ANALYSIS: Is the distillate price spike here to stay?
Quantum Commodity Intelligence - In the run-up to the rollout of low-sulfur restrictions on shipping in 2020, analysts and observers predicted that vessel operators would need to either fit scrubbing technology to remove the sulfur or rush to buy up distillates, likely causing a significant spike in gasoil prices.
Indeed, some shipping analysts predicted that such a scramble for lower-sulfur fuel from the middle of the barrel could lead to diesel prices soaring at the pump so high that they could cause a repeat of the 2018 year of unrest in Brazil, where trucker unions brought the country's economy to a halt over soaring diesel prices by blocking the country's highways.
But the outbreak of Covid just a month into the start of new IMO 2020 sulfur restrictions for shipping at the start of 2020 slashed jet fuel demand 50%, creating more supply into the wider distillate pool, while at the same time, diesel demand slumped due to lower economic growth.
That means diesel refining margins and prices have yet to hit the daunting peaks predicted as early as 2011, shortly after the IMO raised the prospect for new sulfur caps.
Until now, that is.
Pandemic high
Diesel and jet prices are at pandemic highs in Europe and Asia.
And while much of that is due to higher crude prices, refining margins are also at the highest level since the pandemic began at above $17/b for both regions.
And all that comes despite jet demand struggling to get anywhere near back to the levels before coronavirus entered the public lexicon.
Indeed, diesel in both regions is trading at a $4/b premium over gasoline and in Asia, jet fuel prices are trading at near parity to gasoline.
Some of the factors that are causing the price spike are transient, but others are more permanent, raising the question as to whether diesel price spikes are here to stay.
Stocks
The main reason for the elevated prices is that inventories of distillates are eye-wateringly low.
According to London-based oil analysts FGE, excluding the hub of Fujairah, which started reporting only in 2017, global stocks of middle distillates are nearing a 17-year low.
In Singapore, stocks were 8.5 million barrels as of last week, more than a third below the average and a trend that is not seeing improvement.
Last week, global land stocks declined 3.3 million barrels towards 220 million barrels, according to FGE.
That's 20% below last year's levels and about 10% below 2019 levels.
Restocking will take some time.
European supply
Lower refinery runs in Europe have contributed to those lower stocks.
Refinery runs in the last quarter of 2021 were the lowest in years due to poor refining margins, and looking ahead, Europe's biggest refinery, Pernis, is about to go into extended maintenance in a turnaround that will last five months.
Higher gas prices triggered by an overall shortage of natural gas have also hit hydrocrackers' economics, which produce diesel, leaving supply also curtailed.
And few analysts think that these prices will recede sharply given geopolitical tensions with Russia, another big supplier of diesel, and low global stocks.
China/India exports
One factor that will determine distillate prices, particularly in Asia, is the likely output from two of the world's biggest exporters of diesel this year, namely China and India.
It is well documented that China is winding down exports of refined petroleum products, with the last six months of 2021 diesel exports roughly half of the first six months.
That is set to decline further this year, or at least for the first few months of 2022, with China allocating just 13 million mt of diesel, gasoline and jet fuel in its latest export quotas round.
That's around half of the first issuance batch in 2021.
While that is highly likely to increase over the year, China is sending a signal to the market that the days of free-flowing exports are over.
Meanwhile, Indian demand is surging, with Q4 deliveries almost eclipsing pre-pandemic levels, according to data from the country's Petroleum Planning and Analysis Cell.
That, however, did not stop diesel exports surging to a 20-month high from India.
That did little to keep the rise in refining margins in check, with the European spot benchmark crack for ULSD up $5.50/b since the start of December to the last day of the year and 10ppm diesel cargoes in Asia up almost $4/b over the same period.
Jet demand
Thirdly, higher diesel cracks come despite the fact a revival in demand for jet fuel has yet to appear, with the expected Q1 2022 move to more air travel normality delayed by the spread of the Omicron variant.
Globally, jet demand remains around 2.5 million bpd below its 2019 seasonal peak, and in countries such as India, China and the US, flights and passenger numbers remain 20-30% below that baseline.
That is expected to start to change later this year, as fears over Omicron subside, which will likely mean less jet in the distillate pool.
For example, the jet/gasoil regrade spread in Asia for Q1 was -$3.70/b on Monday versus -$1.60/b a month ago, according to Quantum data.
Looking at the forward curve, that regrade is expected to narrow this year to -$2.40/b over the summer as gasoil demand weakens, before blowing out to nearly $6/b again in the northern hemisphere winter when diesel demand is typically high.
If jet demand increases as expected, that means Q2 will see a lot less distillate from jet in the diesel pool.
Offset
All that being said, the current spike in diesel margins may be seen as only temporary, largely due to expected supply constraints from the Middle East, the US, Russia and the general seasonal impact of winter.
Traders are said to be factoring in concerns that any banking sanctions against Russia could lead to the temporary disruption of diesel supplies, but the important word here is temporary.
It's hard to see a country that produces 900,000/b of seaborne distillates each day would disappear from the international market, more likely, and at the very worst, it will trade at a steep discount for credit and banking constraints.
And in the Middle East, there are some concerns that Saudi Arabia's shift to 10ppm from 500ppm diesel has pushed up 10ppm cracks as it may mean more ULSD supply will be needed at home and less for export.
Again this may be a temporary issue as it is reported to suffer from a lack of hydrogen supply to some hydrocrackers that were slated to boost supply.
And the Baystown outage in the US has also had an impact, one reason why European cracks have surged more than those in Asia.
Shipping
Nevertheless, the structure of the market appears to have changed.
Not many shipping companies have fitted scrubbers due to what has so far been a very low Hi5 spread between 0.5% marine fuel and HSFO 380cst.
The financial payback on a scrubber is around 3-5 years providing 0.5% marine fuel is $100/mt more expensive than 380cst.
According to Quantum's 0.5% marine fuel versus 380cst assessments basis FOB Singapore, over the past year, that figure has been $125/mt, indicating the benefits of installing the sulfur-reduction technology on ships.
Indeed, over the past three months, it has been $163/mt.
And that comes although demand for distillates is yet to get anywhere near 2019 levels.
