Given where Atlantic basin diesel stocks are, ICE gasoil timespreads are clearly underperforming relative to recent history. The risk-reward equation alone suggests the autumn timespreads are cheap, though stocks are set to build through August, which is likely to limit the upside in the very short term. But the market has grown fearful and timid after a very challenging H1 18 for anyone wanting to be long diesel. Tensions over trade mean the longer-term macroeconomic outlook looks less unequivocally bullish than before, but if we are in a trade war, we are still very much in the ‘phoney war’ phase, so demand will still be good for at least another quarter or two.
European refineries will run hard in July and August, cutting the region’s import needs just as US exports to Europe pick up as Latin American import needs are slipping, largely due to higher Brazilian refinery runs. East of Suez, Saudi demand looks set for a much longer stay in the doldrums than we had thought. This has proven to be our worst error so far this year on diesel. We started 2018 thinking Saudi diesel demand would recover from a poor showing in 2017, when it contracted by 0.11 mb/d, but it has worsened materially. It slumped by 0.12 mb/d y/y in May, as lower subsidies and an exodus of foreign workers eroded demand.
Even so, our balances show that European inventories will start September at around 420 mb, some 20 mb higher than at the end of June, but 13 mb lower y/y. Given that a draw of 20 mb over September and October in European inventories is hardly out of the ordinary based on recent history, regional stocks could be around 400 mb by the end of October, a level largely unseen since late 2014.
Likewise, even if US inventories rise by another 10 mb by the end of August, stocks there will be lower y/y by around 16 mb. These barrels will be needed though, given the heavy turnaround profile that is emerging for the autumn. Scheduled maintenance at European refineries is already comparable to year-ago levels for September and October, while a gigantic turnaround season seems set for PADD 2 in the US, which will limit exports of diesel from PADD 3.
The bullish balances don’t end with Q4 18. Even though the market is expecting a deluge of Saudi and Indian exports at the start of next year—in a repeat of what happened this year—probable delays to the start-up of the STAR and Jazan refineries mean that the H1 19 supply situation looks like being similar to today’s.
If supply is not going to be a problem until mid-2019, demand is the only thing that can derail this market. But beyond Saudi Arabia, there is little reason to panic, and we see no cause to adjust our forecasts given that we had already assumed a slowdown in Europe. The US economy is roofing and there is nothing to suggest that balance-of-year Capex budgets will be reined in.
Trade war fears have temporarily rattled the market, but a clear-eyed assessment of the situation shows that while there are legitimate reasons to worry that the global economy is going to suffer a slowdown, that is still some time away. So if we are not in a recession and a hefty turnaround season is around the corner, there is upside to winter gasoil timespreads. ARA should reconnect with the broader market this autumn as maintenance boosts stockdraws.