Optimism has returned to the diesel market. Though demand worries persist, Atlantic basin stocks have not built by as much as many feared, ourselves included. We still think the IMO transition is manageable given the new refining capacity due onstream and the looser specifications for marine gasoil. But if stocks are low headed into this shift, the wind will be put into the sails of the bulls. Heading into this transition, which we expect to create some 2.1 mb/d of new marine gasoil (MGO) demand, with low stocks is a recipe for a very strong diesel market, especially with worries growing over the ability of refiners to shift yields to distillates.
Atlantic basin diesel stocks have been drawing for two years and low oil prices have boosted demand worldwide for fuel. So, a bit of weakness in European demand in Q4 18 will not be enough to bring the market back under control if supply is struggling. After all, even with a soft Q4 18, European diesel demand in 2018 was probably more than 0.5 mb/d higher than in 2014.
Floating storage in Asia has shrunk considerably and flows to the Atlantic basin were lower than expected in December due to TARs in India and the Middle East. Indian diesel exports were 0.68 Mt lower y/y at 2.04 Mt in December, according to Kpler cargo tracking, with shutdowns at key exporting refineries (Kochi and Reliance) pointing to more of the same in January. However, some of these barrels were moved into onshore storage and are likely to be put into newbuild VLCCs and shipped west in time to arrive in Europe in April for turnaround time.
Upcoming Indian elections and the country’s ongoing transition to BS-VI fuel specs will also complicate matters. Indian elections tend to be supportive for fuel demand and the BS-VI transition is forcing refiners to schedule plenty of turnaround work this year to make the necessary modifications to their refineries by the end of the year.
Last year’s sharp fall in gasoline cracks led to expectations that refiners would dramatically shift yields, but changes have been modest so far, not least due a lightening crude slate. We peg European refineries’ diesel yields at 44.6% in November—1.3 ppts higher y/y but still below highs seen in recent years—while US diesel yields fell by 0.3 ppts y/y to 30.5% in October.
The 0.21 mb/d Star (Turkey) and the 0.31 mb/d Rapid (Malaysia) refineries are both moving towards commercial operations, but the big problem is Saudi Arabia’s 0.4 mb/d Jazan refinery—construction here has been slow, stoking worries that its expected 0.25 mb/d of middle distillates may not hit the market as soon as many assumed.
The strength of demand will in H1 19 will go a long way to determining the course of the rest of the year. If visible diesel stocks build substantially over the next six months, a lot of traders worried about IMO 2020 will breathe a lot easier. Even so, just building stock at bunkering ports will inject new ‘demand’ into the market long before 1 January 2020. If bunker sellers want to hold 10 days’ inventory, then some 20 mb of commercial stocks must be bought at some point, which works out to over 0.22 mb/d if done over a single quarter. The closer we get to this transition, the greater the anxiety over stocks will be if diesel yields and supply cannot both put in big gains soon.