Run to the hills

Published at 10:16 20 Apr 2018 by

Diesel markets are tightening already, and, with crude rallying, production growth will be a challenge in the near term. Simple margins have been hammered by the surge in Brent prices. Meanwhile, the Atlantic basin stock situation is much more bullish than a year ago—inventories have likely fallen by nearly 18 mb since the start of the year (0.16 mb/d), while they built slightly over the same period in 2017. Commercially available stocks are much lower than headline numbers suggest. US bulk terminal stocks are no more than 68.2 mb (17.4 days of forward cover), a level last seen in Q3 14. EU commercial diesel inventories are probably closer to 10 days of forward cover and the continent’s stock buffer, before things get really uncomfortable, may be as small as 21 mb.

The market could therefore be in for a torrid summer if supply and demand patterns are anything like those in 2017. Between the end of April 2017 and the end of November 2017, European diesel inventories plunged by nearly 55 mb and US stocks dropped by another 22 mb. Runaway cracks were prevented by the fact that Europe and the US were sitting on 476 mb and 155 mb of diesel, respectively, at the end of April 2017. This year, European stocks could be as low as 430 mb, while US inventories already stand at just 125 mb.

There are few signs that demand has cooled off. Between January 2016 and February 2018, European diesel demand has grown y/y in all but seven months. More often than not, European diesel demand has been notching up big increases, but there has been strong growth elsewhere, too. Global diesel demand rose by 0.75 mb/d in February, helped by solid growth in India and Australia, among others, easily outpacing global supply growth of just 0.41 mb/d.

The main incremental source of supply this year has been Saudi Arabia, which has emerged as the second-largest supplier of diesel to the EU after Russia, eclipsing the US. But a lot of the growth in Saudi shipments to Europe is making up for lower imports from the US. As a result, European diesel imports are continuing to trend lower even as demand is growing strongly.

Increased Russian supplies will help but cannot alone plug the gap. Expectations for a deluge of Chinese supply need to be tempered, too. Exports in March likely smashed previous records, but they will slow from here, and three much-publicised VLCCs will only hit Europe, even if that is their final destination, in early June at the earliest. On our balances, European import requirements are slightly higher this year vs 2017, while stocks are far less comfortable, and incremental Chinese supply will not be enough to fill the shortfall.

If there is little let-up in demand, how will the market balance? Another 2017-style massive inventory drawdown is impossible because there simply is not enough in stock. Yet there is little room left for y/y gains in refinery runs in Europe beyond June as plants were largely running at capacity in the summer of 2017. Moreover, refinery margins are getting hammered and while geopolitics is dominating crude markets, all product cracks are likely to struggle until product stocks are drawn to very tight levels, which will be signaled by timespreads.

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