The diesel crisis lies dormant. While prices have dropped from a March spike, record-low stocks, demand expected from the onset of winter, and the threat of a drop off in Russian supplies could all cause prices to erupt.
Diesel prices may have fallen some 25% since hitting a record high March 8 amid growing demand destruction as the global economy creaks, inflation spirals, and Russian oil flows keep coming.
But diesel prices remain at elevated levels, including the important ultra-low sulfur diesel benchmark.
S&P Global Platts assessed the key ULSD 10ppmS FOB ARA price at $1,079.75/mt on Aug. 18 compared to a peak of $1,466.50/mt, but this is still significantly higher than the $686/mt price seen at the start of the year and before the outbreak of the Russia-Ukraine war.
And there are credible reasons to think these high prices could continue.
Diesel stocks in Europe, most easily tracked at the Amsterdam-Rotterdam-Antwerp refining hub, are at historic lows and at the lowest monthly average levels in over a decade. Backwardation continues to discourage storage of product.
Inventories elsewhere are heavily depleted, including at key hubs in the US and Singapore, as global diesel levels are well below recent averages. Platts Analytics has warned stocks are "not building fast enough ahead of harvest and heating seasons."
Demand on the rise
With winter approaching, demand for heating using diesel and rampant gas-to-oil switching, given the likelihood the global gas crisis will dwarf any difficulties in oil market tightness, will keep demand for the middle distillate stronger than economic conditions may otherwise suggest.
"The diesel crisis is far from over, but the drivers are changing as we head into shoulder season," said Mark Rossano, CEO of C6 Capital Holdings. "As winter comes into focus, the global market now has to contend with mother nature as storage is very low and people haven't even started using their heating."
Russian flows to fall
Russian gasoil exports to Europe are expected to drop as EU sanctions against imports of Russian products come into effect in February 2023.
Russia is a major exporter of diesel and gasoil, with Russian oil products accounting for well over a third of European oil imports.
Some market watchers are skeptical on the extent of the fall given the difficulties in tracking blending products, but with year-end EU curbs also set to hit the global shipping insurance market, there will indeed be uncertainty over tanker accessibility after December.
The threat of a tighter market has helped maintain diesel's high margins compared with other oil products, and that has incentivized refiners to maximize diesel.
"Uncertainty over Russian supplies to Europe has preserved strength in the diesel market since Feb. 24, with ARA ULSD keeping a wide premium to gasoline for most of the time since the war began," said Platts Analytics oil market analyst Rebeka Foley.
Diesel's premium to gasoline has averaged $20/b over the summer months, which is well above historical levels as it is usually the peak demand season for gasoline.
"ARA ULSD cracks are expected to maintain exceptional strength through end-2022 as very low stocks coincide the start of the heating season and ramp-up to the sanctions coming into effect," Foley added.
There are certainly signs that Europe is a magnet for diesel far and wide. Those record prices helped open the arbitrage from East of Suez, with cargoes now landing in Europe in August.
Around 1.093 million mt of East of Suez ULSD arrived in Europe in July, with the majority arriving in the second half of the month, according to S&P Global Commodity Insights tracking data. August arrivals are currently expected at around 1.434 million mt, a 31% increase month on month, the data showed.
Many analysts have argued since the Dated Brent benchmark peaked at close to $140/b in March that the tightness was a product-related one rather than a crude one, with diesel in the spotlight.
Refiners were playing catch up as they cashed in.
Diesel production had been undercooked well before the Russia-Ukraine conflict due to already high natural gas prices used in the diesel-making process to remove sulfur. Diesel also requires getting the right distillate-rich crude grades to refineries, but sweeter crudes help to keep desulfurization costs low.
But with natural gas prices continuing to rise at pace, bringing with them the associated costs of making diesel, refiners are expecting to feel the pinch going into winter. Production levels could be in for some pendulum swings, however, as lower production at a time of strong demand should boost diesel prices, widening the margins again.
High refining margins for diesel may last for some time, albeit not without some bumps on the road. Those high margins could be just what the oil market needs.