White swan

Published at 10:44 17 Mar 2017 by

Wavering faith in the crude rebalancing story prompted a wave of selling this month and product markets were not immune, but it was bizarre for diesel to be caught in the panic. Globally, the overwhelming majority of recent economic headlines have been undeniably bullish for diesel. The only real market anomaly has been the relatively slow pace of reported demand versus market expectations.

Against a backdrop of seemingly weak demand figures, the market has become complacent about supplies and stocks, but perceptions of diesel stocks as bloated are partly misplaced, particularly vis-à-vis the US. At the start of this year, the US was indeed struggling with a massive overhang of stocks on the US East Coast as warm weather eviscerated heating demand. Yet since early February, US East Coast diesel stocks have fallen by nearly 10 mb and total US stocks are down by nearly 13 mb. Over the same period, ARA diesel stocks are down by nearly 3 mb.

Anecdotally, there are now signs that end-user demand in both the US and Europe is picking up. Indeed, the apparent softness in early Q1 17 demand is likely linked to end-user destocking. If this recent emergence of end-user buying keeps up, the market may suddenly wake up to the erosion of a decent chunk of the diesel overhang, especially as supplies remain constrained amidst peak planned maintenance and a plethora of unplanned refinery outages.

The likely destocking by end-users likely explains why it has taken this long for demand to kick into high gear despite the torrent of good economic news. Even in Europe, where concerns over Brexit and rising populism have hogged media column inches, macroeconomic proxies thus far in 2017 suggest further demand strength is likely. Granted, there are downside risks to demand—including in China and Saudi Arabia—but global diesel demand growth of 0.6 mb/d this year, following zero growth in 2016, looks like a safe bet.

Interestingly, this constellation of good economic news comes as resupply into some key markets will be tricky. Anticipation of a heavy turnaround season in Asia starting in April has already led traders East of Suez to bid up east-west values to the point that spot shipments of Asian gasoil to European markets are likely to be unattractive for months. This leaves Europe reliant on getting barrels from the US Gulf Coast, to supplement supplies from Russia, to meet demand. But the US will likely be relatively tight for the next month or so as seasonal maintenance grinds on and demand from Latin America recovers. All this means that European diesel should perform well over the next three or four months.

None of this, however, should be taken as suggesting there are no headwinds in the diesel market. Much like crude, diesel will have to contend with a steady trickle of barrels to market as storage economics unwind. Capacity growth—mainly in Asia—is also a risk, but ramp-up delays are likely and tighter crude markets, particularly if the OPEC deal is extended in May, will pressure margins and undermine long-range export economics. Ultimately, diesel is a derivative of crude oil, and the course of the crude market will have a decisive influence on the path diesel takes this year. If OPEC is successful in regaining control over the oil market by forcing down inventories of crude, diesel will have to tighten as well.

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