Stretched thin

Published at 09:54 22 Sep 2017 by

Even before Hurricane Harvey deluged the Texas Gulf Coast, shuttering more than a dozen refineries in the process, the Atlantic basin diesel market had been tightening significantly. The storm can rightly be called the proximate cause of the rally in diesel cracks and timespreads over the last month, but the roots of this upswing run deep. Between 3 February and 25 August, US distillate fuel inventories fell by 21.6 mb despite record refinery runs in the US and the highest refinery throughputs in Europe in years. So, at the very least, the market is entering the strongest time of the year for demand after losing a lot of its inventory cushion.

It is therefore hard to view Q4 17 as anything but unequivocally bullish. Since the start of September, US diesel stocks are already down by 10 mb and more draws are likely—exports are pushing back towards pre-Harvey levels, refinery disruptions are proving persistent, the hit to demand looks to have been modest, and Latin America’s import requirements are hovering around record highs. On our balance figure, US diesel stocks are poised to slide to as low as 130 mb by the end of October, a level not seen since May 2015.

The strain on the system in the Americas would be more manageable if not for similar pressures on the other side of the Atlantic, but Russian diesel exports will be sharply lower this month at a time when Europe’s net diesel short is more than 0.1 mb/d higher y/y owing to strong local demand and a flat y/y turnaround profile. Yields have recently favoured jet over diesel while European refinery runs have been unable to push higher across the summer, even with margins ratcheting up. This speaks to a broader issue—globally there is little spare refining capacity.  

The blowout in East-West gasoil spreads is a symptom of this impending supply crunch, but resupply from Asia will be delayed by long sailing times, and rising clean freight rates mean prompt arbs are not nearly as workable as many believe. Indian balances tighten into Q4 17 as demand should swing higher q/q by 0.25 mb/d, which may limit how far Asian ULSD can weaken as well. Moreover, infrastructure limitations, as well as ongoing environmental and safety inspections, will cap China’s Q4 17 diesel exports despite new export quotas being issued.

The saving grace for European resupply is the ongoing collapse in Saudi demand, which should free up barrels from the Kingdom’s export refineries, although Middle Eastern ULSD has struggled to meet European cold properties in the past. This is a key point. While balances do not look significantly worse than a year ago on a molecule basis, tightening specifications in a number of markets mean that competition for cleaner diesel is increasing.

Given the limited resupply coming from the US, FSU and Asia, European draws should be bigger than usual in Q4 17. Declines of 10-15 mb in European inventories over September are not out of the question given how low resupply from the FSU will be this month. If such declines occur, the market is not only looking at a return to Atlantic basin stock levels from early 2015, but perhaps to a diesel market as tight in Q4 17 as it was in 2012.

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