Weakness in diesel demand is no longer speculation. Incoming data show softness in demand and while the latest figures are lagged, there is little in the preliminary figures coming through that suggests a major change in the trend since May. Diesel yields are also on the rise ahead of IMO 2020. European refinery yields in May were the highest since February 2016.
Global demand is likely to stay anaemic throughout the year. US freight shipments on railways and trucks were down y/y in H1 19 and agricultural demand is likely to be hit hard following a poor planting and growing season that will lead to a modest harvest this autumn. The picture is not much different in Europe, where the US-China trade war continues to weigh on diesel demand growth figures.
The rise in ARA stocks this summer serves as a striking reminder of just how weak European diesel markets have become, despite global supply coming in flat y/y in May. Supplies should continue to grow with the restart of Russia’s 0.18 mb/d Antipinsky refinery, which routinely exported 0.12 Mt of diesel to Europe until the plant’s former owner ran into financial difficulties this spring. Margins are also strong at present following the shutdown of the USEC’s largest refinery and while forward margins are less impressive, they are not weak enough to push refineries back into run cuts mode.
The closure of the 0.35 mb/d Philadelphia refinery means the USEC’s import requirement for the foreseeable future will need to rise by some 0.1 mb/d, though the market appears sanguine about the issue for now. Recently, East of Suez suppliers have grown in prominence in meeting PADD 1 demand for marginal barrels, with flows being diverted away from Europe to the USEC. However, if the region is to attract more diesel imports on a regular basis, prices will likely need to adjust upwards.
For now, cracks are unlikely to gain much further due to soft demand, and while the forward market continues to be supported by IMO, this might be more based on hope than fact. Amid slow bunker sales and apparent higher-than-expected VLSFO acceptance, marine sector diesel demand could be 0.5 mb/d lower than our base case in 2020. Moreover, given the soft growth in global diesel demand so far this year, the non-marine sector also looks set to disappoint too.
The transition to 0.5% sulphur marine fuels should be underway in earnest by October of this year, but if it happens at a time of economic weakness, the switch will prove to be much easier than many have expected. Indeed, given the weakness in ship fuel demand today, the soft growth in onshore global diesel demand and the possibility that VLSFO adoption by the marine sector will be faster than expected, diesel demand growth in 2020 could be well below our base case of 2.7 mb/d. Indeed, recent trends suggest the increase could be just 2 mb/d. This is still a significant number and will stress the refining system but would be far more manageable. Indeed, growth of 2 mb/d means that a significant delay to key refinery projects, such as Saudi Arabia’s 0.4 mb/d Jazan refinery, no longer portend surging diesel cracks. IMO 2020 optimism is keeping the forward curve buoyant for now, but demand trends need to be watched closely.