At any other time in history, the current state of the world diesel market would have sent some countries into a panic.
Around the world, fuel prices are sky high relative to the crude it’s made from, pointing to a shortage that should alarm inflation-obsessed governments everywhere. And in a few months, the northern hemisphere will enter winter, increasing the demand for heating.
The good news is that the market looked even worse at this time last year after the Russian invasion of Ukraine, and prices eventually came down, helped by a relatively mild winter. However, current reserves mean the world cannot afford bullish market surprises: supply curbs can occur at any time, or demand shocks can come from cold weather or surprisingly strong economies.
“We should build inventories now as they usually start to be drawn seasonally from September,” said Eugene Lindell, head of refined products at industry consultancy FGE. “There is concern that inventories will not build enough before October and then we will start to see benefits from what threatens to be a low base.”
The core of diesel supply concerns now lies in Europe and the US Atlantic coast, he added.
Oil markets have been rocked by widening fuel production margins in recent weeks, with refinery freezes cutting global supply at a time when crude producers including Saudi Saudi, keep the barrels off the market.
Lean inventories
Inventories of diesel-type fuel in northwest Europe will fall in the coming months, according to consultancy Wood Mackenzie Ltd. While this is typical for the time of year, inventories are currently lower than historical norms, although they continue to increase year over year.
“The outlook for diesel/diesel supply in Europe is tight to our current forecasts, driven by lower diesel/diesel yields expected from lighter crude oil shale, the shift to jet yields and disruptions from refineries,” said Emma Howsham, research analyst for refining and petroleum products markets at Wood Mackenzie. “Demand is expected to increase month-on-month until November.”
The shift to leaner crude, driven by cuts from Saudi Arabia, Russia and others, has made OECD Europe diesel fuel yields more than 1.6% lower in July compared to with the historical average, he said.
Amid the ongoing supply crisis, markets are watching China closely as its refiners wait for a new round of fuel export quotas from the government, which will allow them to continue sending fuel. While the large Chinese flows could help ease the current tightness, there is a chance that this time around they will offer some light relief.
An increase in Chinese diesel shipments is unlikely, even after the quotas are issued, said Jianan Sun, oil analyst at Energy Aspects. China’s domestic diesel demand has “surprised to the upside” with higher-than-expected infrastructure spending offsetting losses in the property market, he added. As a result, stocks did not build up even during seasons of weaker demand, Sun said.
In the US, retail diesel prices have risen steadily since late July, so much so that in August it contributed more to inflation than gasoline. US refiners have been unable to build inventories this summer, the typical period of supply growth between crop seasons and before winter warming. This is because market conditions have made storage a losing business, similar to last year.
New England’s main supplier, Eastern Canada’s Irving refinery, will undergo major seven-week maintenance work starting in September. This leaves the region beyond the reach of pipelines, at the mercy of sea shipments from further afield.
Bullish bets
The performance of the diesel market is important beyond the universe of a few specialist traders.
In its broadest definition, this type of fuel, which has different specifications and is used in everything from cars and boats to heating and heavy machinery, is the biggest part of the demand for petroleum products.
Hedge funds are lifting their bullish bets, with net long positions on ICE diesel rising to the highest since March 2022 last week. Nymex diesel net long positions also jumped to an 18-month high earlier this month.
Beyond that, it is a vital fuel for the world’s supply chains, and major shortages and price shocks can have implications for governments and industries.
Last year, high diesel prices sparked trucker strikes across Asia, putting pressure on governments trying to stave off inflation from rising energy costs. In the United States, farmers and trucking companies that buy in bulk will suffer even more from rising costs.
The current crisis highlights a dilemma nations face in phasing out oil refineries as they try to move away from fossil fuels.
Recent heat waves have limited refinery output and affected an overall system that is still dealing with several plant shutdowns in recent years, FGE’s Lindell said.
