After a long wait, refiners appear to have finally boosted diesel output at the expense of gasoline, causing a collapse in Atlantic basin diesel ahead of the March ICE gasoil expiry. Just as the market sought to test how low it could push gasoline down in Q4 18, it looks set to probe how much of the diesel premium it can erode this spring. However, tightening US physical diesel markets are likely to keep diesel from slipping too far into contango, and with crude slates continuing to lighten, there is still the challenge of boosting diesel yields while curbing light product yields.
The first test will come from jet, which is still favoured by refiners over gasoline, despite the recent rally. Diesel, on the other hand, stands at a healthy premium to gasoline in both the Atlantic market and East of Suez, and even outpaces jet on a per barrel basis. This should incentivise refiners to divert molecules from the oversupplied jet pool to the diesel pool. USGC data suggests that that diesel yields are already competing with those of gasoline and jet, forcing diesel into a slight contango.
Yet it is interesting that diesel stocks have been so slow to rise in the Atlantic basin in Q1 19 so far. Visible gains in the US and Europe are modest and there is evidence that yields are already swinging back towards gasoline, something which could accelerate with RBOB rallying amid another unplanned USEC refinery outage.
The sell-off in physical diesel markets has laid some of the groundwork for a recovery, as the economics of sending diesel from the East of Suez westwards has been eroded, pulling Asian markets into a modest contango. But with seasonal maintenance beginning, Asian markets are faced with fewer challenges than Europe as the dearth in sours weighs on refining margins, likely incentivising more maintenance. US refiners also continue to bemoan the dearth of heavy sour crude worldwide, which, due to US sanctions on Venezuela, has increased the region’s reliance on domestic crude, which, in the face of a severe lack of alternatives is finding its way into refineries, quality issues or not.
It is the competitiveness of these lighter crudes that threatens the idea of a sustainable increase in diesel yields. West Texas Light crude, the new segregation being created to deal with the Permian’s rapidly lightening production, is being discussed at a $5 per barrel discount to MEH crude in Houston, and lower quality barrels probably command even greater discounts. Moreover, with US sanctions policy on Iran set for review by May and likely to lead to further cuts (however small) in imports of Iranian crude by Asian buyers, the tightness in sour grades is going to get worse before it gets better.
Stocks are likely to be broadly flat in April and build in May due to the front-loaded turnaround season this year. We expect refinery runs in the Atlantic basin to be broadly flat y/y in April before rising in May by around 1 mb/d y/y, boosting European diesel supply, but the US is still likely to draw amid exports to Latin America, where runs are falling but GDP growth is rising, while Asian sellers have seen their incentive for sending supplies westwards evaporate. If our assumptions play out, the world will enter the peak period of summer demand in the Atlantic basin with only a modest stock cushion.