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Feature: US Atlantic Coast, Midwest see historic low diesel stocks heading into fall season

Highlights

Midwest diesel stocks are 19% below the 5-year average

Delayed harvest season and increased pipeline shipments could relieve Midwest

Atlantic Coast stocks are 41% below the 5-year average

Market participants see no relief in sight for Atlantic Coast - and a rough winter ahead

Record low diesel inventories could signal trouble ahead of the winter heating oil demand season on the US Atlantic Coast and harvest season for the Midwest.

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Midwest diesel stocks at 26.8 million barrels the week ended Sept. 2 were 19% below the five-year average, EIA data showed.

USAC distillate stocks at 28.95 million barrels the week ended Sept. 2 were 41% below the five-year average, US Energy Information Administration data shows. That was down from a 47% deficit the week ended Aug. 12, but still historically tight considering the upcoming heating season, and considering that refiners are due to begin fall maintenance, which will limit production.

Current backwardation in diesel futures does not encourage building storage, but because it implies strong current demand, it does encourage maximizing diesel production.

The NYMEX ULSD front-month/12-month spread has averaged 67.28 cents/gal so far in September. While that is down from a $1.78/gal average in April -- when USAC distillate stocks were roughly 50% below the five-year average -- it is up from a 13 cents/gal average in September 2021.

Midwest

Planting and harvest seasons are responsible for much seasonal diesel demand in the US Midwest. October is a peak month for harvest for many of the region's largest crops, including corn and soybeans, which together comprise 75% of the crops planted on the region's arable land, according to the US Department of Agriculture.

Midwest diesel inventories peak in August each year at an average of 33.8 million barrels, then draw down during harvest to the lowest point of the year in November at an average of 26.9 million barrels, according to US Energy Information Administration monthly data from 2017 through 2021.

This year, August diesel inventories are estimated at 26.4 million barrels – already below the average post-harvest level for the past five years.

Inventories were even lower in June, at 25.5 million barrels, a monthly level that has only been lower a handful of times since 1981. Despite rising slightly, June, July and August diesel inventories have set new historic lows for each month going back to 1981.

Diesel production in the region has been above the five-year average every month so far in 2022, spurred by high prices. Through August, the Midwest has produced a total of 13.9 million barrels more than the five-year average for the first eight months of the year.

From 2017-2021, the highest monthly average price for Group 3 X-grade fuel was $2.4559/gal, with the highest one-day price reaching $2.5212/gal. In 2022, average monthly prices was as high as $4.2816/gal in June, with the highest one-day price reaching $4.6254/gal on April 28. The date's price is also the highest X-grade price in Platts pricing history going back to May 2006.

With backwardation discouraging storage but production steadily above average, lower inventories can be attributed to the Midwest pulling less fuel from other regions – in particular, from the Gulf Coast. For the first six months of the year, the most recent data available from EIA, the Midwest pulled 10.5 million barrels total from the Gulf Coast – 38% less than the 17 million-barrel average for the first half of the year from 2017-2021.

"Harvest demand hasn't really ramped up and will be late this year," one market participant said Sept. 13, partially explaining a sharp drop in diesel prices in the Tulsa area.

A second market participant said Sept. 13 that prices fell in Tulsa because inventories had been bolstered in the past few days. With the temporary outage of BP's Whiting refinery, prices in Chicago rose more than 35 cents/gal to a peak of 30 cents/gal over the underlying futures contract Aug. 31, prompting large shipments of diesel from the Gulf Coast towards Chicago, he said.

"Once Whiting restarted, all that fuel fell out in Tulsa," the source added.

Atlantic Coast

The inventory situation on the US Atlantic Coast is even more severe. August diesel stocks were reported at just under 27 million barrels, versus the five-year average of 49 million barrels for this time of year.

Atlantic Coast inventories have set historic all-time lows going back to 1981 for each month since March – shortly after Russia invaded Ukraine Feb. 24. The inventory shortage is created by a loss of refining capacity in the region since 2019, and compounded by international market dynamics slowing movement of diesel to the area from both imports and from the US Gulf Coast.

The international situation has come into play for the USAC because of the June 2019 explosion and closure of the Philadelphia Energy Solutions refinery in Pennsylvania, which severely reduced production in the region.

In the five years prior to the PES closure, 2014-2018, the Atlantic Coast produced an average of 8 million-10 million barrels of diesel per month. Since the PES closure, however, the region has produced an average of 5.5 million-7 million barrels/month, or a shortfall of 3 million-5 million barrels/month compared to before.

After the PES closure, the Atlantic Coast partly made up for this shortfall through imports, which increased to an average of 6.5 million barrels/month. This was up 2.1 million barrels/month from an average of 4.4 million barrels/month before the PES closure.

Since the Russian invasion of Ukraine, diesel prices worldwide – especially in Europe – have surged. And the demand for fuel in Europe has also caused freight prices to surge. This has meant that the Atlantic Coast is now competing with Europe for diesel cargoes - and higher prices in Europe make it a more attractive destination for shippers. Additionally, freight costs have made the arbitrage into the Atlantic Coast from Latin America and other countries difficult or impossible for large periods of time since March.

From March through June of this year, the most recent month for which EIA has released data, the USAC imported an average 3.5 million barrels of diesel per month, even less than before the PES closure and 3 million barrels/month less than before the invasion of Ukraine.

Within the US, for the 5-year period from 2017 through 2021, the Atlantic Coast received an average of 3.85 million barrels/month from the Gulf Coast by pipeline during the first six months of the year. For the same period so far in 2022, the Atlantic Coast has received 1.75 million barrels per month from the Gulf Coast, 2.1 million barrels/month below the 5-year average.

Shipping on the Colonial Pipeline with a two-week travel time is a risk for shippers, particularly after mid-month, when diesel will ship and arrive on separate, and strongly backwardated, futures contracts.

"With the backwardation, I don't expect this will change," a third market participant said Sept. 13 of the low inventories and smaller shipments from the Gulf Coast. "Lots of people will be burning wood up north" to stay warm this winter, he added.