Refining margins are crushed, led by middle distillates and recent Fuel oil weakness.

Market actions suggest we are at a little cross roads this morning. USTs rallied into the close, and continues its rally over night and asian hours. This is keeping a cap on the performance of risk asset including Gold, Oil and giving USD a little boost. Given the HF community's current theme is the reflation trade, there must a quite a few shorts in USTs currently, and perhaps a little squeeze is due in the longer end? In a scenario like this, perhaps it is wise to take off lengths in risk assets for now, and SFOT is happy to return to neutral in his outright exposure at this moment and he shall do just that.

Within the barrel, although SFOT has been pointing out the weakness of the middle of the barrel, one thing that has been consitently weakening is the bottom of the barrel, fuel oil. While this has been the strongest product earlier this year, the recent shine on Gasoline took its outperformance away. Bearing in mind this product is still around some 20% of the barrel, its effect on refining margins is not negligible. The low sulfur fuel oil, which is used for power generation, is a direct competitor to coal and gas. As oil prices keep going higher, fuel oil prices are dragged up, and at some point, coal and gas(which has been underperforming), will be a cheaper alternative. SFOT hears this might be the case now, and end users are switching their input, which is putting a damper on Fuel oil cracks, particularly the low sulfur type. Coupled with good supply coming out of the black sea region, fuel cracks may continue to see a cap. With middle distillate also weak, refining margins are now coming under significant pressure. This is a clear example that the recent rise in price is fairly unwelcomed, and while momentum can overshoot flat price, the faster and higher it goes, the faster and stronger any pullback will be.

Proxy Brent crude refining margin

Low sulfur fuel oil crack at the year's low