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Global prices for middle distillates such as gas oil and diesel are falling as the economy slows, more refineries come onstream, and exports from Russia are re-routed and replaced by fuel from the Middle East.

European gas oil futures prices for deliveries in December 2023 fell to $737 per tonne on April 4 down from $776 on January 3 and a peak of $906 on June 9, 2022.

Prices for gas oil have been falling faster than for crude petroleum as fears about shortages caused by Russia's invasion of Ukraine and the sanctions imposed in response fade.

The premium for gas oil over Brent, both delivered in December 2023, the gross refining margin or “crack spread”, has been narrowing consistently for the last six months.

The crack narrowed to $134 per tonne on April 4 down from $191 at the start of 2023 and a peak of $254 on October 10, 2022.

Gas oil and other middle distillates account for more than 45% of all petroleum consumed in the European Union and are the most cyclically sensitive oil products.

But manufacturers across the eurozone have reported business activity has been falling for nine months since June 2022 according to purchasing managers' surveys.

In the U.S., the spread for ultra-light sulphur diesel over Brent delivered in December 2023, narrowed to $205 per tonne on April 4 down from $261 at the start of 2023 and a peak of $316 on Oct. 13, 2022.

U.S. manufacturers have reported business activity has been falling for five months since November 2022 according to the Institute for Supply Management (ISM)'s purchasing survey.

Major U.S. railroads hauled 10% fewer shipping containers in the first 12 weeks of 2023 compared with the same period in 2022, according to the Association of American Railroads.

At the same time, Russia's distillate exports have successfully been re-routed to destinations in the Middle East, Africa and South America, following the imposition of sanctions by the European Union on Feb. 5.

In turn, Europe's distillate requirements have been backfilled by diesel exported from the Middle East, as well as smaller volumes from Asia and North America, easing concerns about sanctions-driven shortages.

Rising Inventories

Distillate inventories have started to accumulate in Europe, North America and Asia, after depleting most of the time between the second half of 2020 and the second half of 2022.

Europe's distillate stocks were still 40 million barrels (-10% or -1.35 standard deviations) below the prior 10-year seasonal average at the end of February 2022.

But the deficit had narrowed from 63 million barrels (-15% or -2.05 standard deviations) at the end of June 2022, according to data from Euroilstock.

U.S. distillate fuel oil inventories were 18 million barrels (-14% or -1.08 standard deviations) below the prior 10-year seasonal average on March 31.

But the deficit had narrowed from 31 million barrels (-22% or -2.05%) on Oct. 7, according to data from the U.S. Energy Information Administration.

In both Europe and the U.S., the accumulation of distillate inventories has coincided with the decline in manufacturing and freight activity.

In Singapore, distillate inventories have risen in 12 of the 15 most recent weeks by a total of 3 million barrels, according to data from Enterprise Singapore.

Stocks are still 1.5 million barrels (-14% or -0.83 standard deviations) below the ten-year seasonal average but the deficit has narrowed from 3 million barrels (-31% or -1.35 standard deviations) on Dec. 18.

Intensifying Downturn

Forward-looking data on industrial orders indicates manufacturing and freight activity is likely to decline further in the next several months, especially in Europe and North America.

The full impact of interest rate rises by major central banks over the last 12 months, and more recently tighter credit conditions following the banking crisis, have yet to filter through to households and businesses.

As it does, slackening industrial activity is likely to keep downward pressure on distillate consumption at least through the second quarter and probably the third quarter.

The deteriorating outlook for distillate use and crack spreads are likely to have contributed to the decision by Saudi Arabia and its allies in OPEC+ on April 2 to announce a reduction in crude output.

China's re-opening after lockdowns severely disrupted manufacturing, as well as internal and external passenger travel in 2022, could boost distillate consumption including jet fuel especially in the second half of 2023.

But recessionary headwinds are intensifying in North America and Europe as persistent inflation hits households and higher interest rates hit both consumers and corporate borrowers.

U.S. service sector firms and other non-manufacturing businesses appear to be following manufacturers into a significant slowdown, based on the latest non-manufacturing business survey by the ISM.

For the time being, distillate stocks are still relatively low after the unprecedented drawdown between 2020 and 2022, which has kept cracking margins well above the long-term average.

But inventories are accumulating and erasing the deficit, which is likely to push margins towards average levels later in 2023 and take more of the heat out of crack spreads.

Source: Reuters