FEATURE: European middle distillate liquidity plummets amid extreme price volatility

High price volatility since the Russian invasion of Ukraine has seen liquidity in European middle distillate markets plummet, causing a self-perpetuating cycle of falling activity as lower traded volumes result in haphazard price moves.

Increased costs of hedging and executing swap trades has also caused a major blow to liquidity, as exchanges such as Europe's Intercontinental Exchange hiked margin calls.

According to historic ICE Risk Model Parameter data, margin requirements for the ICE LSGO April 22 future contract rose 90.3%, effective March 11. For the current front-month contract, July, margin requirements have increased a further 6%. In nominal terms, $6,466 was the required margin to trade one contract of ICE LSGO futures in early March. Today, the requirement is $13,494 – up by a factor of two.

Many traders said the increase in margins calls was the most dramatic blow to futures and swaps trading as many companies had to either reduce their positions, or even stop trading altogether in the European refined oil products paper market.

Open interest in ICE low sulfur gasoil futures tumbled in the week to June 21, falling by 4,677 contracts to 508,268, representing a more than seven-year low for interest in futures contracts, ICE data showed.

The front-month ICE LSGO future was assessed lower by $56/mt June 30 to $1,159/mt, having trended steeply downward from a recent high of $1,385/mt June 9, contradicting upward moves in crude oil futures. As such, the front-month ICE LSGO Brent crack slumped from $61.33/b June 20 to $41.97/b June 30.

"The extreme volatility is causing liquidity to evaporate. Less liquidity drives more volatility and the cycle builds, it's hard to pinpoint an exact reason...Fears of a recession seem to have caused selling when cracks were at all-time highs and in such an illiquid market the move lower has been swift," a trader said.

"It's a tough one to figure out why, front gasoil cracks [ICE LSGO futures] are also off almost $20 in four days, [I've] never seen ranges like this," he added.

Trading evaporates

Paper and physical market activity June 29 dwindled to minimal levels, with only a very slight rebound in activity June 30.

In the Platts Market on Close assessment process from S&P Global Commodity Insights, there was only one indication reported for middle distillate swaps -- a bid for a CIF Northwest Europe 0.1%S gasoil cargo July frontline swap. Traded volumes in the over-the-counter market were also very thin, with the exception of CIF NWE jet fuel cargo swaps, according to ICE data. Furthermore, across the distillate complex, trades occurred with low quantities per trade, the majority of which were five lots each.

There were zero bids or offers for physical ULSD or 0.1%S gasoil cargoes in the MOC process June 29 and 30, and just a handful of bids and offers for jet fuel cargoes and barges.

"The drop in liquidity is not limited to the Platts window, it is not only due to the issue of origin, it is general across the paper and physical OTC markets," a second trader said.

According to him, the main reason for the drop in liquidity in the physical market is the steep backwardation which means that people are buying hand to mouth, buying only what they need on a prompt basis resulting in shorter trading chains, as it is very costly to keep product in storage. Furthermore, hedging cargoes has become more costly due to higher margins calls.

"In the past, some people could buy an opportunistic cargo but now unless they're big oil majors, it might just be too much money to put forward for a potential small gain."

According to a third trader, "the market seems to have gone quiet for the summer. Not many refiners [are] hedging, I think it's due to the backwardation. Cracks are backwardated and there is no incentive to hedge."

Other traders also cited uncertain physical fundamentals as a deterrent to trading.

A fourth trader said US inventory data this week was "scaring markets as production is probably now too high for the demand profile," while "uncertainty that demand will perform at all with this recession" also meant people might be liquidating positions before holidays.

US distillate inventories saw back-to-back builds over the past two weeks, climbing to 112.4 million barrels in the week ended June 24, although stocks remain tight at around 20.6% behind the five-year average, albeit at the smallest deficit to the average since mid-April, Department of Energy data showed.

Several traders cited potential supply builds in Europe as a result of increasing refinery runs.

"Liquidity on the swaps has been very low. Everything seems to be on hold, it's as if the market is on holiday. [It] seems like it is in wait-and-see mode," a fifth, Mediterranean-based, diesel trader said.