Talk of a global diesel shortage subsided in the past few weeks as oil prices once again took center stage, but the tight supply situation in middle distillates appears to have remained unchanged, and traders are betting it will continue to be tight.
Tighter than the situation in oil, in fact.
In his regular column on oil buying, Reuters’ John Kemp said this week that more traders were bullish on middle distillates than on crude oil. Even though sales of diesel in the last week of 2022 hit 2 million barrels, they were nowhere near sales of crude oil at 30 million barrels for WTI.
It’s all about the outlook. Diesel and other distillate fuels swung close to a shortage over the past two years as demand for freight transport surged amid the pandemic and the lockdowns, but production didn’t.
As the pandemic began to subside and the lockdowns ended, demand for transportation remained strong and, it seems, so did demand for freight transport specifically. Air travel began to recover, too, with pent-up demand adding to the shortage worry in middle distillates, which, besides diesel, are used to make jet fuel.
In the United States, the East Coast got a scare last October with diesel and heating oil inventories lower than usual and demand about to take off as heating season began. Luckily, a shortage was avoided, but prices soared along with many people’s heating bills.
Farmers in some parts of the country are also suffering the effects of tight diesel supply and the resulting higher prices even as they still try to recover from the blow the industry suffered from the pandemic.
In Europe, buyers rushed to stock up on Russian diesel before the February 5 embargo on fuels kicks in. This week Bloomberg reported that Kuwait is preparing to ramp up its diesel sales to Europe considerably this year to replace embargoed Russian fuels.
However, the Kuwaiti fuel will not be able to replace all of the lost Russian diesel supply, so China and India will also probably be exporting more diesel to Europe. It is no coincidence that Beijing issued higher fuel export quotas for Chinese refiners this year.
Meanwhile, the silver lining of all the bad economic news reports that marked the last quarter of 2022 appears to be lower diesel use, alleviating the tight supply situation somewhat. Reuters’ Kemp again noted it first in a column from the start of December and then another written a month later.
A decline in manufacturing activity and freight transport in response to rising fuel prices has led to a decline in the demand for those fuels. As a result, U.S. distillate fuel inventories inched up between October and November, which was a very welcome development. However, they still remained lower than the five-year average for that time of the year.
With U.S. manufacturing activity marking a decline for the second month in a row in December, distillate fuel demand is set to have declined further with it. While such a development is usually a cause for concern, when it comes to distillate demand, it’s more on the good news side because lower consumption could eventually lead to some price relief.
Production remains the big problem, and traders appear to be betting on continued tight supply because of this fact. There is simply not enough refining capacity in the U.S. or Europe to ramp up production fast enough to respond to demand levels. As some analysts from the banking industry said last year about oil prices, the only surefire way to bring them down was a recession. The way would no doubt work for distillate fuels, too.