What To Look Out For In The Middle Distillate Markets this Autumn

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

Thu, 28 Sept 2023, 13:00

What to Look Out for in the Middle Distillate Markets this Autumn

Harry Altham

Energy Analyst, EMEA & Asia

The headline of Russia’s decision to impose diesel export restrictions rocked middle distillate markets last week, with ICE Gasoil’s 2nd crack (currently November / December) surging 24% to above $37/bbl and consequently threatening nine-month highs of $41/bbl reached in September. Though those cuts have been partially cut back (restrictions are to be lifted on vacuum gasoil, used in cracking units for light and middle distillate production), the changing seasons provide an excellent opportunity to evaluate the middle distillate markets ahead of the European winter.

Source: ICE, StoneX

Global net flows of middle distillates tightened significantly in September. Imports outpaced exports by 667k bbd across the globe. In part, global diesel exports have fallen by 50k bbd, with reductions from all of the top five diesel exporting nations (U.S., Saudi Arabia, Russia, India and South Korea).

Source: Vortexa, StoneX

More key than that though was that the quantity of gasoil in floating storage fell to 11.7M bbl from a 14th September recent high of 20.7M bbl (a staggering 43% fall in just two weeks). Offshore stocks continue to trend lower (it has only been lower for just two days in 2023, on 17th March at 10.9M bbl and 26th July at 11.6M bbl).

Diesel in floating storage globally since September 2022. Source: Vortexa

Europe (excluding Turkey) has accounted for 33% of the 667k bbd excess global demand figure. Net imports in the region rose by 150k bbd m/m in September (+220k bbd imported, +70k bbd exported), which has been critical in ‘stopping the rot’ in ARA commercial inventories, which actually rose by 3% this month to 14.2M bbl (although rising above the YTD low seen on 31st August). That stocks have barely rebounded is testament to robust demand in recent months, particularly in transport fuels.

Source: PJK, StoneX

Europe has been able to sustain those imports because it has taken advantage of an open East/West middle distillate arb, boosting imports from India by 111k bbd and the Saudi Gulf region by 122k bbd (among others) which netted against a 105k bbd decline in imports from the United States.

And yet, the calendar spreads have remained tight throughout this month.

A key reason why the spreads were jolted so significantly on the Russian supply cut news was due to Russia’s opaqueness – in both the announcement and the available data. The Russian Finance Ministry cited low diesel inventories as a key reason for the cut, although data are largely unobtainable for the majority of the market (but it is known that storage capacity is very limited in Russia). No timeline or scale for export cuts have been provided either.

Russian Exports Already Struggling

A reason why the uncertainty is troublesome in this instance becomes clear when analysing flow data. Russia’s seaborne diesel exports have already fallen by over 15% in September (m/m), so a further tightening of exports could have a significant impact for global markets. Remember, Russia has been the joint highest exporter of diesel globally in the past year, at 1.04M bbd (alongside the U.S.).

Russian Middle Distillate Exports by Month, Broken Down by Destination. Source: Vortexa

With Russia’s key export destinations being Turkey, Brazil, the Middle East and West Africa (after ship-to-ship transfers in the Mediterranean), the cuts do not directly impact Europe per se, but reduced Russian exports will increase global reliance on ‘legitimate’ barrels – which Europe competes for.

In the European Union, this year’s autumn refinery outages are set to top 800k bbd, which is 200k bbd above August stoppages but nearly 50% below last autumn’s turnarounds (and 5.5% of total capacity). Nonetheless, Europe will remain a significant net gasoil importer (between 1M-2M bbd throughout the last twelve months, we expect above the 7th decile of that range between now and year-end), which means the availability of cargoes over the next few weeks will play a key role in any case.

Where will these barrels come from in the coming weeks, and will the landscape tighten further before year-end?

The East / West gasoil EFS provides the initial clue to the former question.

The differential has doubled since the beginning of August and is currently close to $4/bbl. This, alongside significantly lower tanker rates, has opened up further arbitrage opportunities from the East of Suez region, with flows rising by 47% since July to 320k bbd this month.

Sources: ICE, Refinitiv, StoneX

India has been the key so far in 2023 as it has constituted 90% of total APAC exports to Europe.

The port of Sikka alone makes up around 80% of that figure, through the vast Vadinar and Jamnagar refineries (2M bbd capacity combined), the latter of which is particularly critical (90% of India’s roughly 230k bbd flows to Europe). For October, we are expecting an additional 100k bbd of flows into Europe from India on the basis of port loadings / departure schedules, but such a level is unlikely to last for the remainder of Q4.

But critically, this does not extend to East Asia. This is partially because the arb is not open, once freight, insurance and capital costs are factored.

European imports from China are limited to just 10k bbd since the beginning of August, with zero flows at all in the prior two months. A year ago, Europe imported around 100k bbd from China, plus another 30k bbd from South Korea. Chinese diesel exports tripled in August 2023 y/y to 305k bbd due to the bulk of export quotas coming earlier y/y, but just 3% of those exports went to Europe. Expectations that the final export quota of 2023 ( expected in the coming weeks) will be relatively small means prospects for a surge in imports are unlikely for the remainder of this year.

Source: ICE, Refinitiv, StoneX

But the more tangible cause of these limitations is the much wider East/West jet kerosene differential, which, at $17/bbl, is much more profitable for refiners. A kerosene premium is what we typically expect to see, but the kerosene arb has been strong enough all summer to be the focus of product flows from East Asia, where the gasoil arb has fallen short. The strong European premium this summer has been pulling increasing volumes of kerosene from East Asia.

European Kerosene Imports from East Asia. Source: Vortexa

Meanwhile, gasoil flows from East Asia have essentially been limited to Malaysia, but transport costs are limiting flows from the Pacific basin.

Elsewhere, the United States appears to be holding barrels for winter due to its own low stocks, with the lack of transatlantic movement explaining lower tanker prices. In any case, the European premium is likely to deter significant imports from the United States.

We therefore conclude that the gasoil arbs in their current ranges are set to pull in middle distillate cargoes from the Middle East and India, but not further afield.

THE OUTLOOK

The Middle East was a key contributor to higher imports in September, but here is where our concern lies. The average daily volume of gasoil loaded onto ships in the Middle East bound for Europe (excluding Turkey) has collapsed by 40% m/m in September. As a result, the total quantity of diesel departing for Europe has fallen by 15% m/m, at a time where the continent’s refinery outages are set to top 800k bbd.

Middle East Diesel Loadings To Europe. Source: Vortexa

The lengthy process of opening Nigeria’s Dangote Refinery (650k bbd), which could have alleviated the issue, remains uncertain. Expectations that a full opening will not happen before next spring means European refineries will continue to export over 300k bbd of diesel to North and West Africa, and (to a lesser extent) the Americas this winter, where beyond we might see greater competition from the vast facility in Nigeria (which in turn could reduce Europe’s net imports).

The flow schedules and regression models are suggesting strong calendar spreads will persist - likely strengthen further - during the month of October. The lack of scheduled middle distillate arrivals are likely to tighten stocks further despite weaker demand (curve conditions pertain to just-in-time inventory management with inventories in the eleventh percentile of a 20-year range). That commercial stocks are so low (EU inventory days from ARA stocks are just 2.5 days) is likely to widen the East/West EFS further in order to attract more cargoes from further East; until then, conditions look set to remain tight.

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