Image Credit: Ship & Bunker

While crude futures are rapidly approaching levels last seen before the war in Iran, the shipping industry should not be expecting a similarly rapid drop in its fuel costs.

ICE August Brent futures closed at $77.90/bl on Monday, just under 10% over their pre-war close on February 27. At its recent peak closing price of $107.92/bl on May 4, the contract was 38.5% over its pre-war level.

But while crude oil prices are sliding in response to the memorandum of understanding between the US and Iran, and the expected resumption of normal traffic levels through the Strait of Hormuz, bunker prices remain elevated far beyond pre-war levels, and their premiums to Brent show no immediate signs of narrowing.

Ship & Bunker's G20-VLSFO Index of prices at 20 leading bunkering locations stood at $734.50/mt on Monday, 35.1% over its level on February 27.

Part of this effect will be down to the different time basis of the two prices - Ship & Bunker VLSFO prices are for delivery within a few days, while the front-month Brent contract settles two months from now - but market fundamentals in refined products supply are a much bigger factor.

Distillates Taking Priority Over VLSFO

One of the main reasons for persistent VLSFO strength is that refineries are continuing to favour output of other products.

Middle distillates have been the part of the barrel most affected by the Iran war - both by Middle Eastern refineries with high distillate output being shut down, and by Asian refineries being cut off from their usual Middle Eastern crude supply - and addressing this shortage is the most urgent issue for the oil market.

"Remember, VLSFO is a blended product," Arne Rasmussen, head of research at hedging firm GRM, said in a webinar on Monday.

"We use some of the same feedstocks that are used for blending VLSFO to produce refined products like distillates, and we see the crack for distillates is still quite elevated, so there is an incentive for refineries to produce gasoil, marine gasoil, and jet fuel instead of producing or providing the feedstock for VLSFO.

"The scrubber spread, or the high-five, is elevated, and we think it's going to stay that way for a while, as long as the profitability for producing gasoil is at that level."

Price Breakdown

Image Credit: Ship & Bunker

The continued fallout of the Iran war is producing very different results in the various marine fuel grades.

The G20-VLSFO Index stood at a 25.8% premium to Brent futures on Monday, compared to a 1% discount on February 27. This premium has widened by 12.2 percentage points in the last month, and is higher than its average over the course of the conflict so far of 19.4%.

For the G20-HSFO Index, the effect is much reduced because the distillate prioritisation does not affect this grade as much. This index stood at a 0.3% premium to Brent on Monday, compared to a 15.6% discount on February 27 and an average premium of 0.7% over the course of the conflict so far.

The G20-MGO Index is where the fuel shortages can be seen most clearly. This index stood at a 93.8% premium to Brent on Monday, compared to a 45.3% premium on February 27 and a 92.9% average over the course of the conflict so far.

Price Outlook

While crude prices have slid rapidly since news of the MoU emerged, there is little room for further sustained downside this year beyond short-lived dips driven by headlines, Rasmussen argued.

"If we look at the next six to 12 months, I think it's important to understand we have borrowed this oil from the future," he said.

"We need bigger oil inventories, we need to replenish them.

"I see oil in a $75-100/bl range for the next six to 12 months, well above what we see in the forward curve, and I think the risk is tilted to the upside.

"If we look well into next year, maybe into 2028 oil supply will probably be coming back, and it may actually come back with quite a vengeance, because OPEC is under pressure."

In its most recent short-term economic outlook report, issued on June 4, the EIA forecast Brent spot prices to average $101.12/bl in the third quarter of this year, before dropping each quarter to an average of $75/bl by the fourth quarter of 2027.

The fact that crude prices are now somewhere around the lowest level likely to be seen for the next year means now may be a good time for shipping companies to fix price exposure, Rasmussen said.

"We are below $80/bl; I think this is actually a time to say, okay, this could flare up again," he said.

"The situation is not soft, it's very fragile.

"Maybe it's time to do some fixed price agreements, or some hedging one way or the other."

Beware of the 'Ketchup Effect'

That said, the market does remain exposed to the possibility of crude prices dropping sharply - and temporarily - in the short term if negotiations between the US and Iran produce positive headlines.

In a separate note to clients on Tuesday morning, GRM set out its view on this risk.

"We see further price declines in the coming days, with a test of $75/bl on the way," the company said.

"A number of developments suggest that a larger volume of oil is now on its way to the global market.

"One could almost describe this as a form of ketchup effect. This is a Danish expression used when nothing comes out for a while, and then suddenly a lot comes out at once."

But any dip of this kind should not be mistaken for a longstanding phenomenon, the company argued.

"The ketchup effect is, as we know, temporary. At some point, the bottle is empty.

"Any further price decline will, as has been the case in recent days, mainly be seen at the front end of the curve. The market has largely priced in the current scenario."