A structural decline in Russian fuel oil exports, combined with a slow recovery in refinery runs after maintenance season in the country, are being felt on the supply side in Northwest Europe, pushing the front-month FOB Rotterdam 3.5% barge swap to minus $0.50/mt versus the second-month, its highest since May 5, 2015, according to S&P Global Platts data.

“Fuel oil exports from Russia are low at the moment,” said one trader Tuesday. “Refineries are returning [from maintenance] at reduced rates,” he said.

“There is a large crude program coming out of Russia,” he added, suggesting that Russia is exporting more Urals crude oil instead of refining it into products such as fuel oil.

Following Russian tax changes in January 2015, export duties were cut on crude and products. That made export netbacks more attractive and boosted export flows. But from the start of this year, domestic processing became less cost efficient as low Brent crude price dented Russian refiners’ economics and many opted to reduce throughput, resulting in higher crude exports and reduced products output and exports.

Further denting fuel oil supply and exports has been the slow restart of Russian refineries from their spring maintenance season, which hasn’t been sufficiently offset by waning domestic demand.

“I think runs are picking up but very slow,” said a second trader.

There are also works ongoing at Russia’s Taneco and Kirishi refineries as well as at Belarus Novopolotsk, also a fuel oil exporter from the Baltic ports.

Meanwhile Russian fuel oil domestic demand has been declining in a typical pattern for the time of year.

“There is normal seasonality in Russian fuel demand. It was well above the norm in February on the low price, and the February normal level is high to begin with. Now we’re back to the seasonal norm I believe,” another trader said.

Demand from utilities was particularly strong in January and February as tumbling domestic prices, which followed the weak export netbacks, prompted them to switch from natural gas to fuel oil.

Starting from April, domestic demand has been dwindling in step with the end of heating season. In addition, domestic fuel oil has become more expensive than natural gas, meaning the power generation demand seen at the start of the year has disappeared.

Fuel oil is gradually being pushed off the radar of domestic consumers as utilities have largely replaced it with natural gas, whereas the bunker market, especially in the north, is switching to low sulfur distillates due to the more stringent sulfur regulations in the Baltic Sea.

Supplies of fuel oil to domestic markets in May were 30% lower year-on-year at 792,000 mt — and down by 35% month on month — while fuel oil production amounted to 4.757 million mt in May, down 22% year on year, according to Russian energy ministry statistics.

LOWER OUTPUT, EXPORTS

Russia’s fuel oil output has been dropping consistently this year even though May output was up from 4.303 million mt in April. Russia’s fuel oil output drop started in January 2015, when the so-called “tax maneuver” increased export duty on fuel oil, denting refining economics.

Throughout 2015 production was declining but remained in the high 5 million mt/month for most of the year, occasionally exceeding 6 million mt/month. Prior to the tax reform, monthly production had been in the high 6 million to low 7 million mt/month range.

But output was further curtailed this year, with monthly volumes now around the 4 million mt level.

“Fuel oil production is consistently dropping since the start of the year,” said a Russian trader.

The production drops have been more pronounced at bigger refineries, which already started reducing their primary processing last year while ramping up secondary units, which increase their yield of light products.

Some refineries, like Lukoil’s Perm, completely halted fuel oil output following an upgrade this year.

More complex refineries are also increasingly processing gas condensate at the expense of crude, in order to boost their light products yield and reduce fuel oil.

Russian refineries have also reduced their runs in response to a weak domestic market, which saw demand for all products, including gasoline and diesel, languish well into May before it started picking up.

But even though the market generally shares the view that fuel oil output has dropped, the overall production level remains mired in uncertainty as data doesn’t always capture mini-refineries, which produce largely feedstocks such as fuel oil and various distillate fractions. According to some, mini-refineries have so far been less affected by run cuts than the bigger refineries.

But a number of small refineries, including Volkhov, Enisey and Usinsky, have at least temporarily halted production, said sources.

“Refineries are being put out of business due to the new [export] tax regime,” said an NWE-based trader.

BACKWARDATION AHEAD?

Along with reduced Russian exports, if gasoil and gasoline cracks come off further, European refinery runs will also start to drop, which could push the HSFO barge structure into backwardation by mid-August, said one trader. A high sulfur barge bull run has seen the front-month time spread strengthen continuously from mid-June onwards. From minus $3.00/mt on June 13 — its lowest in almost two months — the contango structure has been narrowing ever since.

On Tuesday morning, the July/August spread saw high liquidity on ICE, trading six times at minus $1.00/mt before 1300 GMT and four times at minus $0.50/mt shortly after. Looking further down the curve, the difference between Q2 and Q3 2017 has strengthened in line with crude oil spreads, a trader said.

The July HSFO barge cracks have been strengthening for five consecutive days and was trading at minus $13.30/b Tuesday afternoon.