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Distillate Inventories Leave Little to the Imagination

The Scramble for Diesel

Author: Brynne Kelly 5/08/2022


Russia’s invasion of Ukraine has set off a global scramble for diesel, prompting buyers around the world to snap up massive volumes of fuel from the U.S. Gulf Coast despite high prices. After all, Diesel is the fuel that powers the economy.


Rising demand for U.S. diesel underscores the extent to which Russia’s war in Ukraine has upended the global energy trade. Domestic supply is set to remain tight, underpinning high costs for the fuel that powers everything from trucking to agriculture.


Global headlines over the last few weeks have been peppered with tales of distillate shortages across the globe :


*The Institute of Energy Security (IES) has predicted that there is a looming shortage of diesel in Ghana.

*Fuel Shortages Appear as Protests at U.K. Oil Depots Continue

*Fuel shortages create long lines, more headaches for Ukrainian civilians

*Cameroon's energy ministry has said Western sanctions on Russia have driven up the cost of fuel imports and led to a fuel shortage. The lack of diesel fuels this week left hundreds of trucks taking goods to the neighboring Central African Republic and Chad stranded at the borders.

*U.S. East Coast Diesel Supply Is Running on Fumes

*The shortage of diesel in the middle of the wheat harvest season has created a lot of problems for farmers. Some analysts believe that the shortage is because of the rumors of an increase in petrol and diesel prices.


The fear now is that the market could tighten further from here with increased competition for distillate molecules as jet fuel demand returns. This is also having an impact on gasoline. With refineries running in max distillate mode, we are not building significant gasoline inventories ahead of peak driving season. As demand grows and inventories remain low, product tankers will need to be the conduit for filling the global supply-demand imbalance. “The lack of spare capacity is causing alarm heading into the peak summer driving season,” Argus warned on Thursday. “The situation is compounded by even higher middle-distillate margins, which have boosted supply of diesel over gasoline.”


U.S. distillate inventories are now at the lowest level in more than decade. The move is even more extreme on the East Coast, where stockpiles are at the lowest since 1996. Diesel and jet fuel at New York harbor are now trading well above $200 per barrel


Last week, East coast inventories of diesel plunged to their lowest seasonal level since government records started more than 30 years ago. The shortage caused a crisis in the diesel market, sending wholesale and retail diesel prices to an all-time high. Diesel is today more expensive in America than it was in 2008, when the price of crude oil surged to nearly $150 a barrel compared with little more than $100 currently.



Looking at US distillate inventory levels above there is little that needs to be left up to one's imagination. It's time to start seeing some inventory builds.


Comparisons to past inventory levels can be misleading because ULSD — with less than 15 parts per million of sulfur — moved into the diesel world gradually over the last 10 to 15 years as sulfur regulations tightened. But the latest data has a couple eye-popping numbers:

  • At 22.4 million barrels of ULSD held in PADD 1 inventory, stocks are at the lowest level since a run of recorded inventories on either side of 20 million barrels in March 2015. But back then, a brutally cold winter probably resulted in some distillate molecules being diverted to the heating oil pool rather than the diesel pool. (Similar numbers were posted in the winter of 2014, which also was a freezing few months on the U.S. East Coast, where most heating oil is consumed.)

  • The U.S. East Coast has seen several refineries close in recent years. The EIA’s operable capacity number for PADD 1 is 818,000 barrels a day. As recently as mid 2020, it was 1.224 million barrels per day.


It may be small comfort but the current DOE/EIA price is nowhere near the highest inflation-adjusted price. When crude hit its all-time high above $145 a barrel in early July 2008, the DOE/EIA price peaked at $4.764 a gallon on July 14. Adjusted for inflation, that is roughly $6.30 a gallon. Assuming truck mileage today is far superior to mileage then, and the reality, as painful as it is, is that the trucking industry has faced a more formidable set of prices than what it is dealing with now.


Headlines such as the following have only helped to exacerbate the issue:

  • Pemex’s 315,000 bpd Tula refinery is operating at 75% capacity after being forced Monday to reduce rates

  • Petrojam’s 35,000 bpd refinery in Jamaica remains offline after shutting late last week due to a fire with no estimate provided for restart. The company had said Friday, “We are continuing our investigation into the cause of the fire that occurred at a section of the Refinery (Wednesday, April 27).

  • PBF Energy Thursday was forced to reduce most operations by 20% at its 160,000-bpd Torrance, Calif., refinery due unplanned hydrogen unit repairs

  • Ukraine estimates it will cost about UAH800 million ($27 million) to repair damage by a Russian airstrike on Ukrtatnafta’s Kremenchug refinery. Officials stated today that about the same amount would be needed for the refinery’s power plant, also damaged by the bombing. The repairs will be running throughout this year, they added. AS REPORTED: Kremenchug refinery was disabled by the Russian strike on April 2.


It is clear is that the world can not afford to lose any more diesel production.



Market Impact

Russia’s invasion of Ukraine has set off a global scramble for diesel, prompting buyers around the world to snap up massive volumes of fuel from the U.S. Gulf Coast despite high prices. Rising demand for U.S. diesel underscores the extent to which Russia’s war in Ukraine has upended the global energy trade. Domestic supply is set to remain tight, underpinning high costs for the fuel that powers everything from trucking to agriculture.


