Pockets of strength are beginning to bubble to the surface in global middle distillate markets. Outside of North America, where the winter has again been mild, albeit colder than a year ago, heating demand has been strong. Spring refinery works in Asia and on the US Gulf Coast look heavy, while European work is concentrated in key diesel markets like Germany. Atlantic basin diesel stocks outside of the US East Coast are likely to be in y/y deficit by the end of Q1 17 and further draws are likely in Q2 17.
A key difference this year is the strength in diesel demand worldwide. The warm winter of 2015-16 coincided with weak industrial activity and the ramp up of new refining capacity in the Middle East. This time around demand is strong and supply growth is limited, despite strong margins, as unplanned outages are eating into refinery runs. Global manufacturing PMI readings reached new multi-year highs in January, suggesting that global economic growth is gaining momentum. Anecdotal reports from Asian oil products traders suggest Chinese oil demand bucked the traditional post-holiday lull and emerged from the Lunar New Year holiday with renewed vigour.
Indeed, there are plenty of signs of an improving macroeconomic environment worldwide. Petrochemicals prices are surging, while the Baltic Dry Index is more than double year-ago levels. Stock markets are performing well and the latest demand data are positive, especially in Asia, where South Korea, Australia and Japan posted strong diesel demand readings in December 2016. Southeast Asian importers are also buying healthily and even China is turning a corner, posting y/y diesel demand growth in both November and December 2016, but rising smog levels may once again lead to reinstated coal output limits that will weigh on diesel.
Despite the good signs from demand, working off a still significant global inventory overhang will require both planned and unplanned supply outages, especially as the global refining system can still make more diesel than is needed if every plant is running flat-out. Planned turnarounds in Asia are higher y/y by a massive 1 mb/d in both March and April, while unplanned outages are adding another layer of support. Despite stellar refining margins in just about every corner of the world, we expect relatively modest diesel supply growth in Q1 17.
As a result, we expect European diesel inventories to be 10-15 mb lower y/y by the end of February. ARA stocks are already down by some 2.5 mb y/y, even though the Rhine has been effectively shut to barge traffic for weeks and is unlikely to reopen until the spring. East-West flows will be minimal for the next several months due to strong pricing in Asia amid turnarounds, while heavy US refinery work this month will limit inbound flows from the Atlantic basin, unless more cargoes can be lifted out of the oversupplied New York Harbor.
The positive conditions will not last forever, though, and we remain concerned about balances for Q3 17, which look very oversupplied unless demand comes in quite a bit stronger than we expect. Current forward margins suggest refinery runs will be very strong in Q3 17, with new refineries and conversion units in China, India, Vietnam and Egypt adding supply. Furthermore, with gasoline markets risking a re-run of the summer 2016 collapse, yield switching into middle distillates is a looming risk.