Over the past few weeks, we have been highlighting how the US gasoline market is becoming increasingly tight ahead of the peak summer driving season. One of the “release valves” we have repeatedly suggested comes in the form of increased gasoline flows from Northwest Europe (NWE), helping to balance out the mismatched market dynamics between the two sides of the Atlantic (on the one hand a tight balance and restrained physical availability in the US, on the other increasing length amidst a high-inventory environment and the lightening of the crude slate in NWE).
However, our freight-adjusted arbitrage incentive has been slow to open, just briefly flirting with positive territory at the beginning of last week, before tumbling back into negative range. On a monthly basis, the arb deteriorated last month vis-à-vis January, falling to minus $5/bbl in February compared to minus $2.5/bbl the previous month.
These calculations are made assuming a refiner who, instead of directly blending renewable fuels into transportation fuels, is buying credits – called Renewable Identification Numbers (RINs) – to meet their Renewable Volume Obligations (RVOs). RVOs are mandated by US law, within the scope of the Renewable Fuel Standard (RFS) set out by the Energy Policy Act of 2005 and expanded and extended by the Energy Independence and Security Act of 2007 (EISA), whereby the Environmental Protection Agency (EPA) establishes a RVO target that sets out the quantity of renewable fuels producers must bring to market each year.
Arguably, though, it would be more profitable for a refiner with the capacity to do so, i.e., an integrated refiner controlling both refinery and distribution operations, to directly blend ethanol into gasoline and sell this to the US market without the need to obtain RIN credits. As such, we have calculated the gross margins a refiner could achieve by blending 10% ethanol (current maximum, achieving compliance with the RFS) directly versus buying credits (see chart below). Even though we are not including the potential logistics and operational costs involved, which should amount to something between $1 to $2/bbl, it is apparent that directly blending is more advantageous.
We have then re-calculated our arbitrage estimates to assess the impact of direct ethanol blending (see chart below). Including ethanol blending, the transatlantic arbitrage has been open since mid-December, which helps to explain the rebound in NWE to US exports seen in January and the steady stream of cargoes making the journey this year.
One important caveat here is the cost of freight, which has been remarkably volatile of late. Indeed, the deterioration in the arb in February coincided with a spike in TC2 rates shortly after the Russian ban on oil products came into effect. This means arbitrage conditions are fairly unstable at present and could quickly worsen.
Still, the opening of the arbitrage window is a welcome development, as we are seeing the US flipping into a net seaborne gasoline importer for a second week out of the last four and US gasoline production remaining below the five-year average level for this time of the year, aggravating tightness in the market.
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