Most Gulf Coast waterborne diesel exports have gone to Latin America in recent years, and that has continued this month with South America heading into the dry winter season, when some of the demand for hydropower typically shifts to diesel-fueled power generation. Europe also has ramped up its intake of U.S. diesel in an effort to wean itself from Russia.


High exports and consumption are draining distillates stockpiles in the U.S., which fell to the lowest level since 2014 in early April. The country’s diesel demand is expected to rise this summer from trucking and industrial sectors amid growing economic activity. American farmers, who use diesel to power their machinery, are planting the largest corn and soybean crop since 2017 this spring.


With the broader narrative outlined above, it has become clear that across the globe not only is there a shortage of spot molecules, but there is real fear that natural gas and distillate inventories will not be sufficient to get us through next winter. As a result, we have seen a relentless bid in winter HO futures (shown below, Q4 2022 HO).


It would be somewhat ambitious to expect this bid for inventory (of winter heating molecules) to relent any time soon. The market is well aware of the seasonality of inventory cycles in heating fuels (store in the summer for use in the winter). Until the dial moves significantly on inventory levels, expect an underlying storage bid.


Calendar Spreads

In many cases, calendar spreads in crude oil tend to mimic those in refined products. This is less true in short-dated spreads due the unique seasonality that exists between gasoline and distillate. But, when looking at longer-dated spreads (i.e. 12-month spreads) we tend to see crude spreads fall relatively in between gasoline and distillate (as shown via the Dec-21/Dec-22 spread below).

Given the nature of refined product demand relative to production and inventory, product spreads like the Dec-22/Dec-23 have taken the lead and are both trading much higher than the 12-month spread in WTI (black line vs green and gold lines above). The release of Strategic Petroleum Reserves is keeping relative pressure on crude spreads vs product spreads, for obvious reasons. We are now seeing the impact of constrained or fixed refinery capacity. Lowering input prices doesn't always lower output prices if there is scarce processing capacity.


Crude Arbs

Crude tankers are doing really well in regions directly impacted by Russia’s invasion of Ukraine — the Black Sea, Baltic and the Med — owing to the higher insurance costs and risks of entering those markets. But overall, the crude markets have been balancing new longer trade routes with the inability of OPEC to meet quotas, Russia [being] offline, and China lockdowns. The market is better than it probably should be based on those latter factors, but the low inventories and longer ton-miles [voyage distances] are offsetting some of the macro headwinds.


“Product tankers are benefiting from localized diesel shortages, high refinery margins and massive trading arbs [arbitrages] that allow traders to pay much higher freight costs and still make a ton on the arb. Inventories are far too low globally and prices will likely remain elevated, forcing more trading in unusual trade lanes, tightening capacity and lifting that market well before and well above crude."


This shifting of global oil movements via 'unusual trade lanes' has kept WTI/Brent spreads on their toes. The market has been flip-flopping between a belief that US SPR releases will dampen WTI prices more than they will dampen Brent prices, hence weakening the WTI/Brent spread. This is further supported by the constant chatter out of Europe that they would like to ban all purchases of Russian oil but have yet been unable to pull it off.

However, the WTI/Brent spread for the balance of 2022 has actually strengthened quite a bit over the last several weeks (light green line above). Are both markets perhaps so tight that the nuances of 'who has more supply' are being overshadowed by blind buying of molecules? It seems like at the moment, the market will take whatever they can get their hands on regardless of export economics.


Crack Spreads

It's no surprise given the above discussion that crack spreads continue to make new highs. The gold line in both charts below represents the most recent settle for the calendar 2023 - 2025 gasoline (left chart below) and distillate (right chart below) cracks versus WTI.

The thing about this is that we cannot simply erect new refining capacity at the drop of a hat. Refining margins are blowing out because capacity is scarce. By capacity we mean not only refining capacity but also inventory levels. There is nothing that can be done in the short term to eliminate these two capacity issues other than severe demand destruction. Lockdowns aren't really going to make the meaningful impact they had 2 years ago because they are no longer globally coordinated. Also, everyone is in dire need of inventory and the market knows this. When a complex is frantic for inventory, the market sniffs that a mile away. Need I say more?


Futures Curve Shift and Structure

While we saw cracks spreads (above) decidedly on their highs across the curve, the futures curve shift looks a little less exciting in WTI futures over the same term. The rally in the front of the curve has outpaced that of the back of the curve over the last month.

Was that due to buying in product cracks perhaps? Are we seeing some 'virtual refinery' buying of cracks in the later years - meaning, if you can't build a refinery, you can buy one via crack spreads. Ok, that is mostly said in jest, but not completely out of the question.


Bottom Line

The initial shock of Russia's attack on Ukraine has passed. Western nations have continued to ramp up sanctions on Russia and the EU continues to move closer to banning oil and gas purchases from Russia. While we made it through the most recent winter season ok, what is not ok is the current inventory levels and the market's confidence that it can be refilled without issue in time for next winter. Until such confidence increases, the inventory bid is real.



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EIA Inventory Recap - Week Ending 4/29/2022


Weekly Changes

The EIA reported a total petroleum inventory DRAW of 6.40 for the week ending April 29, 2022.


YTD Changes

YTD total petroleum EIA inventory changes show a DRAW of 71.90 through the week ending April 29, 2022.



Inventory Levels

Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.




 




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