Those who grew in confidence that the bottom might have been found yesterday afternoon after a dollar rally in crude oil prices saw their hopes ruthlessly shattered by the close. The rally, which was probably triggered by technical supports holding on Wednesday, reversed mid-afternoon and both WTI and Brent touched a fresh 3-month low in the process. It is a fair bet that rate cuts are slipping away. We learnt this week that the inflation in the UK fell less than hoped. The Fed minutes revealed serious reservations amongst policy makers about the effectiveness of the current round of monetary tightening with US manufacturers reporting an increase in prices for inputs, which could be the harbinger of elevated consumer prices in months to come. Weekly jobless claims also declined last week. Add to that the noticeable rise in negotiated wages in 1Q in the euro zone and accurately predicting where the long-awaited rate cuts will turn into a dubious undertaking.

Macroeconomic developments have been failing to provide meaningful support for oil, which has its own problems to deal with. Russia, admittedly, overproduced in April but promised to make amends, nonetheless it struggles with credibility issues. Next week’s OPEC meeting is widely expected to roll over the current production ceiling, especially now that oil prices are in a relentless downtrend, but it would probably not be enough to unambiguously brighten the mood, simply because there is nearly 6 mbpd of supply cushion attached to the seemingly oversupplied market. Yet, help might just be around the corner as the traditionally demand-intensive summer period is about to take off. 
 

Bleak Future for Distillates

It is widely believed that the current downtrend in oil is partly the result of resilient inflation, which delays rate cuts in major economic centres. No-one remembers the days when 3 or 4 lowering periods of the cost of borrowing was predicted in the US. The CME FedWatch Tool now forecasts one cut, but it would not be surprising to eventually see 2024 passing by without easing monetary conditions. It is, however, foolish, to put the blame for oil’s misfortune exclusively on interest rates. The market is well supplied. It is blatantly mirrored in the narrowing backwardation in crude oil and RBOB and the contango nature of Heating Oil and Gasoil. Refining margins, perhaps the most reliable metric of the health of the oil market, have also come under pressure. Declining consumer and industrial demand for products results in crumbling refinery appetite for crude oil. The present state of the oil market is aptly mirrored in the distillate/crude oil price differential and the longer-term distillate outlook is equally bleak.

Both the CME Heating Oil and the ICE Gasoil price differentials to their crude oil benchmarks have weakened considerably. The Heat/WTI crack has dropped from over $40/bbl in February to below $25/bbl yesterday. The Gasoil/Brent spread has almost halved in the past three and half months. The weakness is partly rooted in the usual seasonal pattern but is also the function of structural changes the middle of the barrel is experiencing. After the winter season is over on the northern hemisphere demand for distillates tends to subside and inventories start increasing. In the US distillate stockpiles rebounded from close to 100 million bbls in November, at the beginning of the heating season, to 117 million bbls last week, EIA data suggests (albeit off the peak of 134 million bbls registered in January when increased refinery activity was met with tepid demand). In Europe, PJK/Insights Global data shows, this trend was even more profound. Gasoil inventories in the ARA region have swollen by 600,000 tons or 36% between November and May.

Distillate and within that diesel demand might struggle to grow meaningfully. Looking at the broader trend consumption is on the descent or stagnating at best. In the US 4.15 mbpd of distillates was consumed in 2018 which slimmed to 3.93 mbpd in 2023 and further retreat is predicted for this year. Global demand for the product is flattening out. Although the post-pandemic recovery pushed gasoil/diesel consumption up to 28.48 mbpd in 2023, the IEA reckons, it will only grow by a meagre 30,000 bpd or 0.1% this year compared with an expansion of slightly over 1% across the board.

There are probably four reasons for the structural loosening in distillates/diesel balance. The first one is the transition from fossil fuel to renewables, which inevitably hastens the shift away from diesel fuel. The increase in the production of biofuel and biodiesel is another unavoidable factor in a well-supplied distillate market. Energy Intelligence estimates that US refiners were ramping up the production of biofuel, particularly renewable diesel. In the first quarter of the year the volume of biodiesel jumped to 300,000 bpd. Global biofuel demand is to reach 200 billion litres by 2028, according to the IEA, with renewable diesel and ethanol being responsible for two-thirds of this growth and the rest covered by biodiesel and biojet fuel.

The growing role the service sector plays in the global economy at the expense of manufacturing, AI-induced enhanced productivity and the generally sluggish state of the manufacturing segment dampens the thirst for distillates/diesel. Fourthly, rising refining capacity will also alleviate any potential distillate shortage. StoneX estimates that new facilities in Kuwait, Nigeria and Oman added 2 mbpd of refining output last year with an additional 200,000 bpd of diesel capacity coming online this year.

The panic-buying that characterized the immediate aftermath of Russia’s invasion of Ukraine is irrevocably over. Europe, the biggest export market for Russia, smoothly and swiftly adapted to the new status quo. Of course, the sporadic attacks on Russian oil infrastructures could cause sudden and unexpected spikes in distillate prices as they might result in regional shortages, but with demand for the product peaking and refinery capacity seemingly adequate the market for the middle of the barrel is likely to be sufficiently supplied for years to come.

© 2024 PVM Oil Associates Ltd