The Middle East fuel oil market is braced for a tightening third quarter as soaring power generation demand is set to curb Saudi Arabia's exports and Western sanctions could deprive the market of Iranian supplies, said experts.

But although tighter supplies should push Gulf fuel oil premiums higher and could lift the Singapore ship fuel bunkering market, fears of regional fuel oil shortage are unfounded, traders and analysts in the Middle East and in Asia say.

'Saudi Arabia is likely to remain a large net exporter of fuel oil, with much of this going to Asia,' Riyadh-based HSBC analyst John Tottie said.

'As we go into the summer season, the import of lower-sulphur fuel oil may increase, just as it did in 2011... Yet the kingdom is likely to remain a large exporter of high-sulphur fuel oil, given the high fuel oil yield of Saudi's oil refineries.'

Barclays Capital said in a note last week that Saudi plans to slash crude use for power generation may turn it into a net importer of fuel oil this summer.

'With Iranian volumes likely to be curtailed severely following the sanctions and with the risk that Saudi Arabia turns into a net importer of fuel oil, more than 1 mt (million tonne) of fuel oil exports are at risk of being lost from the market,' London-based analyst Miswin Mahesh said.

Asia-based traders who also rely on Middle East fuel oil do not expect major shortages as they anticipate increased fuel oil shipments into East Asia from other producers.

Industry players still point to Western arbitrage cargoes as remaining the main bearish factor for East Asia's fuel oil market.

'Together those two factors - fall in supplies from Saudi and Iran could be very bullish,' a Singapore-based trader said. 'But it will also depends on Singapore strength.'

Asia's fuel oil market fell sharply in early March under the weight of heavy supplies and slow demand.

Spot cash premiums for the 180 cst and 380-cst grades have since improved to above $2.00 a tonne though, recovering from a discount low of 10 cents and 50 cents respectively as Western imports fell to three-year low levels in April.

Saudi Arabia's plan to reduce direct crude burn for power generation and rely more on natural gas and fuel imports this summer could result in a drastic drop in its monthly average fuel oil exports of around 500,000 to 600,000 tonnes.

But several Gulf-based traders say the drop in supply from the leading fuel oil exporter was unlikely to shock the market, thanks to ample Saudi stocks and alternative fuels.

'They have been building inventories of gasoil, which they will use in summer,' one-Gulf based fuel oil trader said. 'It also depends on how much gas they can obtain from the fields. In the end, crude burning may not be much less, but just a bit less,' he said. 'They have other options than fuel oil.'

Uncertainty over temperature-driven electricity demand, or how much will be met with gas, make it impossible to predict how much fuel oil will be burnt by Saudi Arabia but there is wide agreement that fuel oil exports will fall.

'In the end their available supplies will fall, but I think they will still be able to export,' a second Gulf-based fuel oil trader said.

Iran issues

The availability of supplies from the other major Middle Eastern fuel oil exporter Iran could take a hit from the US-led sanctions.

Western sanctions aimed to deter Iran pursuing its nuclear programme may not specifically ban purchasing Iranian fuel oil, but financing and shipping difficulties make overall trade with Iran almost impossible.

'Already a few of Iran's existing fuel oil lifters have been sanctioned by the U.S. government, and as long as the sanctions exist, these volumes are likely to find it difficult to access consumer markets in the Far East,' Barclays said in its note.

While there is a consensus that July 1 will mark a much tighter era for Iran to export crude and oil products, some traders still believe the sanctions have never been water-tight.

'It will end up one way or the other in either Singapore or in China,' a trader said.

Record volumes of Iranian fuel oil flowed into East Asia in 2011, even though there were some sanctions already in place, making up nearly 8 percent of the 7-million tonne monthly inflow into East Asia, the world's biggest fuel oil market.

The region typically gets two grades - the National Iranian Oil Co's (NIOC) straight-run 280-cst, mainly used as feedstock in refineries, and the cracked 380-cst as bunkering fuel.

Iranian cargoes are in high demand in Asia because their low-density, low-water specs allow blenders to extract more value from the oil.

Regular lifters of Iranian fuel oil have included Shell, China's Tianbao, a subsidiary of Zhuhai Zhenrong, Vitol, Saudi trader Bakri, as well as Singapore's Kuo Oil and Middle East trader FAL Oil, both of whom has been placed on the U.S. government's sanction list.

Both Iranian and Saudi fuel oil is high-sulphur cargoes and therefore usually finds home among China's refiners as well as Singapore and Fujairah bunker market for ship refuelling.

But since March, cargoes out of Iran's Bandar Abbas refinery have trouble finding buyers in the local shipping hub Fujairah, due to payment problems.

'I don't think a lot of the Bandar Abbas cargoes right now are ending up in Fujairah as no one here can pay for it,' a fuel oil trader said. 'No bank will allow it..They're mainly going to Far East, Singapore.'

After July 1, when sanctions tighten further, it will be a matter of available customers instead of available cargoes. 'The cargoes will still be there,' said an Asia-based fuel oil trader. 'They're not cutting back production, so the cargoes has to go somewhere,' he said.

'China seems to be everyone's bet.'

The EU will prohibit European insurers and reinsurers from indemnifying tankers carrying Iranian crude oil anywhere in the world from July, threatening to curtail shipments and raise costs for major buyers like China, India, Japan and Korea.

Jordan's increased thirst for gasoil and fuel oil, because of repeated attacks on its Egyptian natural gas supply line, could also add to a tight market and has already led to some supplies being re-routed west to Jordan.-Reuters