Diesel markets appear to be stuck in a rut as envy of the price gains in crude has translated into frustration that cold weather in the US has not proven to be much of a price catalyst for the fuel. As a result, diesel spreads have given up much of the gains won in the initial euphoria over the cold weather. This means there is value to be realised, but capturing it will require a more expansive outlook.
Fundamentals in the diesel market are little changed from 2017, with the key exception that we can no longer endure the massive stockdraws that filled the gap between supply and demand last year without causing a price spike. This means that to meet 0.77 mb/d of global demand growth, runs will have to rise by well over 2 mb/d. So once inventories start to decline in turnaround season, things will tighten up quickly.
This is why short-term builds are not a huge problem. Despite chunky stockbuilds that took European diesel inventories up by more than 25 mb from end-2016 levels to 476 mb in April 2017, European stocks likely fell to around 430 mb in November 2017, which would be their lowest recorded level since July 2015. Over the same period, US diesel stocks fell by another 20 mb even as European refineries ratcheted up runs to near maximum levels. This year, stocks are starting from a lower base and demand fundamentals have improved a lot since H1 17.
Following bumper OECD demand growth in 2017, the key chapters of this year’s demand story will be written in the non-OECD. The laggards of demand growth over the past year are also some of the largest diesel growth centres of the past—the Middle East, Latin America and India—and all are poised for a brighter 2018. Growth in the OECD is set to be strong too, albeit slower than 2017. Europe and North America together accounted for 0.31 mb/d of global diesel demand growth in 2017, and we expect the two regions to record combined growth of 0.24 mb/d in 2018 despite an exceptionally strong base.
Importantly, meeting this demand growth and curbing the rate of stockdraws will require hefty increases in crude runs. Scheduled global net CDU and condensate splitter additions are 0.7 mb/d in 2018, but most of the additions will only come onstream in H2 18. The ramp-up of 2017 additions will add to supplies, but scope for a significant y/y uptick is limited. A potential wildcard, on the supply side, is China, but high crude prices and impending invoicing changes there are likely to weigh on margins, capping runs growth.
Our global balances are tighter y/y by 0.13 mb/d in Q2 18, at a time when the market is entering 2018 with limited inventory buffer given that OECD diesel stocks ended 2017 below the five-year average. European refiners will keep runs close to their Q4 17 highs in Q1 18, pumping out 0.17 mb/d more diesel than last year, and FSU diesel production may be 80 thousand b/d higher y/y thanks to improving yields at Russian refineries. But the market needs these barrels. Planned Q2 18 CDU work in Europe is already 1.1 mb/d, higher y/y by 0.22 mb/d and Asian refinery works in key export countries (i.e. India, Taiwan, South Korea and Singapore) over March and April will tighten the East of Suez market further, thus limiting flows from the region into Europe. FSU work looks light, for sure, but Europe cannot live on Russian barrels alone.