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Oil Markets Taking Orders from API Data

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

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Could Europe’s Distillate Markets Overtake the United States?
 
Harry Altham
Energy Analyst, EMEA & Asia
harry.altham@stonex.com

The oil complex has had a mixed start to the week, with Brent $1 lower and fluctuating around $95 as of 12PM GMT; NYM Heating Oil is the main up-mover of the day, rising by 2% to trade at $3.63/gallon. Although many factors are at play, it is OPEC+ policy that has driven the latest benchmark rally; markets are finding some support this morning from Prince Abdulaziz bin Salman, the Saudi Arabian Energy Minister, who has reiterated OPEC+’s ‘cautious’ approach to oil production ahead of its next meeting on 4th December. OPEC+ has cut its demand outlook today by 1M bbd in Q4 2022, in large part due to China’s anti-COVID measures – a move which markets will likely interpret as a pretext for further demand cuts by the group. 

As Prince Abdulaziz spoke, China revised its COVID-19 management strategy – a move the Prince believed should be approached with some pessimism. China is to reduce its mass testing requirements, release people from quarantine camps and further reduce restrictions on entry requirements for foreigners. The general optimism has boosted the Hang Seng Index by 20% over the last two weeks, although it remains the case that full economic reopening appears to be some way off.

image 55176
Brent and Heating Oil moving out of lockstep. Source: Bloomberg
funds boosting crude positions, but middle distillates lagging
Some of the general strength in oil markets since early October is translating into a more bullish outlook by funds, who have increased long positions in Brent by 39% since the end of September and reduced shorts by 5%; net positioning in futures and options among money managers is close to its most bullish level since September 2021 (74% long November 2022 versus 75% long in September 2021). 
image 55181
Source: CFTC, StoneX
 
Surprisingly, net positioning is currently indicating a less bullish outlook in the middle distillate markets. Even more remarkably, ICE Gasoil’s net positioning is more bullish than NYM Heating Oil, despite extremely tight inventories in PADD 1 and rising distillate flows into Europe from the Middle East and India. Why might this be, and how does this impact our outlook?
image 55190
Source: CFTC, StoneX
image 55189
Source: CFTC, StoneX
gas substitution looming in the background
For ICE Gasoil (whose inventories are also close to eight-year lows in the ARA region and are falling continent-wide), weakening manufacturing indices are historically indicative of a dampening demand picture, which could explain some of the relative price weakness in Europe vis-à-vis the United States. On this occasion however, we are expecting a buck of historical trends, as the landscape is subject to heightened demand pressures arising from sky-high natural gas prices, which will lead to greater substitution into diesel for high-energy industrial processes and electricity generation needs. 
image 55198
Electricity Generation Cost Inputs by Fuel: Source, ICE, Bloomberg, StoneX
We are revising down our additional gasoil demand forecast from a 400k to 300k bbd surplus to 2021 this winter, on the basis of easing European natural gas prices resulting in a diminished substitution effect (we need to express that this outlook is not considering any changes in European demand side policy alterations - namely a possible price cap, which we think is both unlikely and politically complex). Europe continues to import diesel from Russia (which it can do until February 2023) and will ramp up imports from the Middle East and India. Indeed, European policy guidance specifically permits Russian oil refined in a third country to enter Europe – raising expectations that Indian refineries could become a key source of origin for European diesel. 
TIGHTNESS IN REFINING CAPACITY A FACTOR
However, there is extreme tightness in global refining markets. Indian refineries ran in excess of 100% capacity until July (where maintenance works began), and facilities are only expected to increase by around 6% per year to 2025 (from 5.2M bbd to 6M bbd). Some spare capacity exists in the Middle East, but much of its crude is locked into Asia-bound cargoes – thereby limiting available crude for refining. Where there is greater spare capacity (China, Southeast Asia), either there are export restrictions or there are infrastructural limitations for the handling of light-mid crude blends. Though we do believe more Middle Eastern crude will get processed in regional refineries before heading to Europe, we believe European markets (which still import 2M bbd of crude and products from Russia as of October 2022) are exposed to the greatest risks of tightening due to these seismic flow changes that are yet to materialise fully. For these reasons, we believe European gasoil markets will narrow in their deficit to, if not advance ahead of, U.S. middle distillate markets - which is notable as inventories show little opportunity for replenishment in the U.S. East Coast.
 
 
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