Diesel balances are still hugely bullish but the market is struggling to find ways to take a view on these balances, with ARA gasoil markets confounding traders time and again this year. We don’t think the benchmark is broken, but the market needs to keep in mind that the idiosyncrasies of the ARA barge market and the hub’s function as a point of storage for surplus barrels mean that there will be times when ICE gasoil futures simply reflect the fundamentals of the ARA market, not the broader global diesel market.
Indeed, we think the ARA market may struggle through July or even August as stockbuilds are the norm during the summer months and any draws will be modest with European refineries running at peak rates. But behind this lacklustre price action, the market will be tightening again. Low diesel yields appear to be a structural phenomenon in the US. Meetings with US refiners this month confirmed something we have suspected—light shale crude is pricing itself into USGC refineries, keeping gasoline yields higher than the market expects because this is the most profitable feedstock and product mix for US refineries right now.
The world might want more diesel, but US refiners will continue to act in their own self-interest. US diesel yields have been flat to lower y/y so far this year as cheap crude, like DSW, has found a ready home in US refineries, which are happy to get discounted feedstock even if it means sacrificing diesel yields. If the market wants more diesel, it is going to have to pay higher prices to incentivise US refiners to make more. In short, diesel needs to rise further against gasoline.
The problem is also seen in Europe. In Q1 18, European diesel yields averaged 44.3%, lower y/y by 1.0 ppt, in part due to the strength in jet, as well as higher runs that boosted the use of unsophisticated topping capacity that pushed up fuel oil yields. US crude being exported to Europe and Asia probably cannot be blamed for lower yields though, as overseas refiners have mostly shunned the least distillate-rich US crudes, leaving them for the US refiners.
Nor can the market expect much supply from new plants. Outside of China, where the latest round of export quotas will keep outflows on a short tether to year-ago levels, net refinery capacity additions have been few and far between since last summer. In other words, a largely unchanged global refinery fleet will need to meet higher demand, at a time when lighter crude slates are making it difficult to increase diesel yields.
So the ARA market, which has parallels to Cushing in the US crude oil market because of its logistical constraints and the fact that it ends up as a main arrival point for long-haul diesel on large vessels given port constraints elsewhere in Europe, may struggle this summer—especially if seasonally normal stockbuilds are concentrated there. But behind the scenes, there are significant structural problems in the diesel market. Demand is robust and supply is not. Over Q1 18 global demand grew by nearly 0.9 mb/d y/y while global supply eked out a feeble 0.1 mb/d y/y gain. This is unsustainable and cannot be contained without higher prices.