to supply from further afield.

Russian clean product exports to Europe (kbd)

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Europe has, for decades, become heavily dependent on Russia for its gasoil/diesel supply, and volumes in November and December reflect this strongly. November saw the total exported from Russia to Europe reach 785 kbd, the highest since February 2020, and up by 350 kbd or 82% from October. What seemed to be Europe preparing to wean itself off Russian fuel turned out to be a false dawn. December is on course to be in line with November. If Europe is to abide by the embargo, as is expected, then the direction of the flow of Russian barrels will need to reflect this new reality.

Volumes from Asia, though, are climbing. In October, a record 900 kbd left the continent destined for Europe, carrying on a trend that began in March, but that has also seen significant variations when the East-West spread has been unfavorable. In October, Month plus 1 (forwards) Singapore – Rotterdam 10 ppm fell to -$61/mt, facilitating such a large volume of arbitrage. The spread has strengthened in November and December but is still deeply negative, which will keep volumes high going into January. Perhaps Europe is finally making alternative arrangements for the new world that is on the near horizon. Asian balances have been lengthened by record exports from China, which has kept Singapore prices under pressure relative to Europe. The majority of Chinese exports stay in Asia, but Europe’s changed balance and supply options may bring a change here too.

Volumes from the United States have also risen in recent months and are expected to rise further once the embargo is implemented, but December’s total to Europe is still only 220 kbd. Russian supply is around 700 kbd, so there is still a big gap to fill. An increase in exports from the US to Europe will leave Latin America short of the gasoil supply that it has received from the US in recent years, but with a rebalancing of flows from Russia away from Europe, it can be expected that some Russian supply will find its way into Brazil and Mexico.  

The second significant clean product export to consider is naphtha. Russian naphtha exports to Europe have risen this year, even into November, which at just over 220 kbd is largely in line with the average of the year so far (240 kbd). This is 28% up on 2021. Naphtha flows, however, may evolve in a different way from gasoil flows. As steam cracker margins in Asia have picked up recently, more Russian naphtha is likely to flow that way, despite a mid-year lull in average volumes this year. As Europe will shun Russian naphtha from February onwards, Russia will look to place its output elsewhere, and increased capacity in China, in particular, will make a very welcoming home for Russian barrels, especially if they are forced into discounts to find buyers.

This will leave European petchem processors short of feedstock, which may drive them towards supply from the Americas, or towards LPG, economics depending.

European refiners are a significant net gasoline exporter, so the embargo's impact on Russian supply is not as deep.  

With the embargo just over six weeks away, there is still considerable uncertainty over how much clean product flows will change, but perhaps some flows are starting to establish themselves more clearly. Europe’s gasoil appetite is not going to go away, and nor is Russia’s supply. Where Europe buys from, however, looks destined to change to sources further afield, while Russian sellers are likely to look to South American outlets. Naphtha will find its way to Asia by forcing the arbitrage open more often and for longer, while Europe’s petchem facilities look for a different source or even a different feedstock.