Over the past few weeks, gasoil timespreads have slumped into contango at the front while remaining firmly in backwardation across most of Q1 18. Part of this divergence can be attributed to over-zealous positioning, but maintenance deferrals, following the spike in margins after Hurricane Harvey, have played a role too, pushing planned global turnarounds across November and December 2017 lower y/y by nearly 1 mb/d just as demand shifts seasonally lower into year-end.
For the moment Europe has more supply than it can digest. The near-term outlook has been further clouded by demand softening from a huge summer restocking bid in Europe, which has complicated the task of absorbing the large volume of barrels drawn from storage over the past couple of months.
East of Suez, diesel prices have also weakened, even though this has less to do with destocking and more to do with sharply higher Indian exports. Compared to Q2 17, diesel supplies within Asia were higher y/y by 0.31 mb/d in Q3 17, the highest Q3 level since 2009 as refineries boosted run rates significantly after an exceptionally heavy spring maintenance schedule.
But the market is already pricing in, correctly, we believe, a return to more supportive balances in early 2018. Fundamentally, diesel looks good, with demand supported by sustained global economic growth and supply growth limited in H1 18 due to delays to refinery expansions and the need to undertake deferred maintenance work.
This coming spring, refinery maintenance in India and Saudi Arabia will reduce combined diesel supply from the two countries by around 0.12 mb/d y/y over March-April, potentially setting up Europe for a crunch in ULSD imports. East of Suez suppliers accounted for around a quarter of European ULSD imports in H1 17, and have steadily increased their share in recent years as the US has busied itself with supplying Latin America.
Recent refinery developments in Latin America—particularly Mexico—suggest that USGC barrels will not be readily available to plug the gap left by East of Suez maintenance early next year. Latin America’s Q1 18 diesel short could actually shrink by 80 thousand b/d in Q1 18, but downside to imports will be severely limited by dysfunctional refinery operations in Mexico and Venezuela—at a time when US Q1 18 diesel length will be virtually unchanged y/y on the back of stronger US demand. At the same time, US distillate inventories are today running lower y/y by 24 mb and contain no buffer at all versus the five-year average. The inventory cushion is more comfortable in Europe, but if Russian resupply falters for any reason, it could be heavily called upon.
Thus, there is no reason to get too worried about ULSD demand in key markets. There is no guarantee that stocks will be readily available in the right place, at the right time, with the right specifications, if required at short notice. This all makes the market less able to cope with refinery outages, particularly if cold weather spurs a burst of renewed heating oil demand. Diesel markets are soft at the prompt, but early spring 2018 looks set to turn things around.