London September 13 2023: Global distillate fuel oil inventories remain much lower than normal for the time of year which is putting strong upward pressure on fuel prices.
Distillates such as diesel, gasoil and heating oil are the primary fuels used by the industrial economy and inventories are normally strongly correlated with the manufacturing cycle.
But stocks in all the major consuming regions were severely depleted in August, despite a prolonged slowdown in manufacturing activity and freight movements over the previous year:
- U.S. distillate fuel oil inventories were 23 million barrels (-16% or -1.31 standard deviations) below the prior ten-year seasonal average in August.
- European distillate inventories were 35 million barrels (-8% or -1.11 standard deviations) below the ten-year seasonal average.
- Singapore distillate stocks were more than 3 million barrels (-31% or -1.44 standard deviations) below the ten-year average.
In every case, the deficit to the prior ten-year average has widened since March and April, putting upward pressure on prices.
Initially, the upward pressure on distillate refining margins was masked by downward pressure on the underlying prices for crude oil.
Since July, however, both crude prices and distillate refining margins have been rising, causing the total price of fuel to surge.
Wholesale prices for heating oil in the New York area were almost 66 cents per gallon or $28 per barrel higher on average in August than they had been in June.
Nearly $11 of the increase was attributable to higher crude prices, but more than $16 was owing to an increase in refining margins.
CRUDE AND MARGINS
Distillate prices are being driven higher by both the extra crude production cuts announced by Saudi Arabia and its OPEC⁺ allies and shortages of refining capacity around the world.
Production cuts by the major exporters in the Middle East have a disproportionate impact on the diesel market because their heavier crudes yield a higher proportion of middle distillates when refined.
But there is also a shortage of refinery capacity in Europe and North America to turn enough crude into diesel and other mid-distillates.
After adjusting for inflation, U.S. heating oil prices in August had risen to the 71st percentile for all months since 1990, up from the 48th percentile in June.
So while prices are already high, there is scope for them to increase much further if crude costs continue rising and refinery capacity remains tight.
U.S. distillate prices peaked as high as $200 per barrel in May 2022 (after Russia invaded Ukraine); $185 in April 2011 (amid crude shortages); and $228 in June 2008 (before the financial crisis).
Distillate consumption is set to increase further if the U.S. economy manages a soft landing and starts to expand faster again.
If the economies in Europe and China also emerge from their current contraction, that would boost diesel use even further.
Diesel shortages are symptomatic of the lack of spare capacity after the pandemic disrupted supply and policymakers engineered a rapid recovery in demand.
If the global economy starts to grow faster again in late 2023 and through 2024, supply constraints are likely to bite quickly.
