The outlook for middle distillates continues to improve. US stocks are down by more than 20 mb since the start of the year and inventories are draining elsewhere too. The drawdowns have halved the overhang in visible middle distillates inventories to just 17 mb, and with Asia and the FSU only starting their turnaround season, further draws are likely.
Impressive stockdraws come even as Asian diesel demand was mired in a temporary slowdown in Q1. After a blowout final quarter in 2016 that saw Asian diesel demand climb by 0.25 mb/d, Q1 17 looks set to come in flat y/y, perhaps even marginally down. The good news is that this is down to a series of one-off events rather than a structural slowdown. Smog in China, the demonetisation in India, and disruptions to mining and port activity in Australia and Indonesia all contributed to the weak performance.
Indeed, the picture for the coming months looks much better, with leading macroeconomic indicators coming in strong and the IMF even raising its view on global economic growth this month, marking a refreshing change from the regular downgrades. Importantly for the Atlantic basin, Europe seems to be shrugging off the doom and gloom of political risks and may be turning in its best economic performance since 2011, which is hugely positive for the market.
The supply side is also proving supportive. There has been plenty of worry in the market that the diesel rally could be short-lived if strong margins encourage high refinery runs and gasoline flops for a second year running, encouraging refiners to switch to maximum diesel yields in the summer. While margins are indeed strong, this looks to be down to good demand, and the gasoline market has so far avoided the mines that sunk the summer rally in 2016. So the fear of yield switching should recede, and given that the new refineries starting up in Asia this summer will take time to stabilise, higher output is unlikely to materialise until the end of 2017.
The supply side could be further boosted by developments in China and West Africa. China is widely expected to slap a $200 per tonne consumption tax on imports of light cycle oil to clamp down on the practice of importing tax-free LCO, which is then blended into the diesel pool in China, forcing Chinese refiners to export surplus product that cannot compete with the untaxed blended material. With up to 0.2 mb/d of LCO weighing on the saturated Chinese domestic market, this development is unequivocally supportive.
Likewise, Nigeria and Ghana, which together account for about a third of West African gasoil imports, appear set to impose a 50 ppm sulphur limit on imports from 1 July, a development that will send shockwaves through the higher-sulphur gasoil market if successfully implemented. WAF gasoil typically contains 2,000 ppm sulphur, so this will not be a question of blending material down but rather a wholesale switch to cleaner product that would otherwise go into the pool of diesel imported into Europe.
Bottom line—we remain constructive on diesel into the summer on a better demand picture and supportive developments on the supply side, with potential for upside surprise in early Q3. After a few dismal years, diesel may finally be a support for global oil demand growth this year.