There are no detail and clear timeline on China’s tax rebate for LSFO. If China is to export all 1.5m tons/month of LSFO, this will increase supply to 4.5m tons in Asia, which is still short of 8.0m-ton demand. LSFO stock, high utilization rate for refiners, and seasonally weak demand in winter lead to weak market GRM. These situations should improve as we move to 2Q20. Refiners’ share prices have fallen 7-16% since market sell-off last week. Top pick is TOP.

No detail and clear timeline on China’s tax rebate for LSFO

According to news flow this week, China plans to approve tax rebate for exported LSFO, which will prompt domestic refiners to export bunker fuel oil to the market vs. none at the moment. The news did not specify the details and timeline, only mentioned to be approved by the Ministry of Finance soon. Currently, Chinese refiners that export LSFO are subject to consumption tax (26%) and VAT (13%). China produces 100k tons/month of LSFO used in domestic market vs.1.5m ton/month capacity. Demand for LSFO in Asia is around 8m tons/month (1m ton in China) vs. 3m ton/month supply. If China is to export all 1.5m tons of LSFO to the market, this will increase supply to 4.5m tons, which is still 3.5m-ton short of supply. Given LSFO stock floating in tankers around 8m tons as of December, this means that it would take 2-3 months for demand to absorb the LSFO stock. We do not expect China’s export to significantly dampen LSFO spread and GRM as market expects and reflected in the sell-off for refiners’ shares.

Frustration and doubt grow over IMO 2020

Investors have high expectation of GRM recovery. But this seems delayed for months following rising crude premium and freight rate. Traders are also well-prepared for the IMO 2020, which led them to stock LSFO as mentioned. Global utilization for refiners is at 83%, the highest January run rate since 2014, as most refiners did their maintenance work last year to maximize their run rates this year. US refiners register at 93% utilization in January vs. 89% in 4Q19. Lastly, gasoline demand is seasonally low in winter and warmer weather in most regions causes slow oil demand. These situations should improve as we move into 2Q20. LSFO price is at US$622/ton and its spread is at US$24/bbl vs. US$13/bbl for diesel. This implies that demand of LSFO is out there, but high inventory and high refinery run rates keep market GRM low

Refiners’ share prices have fallen 7-16% since market sell-off last week. Top pick is TOP

All refiners will report weak 4Q19 earnings, which are known to the market. We believe that demand of bunker oil is hindered by LSFO stock. We would flag rising crude premium and freight rate as potential drags for GRM this year. TOP has locked freight cost for 75% of its crude intake, which will cushion its GRM. BCP does not import crude from Middle East. Rising oil price will push up its bottom line (from stock gain) in 1Q20. TOP’s earnings are highly leveraged to rising oil prices and is the second worst refinery performer since market sell-off last week.