ANALYSIS: European diesel benchmarks under spotlight amid war

Quantum Commodity Intelligence - European diesel benchmarks have become increasingly reliant upon volatile derivative markets as traders shy away from publicly offering physical cargoes for sale amid a shortage of non-Russian supply, along with not wanting to be seen holding Russian oil and a reluctance to cause major price distortions.

Platts, the world's largest price reporting agency (PRA), publishes daily assessments of the tradeable value for diesel and gasoil cargoes in Europe.

They are then aggregated to a monthly average to settle financial derivatives that are cleared primarily on the ICE exchange and used by the biggest producers and consumers to hedge positions and determine inventory value.

To assess the fair value of gasoil and diesel on the spot market, Platts runs a price discovery window between 1600-1630 each day and invites companies to bid and offer for the cargoes delivered into the Mediterranean and Northwest Europe for up to 25 days from date of publication.

But, according to market sources, there have been virtually no public offers of diesel or gasoil in the Platts market-on-close since the start of Russia's invasion, with bids for cargoes of non-Russian and open-origin well below levels that would attract exports from other regions.

The situation has become acute, with market sources saying that there is no liquidity and price reporting agencies are currently assessing the value of cargoes, not on bids and offers, but on the back of derivative markets that can be extremely volatile.

Break the system

To determine value in the absence of physical indications, PRAs, including Quantum, typically use the prevailing price relationship to more liquid instruments, such as futures, swaps or the same product in a different region.

It is a well-established process pioneered by Platts, which employs about 1,000 people and has revenues of almost $1 billion.

But given there are so few European trading houses or majors that want to be seen publicly trading Russian oil, there are fears that aggressive offers of Russian diesel and gasoil in the Platts window could depress the price for swaps.

That's what happened last week for naphtha.

Like diesel, Europe is reliant on Russian naphtha, and also in common with diesel, the benchmark is administered by Platts.

On Tuesday, Platts reported offers of open-origin naphtha below bids for non-Russian grade, creating a dilemma for the market about where the true value of physical naphtha was.

The dynamic attracted widespread attention, with even Bloomberg writing news about the intricacies of naphtha bids and, according to market sources, encouraged some participants to lobby other price reporting agencies to establish non-Russian naphtha assessments.

Excluded

Two days later, the price reporting agency said it would no longer consider Russian barrels as merchantable, sending swaps values soaring.

One market source said if the same thing happened in diesel, the functioning of the market would be at risk of collapse.

That's because, unlike naphtha, Europe as a whole is structurally net short of diesel, meaning that the market relies on the swaps to price in cargoes from elsewhere, such as Asia and the Middle East.

Without that hedging instrument, shipping distillates in from Asia would be much more challenging.

"I don't think people will start offering the Platts diesel window down with Russian spec like they did in naphtha. Frankly, we are net short, the Med is net short, and at the end of the day, we need oil through arbs," said one market source.

"And if someone were to offer down the window, the entire market would break. It would also not be in the interest of Russian companies," he said.

"It's in no one's interest to rock that boat," a second source said.

Platts adopted the merchantable criteria more than 20 years ago, in that the oil bid/offered during the market-on-close window must be widely acceptable to the market at large.

In the past, merchantability has usually been around quality issues, such as unusual additives that are not widely accepted in the market, or generally off-spec material as well as the size of cargoes and the vessels required to carry them. 

But to take the same approach with diesel is much more challenging for Platts.

"With naphtha, one could argue they very cleverly changed their methodology, without changing their methodology. They can't necessarily do that with diesel," a third source said, adding that the Platts assessment is for 30,000 mt, which is tailored only to Russian supply and not imported volumes, which typically travel on larger vessels.

Any change to move away from Russian diesel would, under Platts' own methodology guidelines, require a more formal process.

Alternative index

This week rival price reporting agency Argus Media said it planned to launch a European non-Russian specification diesel assessment for Europe in a bid to provide a "fair price" for those companies that did not wish to trade Russian diesel.

But some believe the existing process excludes Russian supply in practicable terms.

Market sources say there is no market to buy Russian diesel in Europe and anyone with non-Russian supply is unlikely to offer it to a competitor below the cost of replacing the supply from elsewhere.

That leaves the swaps market reflecting theoretical arbitrage levels and physical supply of non-Russian diesel, regardless.

Essentially, the market, in diesel at least, is self-regulating.

"It makes sense for Argus to launch the non-Russian diesel quote. But honestly, I can't even see what the difference is between Russian and non-Russian diesel," said the first source.

That's evident in the swaps.

Diesel cargo swaps in Europe were marked at $1,091/mt CIF Northwest Europe for April by 1630 Singapore time, $75/mt above where Singapore values were for loading in the same month and levels that are historically high.

Indeed, the EFS for April – the main yardstick for arbitrage opportunities and calculated as 10ppm Singapore cargo swaps minus low sulfur gasoil futures – have been trading at a record low of minus $100/mt on average this month, down from around minus $20/mt before the invasion.

Nevertheless, some will argue Russian diesel is no more merchantable than Russian naphtha and should be excluded from the assessment.

Platts did not respond to questions about whether it planned to issue the same clarification for gasoil and diesel as for naphtha.

Quantum competes with Platts in providing cash assessments of commodities in Europe. It assesses open-origin supply to Europe.