Emerging market risks are growing for diesel, including Turkey’s slowing imports and Brazil’s unsustainable subsidy programme. Turkish marketers are running down stocks to meet demand and preserve foreign exchange, which is pushing Indian and Saudi diesel into other European markets. Atlantic basin diesel yields are also up strongly amid gasoline weakness while heating oil and agricultural demand has been soft. Despite these challenges, stocks are mainly building at pricing centres and, given gasoline’s weakness, diesel cracks cannot fall too far.
European inventories were probably near 420 mb in early September, some 21 mb lower y/y. US stocks were flat y/y in mid-September, which is favourable since huge amounts of refining capacity were offline last year due to Hurricane Harvey. High Brazilian refinery runs in June and July slashed imports from the USGC, but the late-August Replan refinery explosion has brought Brazil back into the market. If Latin America can pull USGC barrels away from Europe until turnarounds get underway and demand swings higher seasonally, then the strength many have sought in diesel will be felt—so long as the winter brings with it normal heating demand.
Emerging market risks are contained but not resolved. Turkey is responding to macroeconomic issues by cutting government spending, but many infrastructure projects have already stalled. But not every country with a weak currency is suffering. In India, despite oil prices in local currency hitting four-year highs, diesel demand was 4.2% higher y/y in August, and heavy government spending should offer further support ahead of next year’s election.
The supply side must also be watched closely. We have long expected considerable refinery capacity creep ahead of IMO 2020—a transition that will effectively begin in mid-2019—and there is some evidence of shifts already (in India, some refineries are running 20% more crude than their nameplate capacities). Looking ahead to H1 19, the likelihood of diesel output growing beyond demand is very high given the steps refiners must be taking to squeeze more clean product from existing plants.
Indeed, for some time now our main IMO 2020 view has been that making the clean product required by the marine sector will be relatively easy. The hard part will be getting rid of unwanted residual fuel oil. This is not to say diesel oversupply is guaranteed in H1 19. Delays to greenfield refinery projects, such as Saudi Arabia’s 0.4 mb/d Jazan project, would significantly reduce supply growth. But the stars are moving out of alignment for diesel. Supply is growing and crude, which is costly and getting mores costly due to the loss of Iranian supply and the need to reverse years of underinvestment, will weigh on oil demand growth rates.
Over the short term, a lot of the bad fundamental news is already priced in. August and September are traditionally weaker periods for diesel demand, and this year will be no exception, especially with agricultural weakness in Europe and Russia. Heavy TARs in PADDs 1 and 2 are set to get underway, and the closure of Trinidad’s refinery will boost Latin American import needs. Indian demand swings higher seasonally from this point too and with the Chinese supply strained by stronger-than-expected demand growth there, Asia should be able to provide some support as well.