Middle man

Published at 10:22 12 Apr 2019 by . Last edited 11:18 22 Aug 2019.

Cash markets have offered diesel bulls little support so far this year, as weak demand for both on-road fuel and heating oil in Europe has limited the pull on supplies from the ARA pricing hub. Between Germany’s struggling car industry and warm weather in February and March well above the five-year average in Germany and France, demand has been hard-hit. Making matters worse, a 30% rise in crude prices since the start of the year has discouraged heating oil restocking, with inland deliveries falling by just as much.

Europe’s economy is not out of the woods yet as trade tensions weigh on the vital export sector. Even so, the Q1 19 builds in ARA stocks were modest—especially as US inventories declined over the same period, leaving the Atlantic basin market roughly balanced. Throughout April and May, however, stockdraws are less likely—despite a slowdown in eastern flows as Asia enters spring maintenance season—due to much lower scheduled turnarounds in Europe and the US.

Atlantic basin diesel markets must also contend with very weak jet fuel pricing, which could pull more kerosene molecules into the diesel pool. Unlike diesel, the big problem for Atlantic basin jet has been supply rather than demand. The shift towards lighter US shale crudes has been instrumental in boosting jet yields to multi-year highs in key parts of the market, including the USGC and the UK. As a result, ARA jet stocks are holding well over last year’s levels.

This crude quality issue is unlikely to go away as the dearth in heavy crudes is emphasised by the OPEC+ cutbacks, the loss of Venezuelan crude amid US sanctions and recurring nation-wide blackouts, and heightened competition for alternative West African grades. Indeed, the growing competition for crude represents the likely key to diesel markets going forward as refineries may have to cut back production due to suboptimal crude slates and strong crude prices.

USGC diesel continues to make its way to Latin America instead of Europe, though this by itself is insufficient to trigger much of a rally in ICE gasoil, as East-West flows have been far more important for European balances in recent years. What Europe genuinely needs is a return to the economic growth that characterised H1 18, but getting there will not be easy. Trade wars, Brexit, Germany’s auto industry woes and Italy’s slow growth curse all mean the region lacks the internal economic impetus capable of driving economic expansion.

So Q2 19 looks like a tough time for diesel bulls, though with the warm winter now firmly in the past, a lot of the worst has already happened. Beyond Q2 19 lies the world of IMO 2020, which should see marine gasoil (MGO) demand in 2020 rise by 2 mb/d from 2018 levels. Furthermore, bunker sellers will need to hold some inventory to meet demand by Q4 19, as many shipowners are expected to begin shifting to the new compliant fuels by then. That means commercial stockbuilding for MGO demand could begin in late Q3 19.

Lastly, as the market nears the end of summer, large turnarounds in Europe and the Middle East will be coming up, and this last burst of maintenance ahead of IMO 2020 is likely to tighten the physical market further. If demand does not deteriorate again, the market could be setting up for an interesting late summer.

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