Event horizon

Published at 10:06 17 May 2019 by . Last edited 11:18 22 Aug 2019.

Atlantic basin diesel markets had been stuck in an unusual contango in H2 19 even though the previous two years were characterised by large draws in diesel inventories. With physical markets being jolted to life by a spate of European refinery issues and the bankruptcy of Russia’s Antipinsky refinery—which has slashed ULSD exports from Primorsk to 0.9 Mt so far in May, the lowest since 2017—the market could no longer afford to be complacent heading into H2 19, especially as the shutdown of the refinery could drag on for months.

On the heels of the Antipinsky shutdown was the Urals contamination issue that has left millions of barrels of crude essentially untouchable, worsening the tightness in crude markets and dealing a further blow to refining margins. At least one refinery in Belarus has been damaged by the organic chlorides in some Russian crude and some recent shutdowns elsewhere in Europe are suspected to have been caused by contaminated crude as well.

Cleaning up the Druzhba system, which carries Russian crude to central and eastern European refineries, is likely to take months given the scale of the contamination, the size of the pipelines in question, and the challenge of segregating millions of barrels of crude from the rest of the system. At a minimum, operational flexibility on the system will be greatly reduced and the strain will grow as refineries in Poland and Slovakia exit turnarounds at the end of this month.

The loss of Russian crude supply has forced eastern German and Polish refineries to rely on waterborne crude imports via the ports of Gdansk and Rostock. The increase in competition on the waterborne market has tightened crude supply in Northwest Europe, weighing on refinery cracking margins. The sharp backwardation in Brent futures means refiners risk losing money on long-haul shipments and despite the rapid tightening of the Brent market, differentials for key grades have continued to rise, suppressing margins further.

Between lower Russian exports and European local supply hurt by the combination of unplanned refinery downtime and poor margins weighnng on refinery runs, stockdraws are likely to be bigger than normal this month. This is lending support to the physical market, where diesel in Northwest Europe is unusually trading above diesel in the Mediterranean.

The weakness in refining margins has been led by the strengthening in crude oil prices because crude supplies are so tight following the OPEC+ cuts and US sanctions on buyers of Iranian and Venezuelan crude oil. Moreover, the sanctions have exacerbated the quality problems that have been building in the market for some time. Indeed, there is growing chatter that US refinery runs may struggle to rise y/y this summer, for the first time since 2012, due to the lack of sour crudes.

High crude prices will lead to further discretionary run cuts as margins fall, as we have seen in Singapore and Korea, reducing the likelihood of a temporary diesel oversupply. European stocks could easily fall below 400 mb this summer and once again trigger a scramble for barrels as we saw in Q3 18. But if we are going to go to a hand-to-mouth market for diesel, such as how the crude market is now, the implications ahead of IMO 2020 are enormous as cracks could well push to the $20 per barrel range this autumn.

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