July 27 (Bloomberg) -- Fuel oil, the waste left after making gasoline and diesel, is becoming as valuable as crude for the first time in six years.

Prices have doubled this year to the equivalent of $66.47 a barrel in Singapore, approaching the $70.30 of Arab Light crude, which has been more expensive since July 2003. Fuel oil output at refineries in the developed world fell 18 percent in April from a year earlier, the International Energy Agency estimates. China’s imports climbed 46 percent in June from a year earlier, Barclays Capital said in a July 22 report.

The increase is squeezing Hamilton, Bermuda-based Frontline Ltd. and A.P. Moeller-Maersk A/S, the world’s biggest shipping companies, while rewarding Exxon Mobil Corp. and Reliance Industries Ltd., owners of the largest refineries in the U.S. and Asia. The shortage is growing as the oil industry builds new plants that obtain more gasoline and diesel from each barrel.

“I don’t expect the situation to change any time soon” in fuel oil, said Christian Laurenborg, a Copenhagen-based trader for Maersk, the operator of more than 500 container ships. “We are suffering a bit.”

Frontline, the world’s biggest operator of oil tankers, has ordered captains to slow their ships to conserve fuel, said Chief Executive Officer Jens Martin Jensen. The average vessel consumes about $40,000 of the fuel, known as bunker, a day.

“With bunker prices going up, it has a strain on the bottom line,” Jensen said in a telephone interview. “We are slow steaming, it makes sense to slow down.”

Refinery Leftovers

Fuel oil is what remains after propane, jet fuel, gasoline and diesel are distilled from crude. Refiners can build plants that take that residue and process it again to strip out more fuels for cars, trucks, trains and airplanes.

Every 42-gallon barrel of Arab Light crude yields 19 gallons of fuel oil when run through a typical refinery, according to New York-based Energy Intelligence Group. Plants equipped with so-called cokers and hydrocracking units produce almost no fuel oil.

Fuel oil cost $10.15 a barrel less on average than crude during the past five years. The discount to Persian Gulf benchmark Dubai oil narrowed to $1.56 a barrel July 24 from $30.46 in June 2008, according to data compiled by Bloomberg.

The price in Singapore may exceed crude within three months, said Harry Tchilinguirian, a senior oil markets analyst at BNP Paribas SA, France’s largest bank.

Fuel oil may surpass crude “for quite some time, six months is possible,” JPMorgan Chase & Co. vice president of energy strategy Vima Jayabalan said in a phone interview from Singapore.

World War II

Refineries are limiting production as the first global recession since World War II curbs oil consumption by 2.8 percent this year, the fastest decline since the early 1980s, according to the IEA. Crude oil dropped 78 percent to a low of $32.40 a barrel on Dec. 19 in New York from a record $147.27 on July 11, 2008.

The Organization for Petroleum Exporting Countries agreed since October to reduce output by 4.2 million barrels a day, or 14 percent, to support prices. Members cut sales of the lowest- quality crudes, which cost the least and yield the most fuel oil, Asian refinery officials said.

Saudi Arabian Oil Co., OPEC’s biggest producer, will supply 20 percent less than contracted volumes to Asian refiners in August, with the deepest cuts in heavy and medium crudes, according to a survey of refinery officials on July 9.

SK Energy, Nippon

SK Energy Corp., South Korea’s biggest refiner, ran its refineries at 72 percent of capacity in the second quarter, and the country’s fuel oil production in May was down 46 percent from a year ago, according to the Joint Oil Data Initiative, a data collection agency for international groups including OPEC and the IEA. Nippon Oil Corp., Japan’s largest processor, planned to cut output 24 percent this month from July 2008 levels, Director Masahito Nakamura said on June 29.

Across Asia, 3 million barrels of daily refinery capacity has been idled, said John Vautrain, a senior vice president at Purvin & Gertz Inc., a consulting firm in Singapore. “When that kind of capacity cuts back, it has an outsized impact on fuel oil supply,” he said.

Bunker inventories in Singapore, Asia’s biggest trading center and fueling port, fell last week to 14.1 million barrels, 19 percent below the two-year average, according to International Enterprise, a government agency. In the Amsterdam, Rotterdam and Antwerp region, Europe’s oil-trading hub, inventories dropped 24 percent in the past year to 567,000 metric tons, according to PJK International BV in Oosterhout, the Netherlands.

Hydrocrackers, Cokers

Exxon and Reliance can increase production of gasoline and diesel by putting fuel oil through hydrocrackers, catalytic crackers and cokers. A refinery with these units can make $1.38 from each barrel of Dubai crude, compared with the 91 cent-a- barrel profit from a plant without them, data compiled by Bloomberg show.

BNP Paribas estimates that refinery units capable of breaking down an extra 1.4 million barrels of fuel oil are being built in Asia that will come on line by the end of 2011.

Refiners “think fuel oil is low so they are cracking more,” said Simon Neo, a deputy managing director at Singapore- based Equatorial Marine Fuels. “This means higher costs for the marine industry.”

The fuel expense of running the biggest oil tankers is $40,280 a day, based on the $424 a metric ton costs in Singapore. That’s more than three times the $12,270 that London-based Drewry Shipping Consultants Ltd. estimates for paying crew, insurance, repairs and related operating expenses.

‘Really Hurting’

“It’s really hurting” ship owners, said Parul Bhambri, a Singapore-based analyst at Drewry.

Maersk said May 12 that falling demand for freight hobbled its ability to pass on fuel costs to customers in the first quarter, when its shipping line lost $559 million after taxes, compared with an $80 million profit a year earlier. The shares are down 40 percent in the past year in Copenhagen trading.

Unlike most shipping lines, Maersk owns bunker-fuel storage facilities and trades cargoes, protecting the company’s profits as prices rise, Laurenborg said. It is also has crude oil production, which acts as a further hedge.

Frontline shares fell 59 percent in Oslo during the past 12 months. The company said in May it canceled one of every three new ships on order and that net income in the first quarter plunged 65 percent to $76.6 million.

Output Incentive

As fuel oil prices climb, the incentive to boost production increases, said Vautrain at Purvin & Gertz.

“If fuel oil rose above crude, then that implies you start getting some decent profitability for simple refining,” he said. “There are too many of those units sitting on the sidelines and they can come back at any time.”

Fuel oil production is also falling as Saudi Arabia and the rest of OPEC cut output of the lowest-quality crudes. Saudi Arabia’s Arab Heavy yields 22 gallons of fuel oil per barrel, three more than what comes from Arab Light.

Saudi Arabia has reduced production this year by about 400,000 barrels a day, or 4.5 percent, to about 8 million barrels a day, according to data compiled by Bloomberg.

“There are availability issues with fuel oil,” said Amrita Sen, an analyst at Barclays Capital in London. “The Chinese are switching to products with a higher margin like diesel and gasoline. Products like fuel oil are suffering.”

China’s bunker output dropped 10 percent to 375,000 barrels a day in May from a year ago, according to the Joint Oil Data Initiative.

Asia’s appetite will increase over the next five years, according to the IEA. Supplies in the region are expected to be 1.2 million barrels a day below demand by 2014, the group said.

“You have to consider fuel oil up until now a byproduct,” said BNP’s Tchilinguirian. “With the additions that we see to existing refineries of conversion capacity, and the new refineries coming on, refiners are aiming to reduce that.”

To contact the reporters on this story: Christian Schmollinger in Singapore at christian.s@bloomberg.net; Alaric Nightingale in London at anightingale1@bloomberg.net

Last Updated: July 27, 2009 02:17 EDT