Coronavirus mutes expectations for higher USGC diesel cracks

At a time when US Gulf Coast refiners thought they would be flush with profits due to cleaner diesel demand for lower sulfur bunker fuel, an outbreak of a deadly coronavirus is working to dampen those hopes.

The outbreak began in December in China and continues to expand outside its borders. As governments around the world scramble to mitigate the impact of the virus, demand for diesel is dropping and so is its value as both trade and economies slow in tandem with growth in medical concerns.

USGC ULSD cracks for export barrels averaged $8.78/b versus Brent crude in the week that ended January 24, while the crack for USGC ULSD pipeline barrels averaged $8.56/b, according to S&P Global Platts data. This compares to $14.76/b and $15.41/b, respectively, in the same time period in 2019.

"The combination of weak industrial production trends and coronavirus-related demand concerns has completely pummeled diesel cracks, with the Gulf Coast down to $9/b over Brent yesterday, the weakest since May '16," Tudor Pickering Holt analyst Matthew Blair wrote in a Tuesday research note.

Blair added that the price of ULSD is also dropping going forward.

"In addition, the 2020 futures curve is a whopping [minus] $5/b lower than levels from just one month ago," he said.

However, while USGC refining margins have softened slightly week on week, they remain healthy and above last year's levels. So far in 2020, USGC Mars coking margins are averaging $6.03/b, compared with $5.98/b in the first quarter of 2019, S&P Global Platts Analytics data shows. In the week that ended January 24, the USGC Mars coking margin averaged $4.92/b, compared with $5.09/b a week earlier.

Coronavirus helps tamps down IMO impact

The International Maritime Organization's revised rules for marine fuel debuted January 1, when the mandate handed down by the agency cut sulfur content in bunker fuel to 0.5% from 3.5%. Expected demand growth for clean diesel had some analysts expecting diesel cracks as high as $40/b in the initial phase of the change.

While global trade disruption and higher freight rates are having a dampening effect on diesel cracks as shipping fleets transition to cleaner fuel standards, warmer-than-normal temperatures across the globe are also cutting demand.

According to Platts Analytics, December was 7% warmer than the 10-year normal in Japan, the Organisation for Economic Co-operation and Development and the US – three key markets. This cut about 330,000 b/d of oil heat demand compared with normal temperatures.

Rising freight rates also pushed down USGC exports. Shipping rates for 38,000 mt tankers from the USGC have risen sharply. So far in January, shippers are paying $16.46/mt to send diesel and other refined products to Mexico, one of the largest importers of USGC products. This compares with December's average of $8.55/mt, according to Platts data.

Knock-on effect on distillate demand from jet fuel

Jet fuel demand was falling even before coronavirus became a watchword. Global air traffic growth averaged 4.2% in 2019, compared with the 7.4% growth rate in 2018.

"Global economic activity slowdowns tend to affect aviation and the recent US-China trade war has taken a toll on air cargo demand and freight volumes," according to recent Turner Mason blog entitled "Don't Stop Believin'-Will the IMO Distillate 'Bump' Ever Arrive?"

Turner Mason notes that continued protests in Hong Kong have also slowed demand for Asian airlines, which is further depressing demand for distillates like jet and ULSD.

"While we can't predict the length, magnitude or impacts of the coronavirus on air travel, it is certain to have a negative impact on air travel land demand for distillates," according to Turner Mason analysts.