This month we highlight the ongoing pain in the top of the hydrocarbon barrel, especially in the naphtha market of which no bullish signals are forth coming until the end of the year now amid disappointing blending and petchem demand and rising Russian and Middle Eastern output. Meanwhile, gasoline balances are unlikely to tighten as much as previously anticipated over the summer as the start of the summer driving season so far been disappoints versus seasonal norms.

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Demand for petrochemical feedstock: Global naphtha balances tightened by more than anticipated in March driven by falling Russian output and surprisingly strong demand growth in China. That said, fundamentals since then have only deteriorated and we maintain our view that balances will lengthen in July and August on a y/y basis amid ongoing meagre petchem demand in Asia, unseasonably poor Atlantic Basin blending demand amid rising Russian, Middle Eastern and West African supplies.

Gasoline Demand: Wobbling demand in the U.S., particularly in PADD 1, poses significant downside risk for gasoline cracks globally, as growing supply in net exporting regions faces a shrinking pool of export opportunities.

Gasoline Supply: The start of the summer demand season in the US has failed to revive gasoline markets, with fundamentals pointing to a sluggish summer. Gasoline markets remain weak, with USGC cracks (both including and excluding RVO) now at half of last year's levels, having shed a few more dollars in the past week. As we've noted, the Atlantic Basin is still searching for a bottom for gasoline cracks, with US implied demand falling short. Exports to PADD 1 remain low, while output is slightly up y/y amid ongoing inventory builds. Meanwhile, Europe and the Middle East are shifting into a longer balance position this month due to rising primary and secondary unit runs. Additionally, the imminent launch of Dangote’s reformer unit, expected within weeks, will add 40-50 kbd of reformate to the Atlantic Basin market through late summer.

NGLs: US NGLs field output continued to grow strongly in March, almost exactly in line with our forecast. Further supply growth is expected for July although y/y output will begin to slow from September onward. Meanwhile easing demand growth in China and flexible crackers in Asia switching back to naphtha combined with lengthening US and Middle Eastern exports means propane fundamentals will weaken until late-July as the market rebalances.  

Key Messages: Dark clouds gather over the summer for light distillates markets

At the very top of the hydrocarbon barrel, deteriorating fundamentals in the US ethane market combined with rising natural gas prices pushed recovery incentives into negative territory over H1 June for the first time since January. The weakening ethane market mimics the general malaise in the downstream petchem market with OECD Asia leading the world in terms of slow consumption growth. This is weighing on regional cracker runs as margins are set to worsen in July as spring cracker maintenance in Asia finally ends.  

Indeed, the recent strength in the propane market, driven by Chines PDH units returning from maintenance and new units starting up, should ease in July as we expect Chinese propylene demand to be slow to improve, ultimately weighing on PDH operating rates which probably peaked in late May this year. Moreover, Middle Eastern LPG exports should pick up next month which will lead to flexible crackers in Asia switching back to propane again by late-July.  

Naphtha markets look set to weaken next month. The abovementioned weakness in petchem demand is also true in OECD Europe but naphtha’s real problem lies in the blending sector. The delay in Dangote’s reformer ramping up is not enough to aid European gasoline producers with high stocks in the US and rising output in the EoS countering the seasonal rise in Atlantic Basin gasoline demand which has so far been below expectations. High octane blendstock markets in particular have borne the brunt of the weakness. Reformate prices in the US and Europe counter-seasonally continue to fall with reformer and C5/6+ Isomerization margins in NWE flirting with unprofitability on a net basis as energy costs in Europe rise (see chart below).

At the same time, the meltdown in NWE VGO cracks, as well as prolonged turnarounds across the wider area have helped regional FCC margins remain level, despite the poor performance in gasoline markets. With the return of European FCC capacity from next month onwards and considering the workable economics of FCC unit margins, there is little in store for gasoline markets over the next weeks, considering the lengthening balances in the Middle East and India as well.

NWE naphtha blending margins (LHS) and reformate price (RHS), $/t

Source: Kpler calculations based on Argus Media prices

Overall, the outlook for the top of the barrel in July and through Q3 is less than rosy. Naphtha in particular will find it difficult to balance as Russian exports not merely normalize but begin to test record levels, assuming Novatek’s new condensate splitter in Ust Luga begins ramping up next month as planned. In the past, an additional 60 kbd of naphtha might have been welcome relief for tightening gasoline and petchem markets over the summer months, but not this year.  

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