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LONDON – Worsening diesel shortages in the United States and the rest of the world are adding upward pressure on oil prices and threatening to restore the conditions that led to record price increases in 2008.
US inventories of distilled heating oil, the category including diesel, fell 2 million barrels to 112 million barrels last week, according to high-frequency data from the US Energy Information Administration (EIA).
Distillate inventories have fallen by a total of 67 million barrels in 52 of the last 79 weeks and are at their lowest level since 2014 and before 2008 (Weekly Petroleum Status Report, EIA, March 23).
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Distillates have emerged as the tightest part of the oil market: US inventories are 20% below the five-year pre-pandemic average for 2015-2019, compared to deficits of 11% for crude and 1% for gasoline.
If inventories follow a seasonal pattern over the past decade, inventories should fall to a low of 104 million barrels before mid-year, matching 2008 levels.
However, in the reasonable worst-case scenario, inventories could deplete to just 93 million barrels, which would be a critically low level and result in explosive upward pressure on prices (https://tmsnrt.rs/3qtkzbh).
GLOBAL SHORTCESS
Similar distillate shortages have emerged in Europe and Asia as the rapid post-pandemic consumption recovery has outpaced increased crude oil production and refinery production of diesel.
By the end of February, Europe’s distillate stocks had already fallen to their lowest seasonal level since 2008. Singapore’s inventories are currently at their lowest seasonal level since 2006.
Middle distillates such as diesel and gas oil are used primarily in freight transport, manufacturing, agriculture, mining and oil and gas exploration, making them the most cyclically sensitive part of the oil industry.
The synchronized global expansion in North America, Europe and Asia has led to an acute shortage similar to 2007/2008.
As a result, distillate prices are driving the overall oil market higher, with the upward pressure on diesel prices spilling over into the adjacent gasoline market and upstream crude oil market.
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In the United States, the average street price of diesel has risen 61% over the past year, according to the EIA, compared with a 47% rise in gasoline prices.
In 2008, distillate shortages helped push crude oil to an inflation-adjusted peak of over $187 a barrel around mid-year, after distillate inventories hit unusual seasonal lows a few months earlier.
UKRAINE INVASION
A similar scenario appears to have played out this year. But Russia’s invasion of Ukraine and the sanctions imposed in response threaten to make distillate shortages worse.
Russia is a major exporter of middle distillates, high-distillate residual fuel oil and crude oil, mainly to countries in Europe.
According to BP (‘Statistical review of world energy’, BP, 2021), Russia accounted for 29% of Europe’s imported crude oil and 39% of its imported products in 2020.
Russia’s invasion of Ukraine and escalating sanctions pose an increasing threat to these distillate and other oil streams.
Futures markets have anticipated a possible disruption by driving distillate prices to a huge premium versus crude oil.
Front month European gas oil futures prices are trading at a $46 per barrel premium to Brent, up from $15 pre-invasion and less than $4 a year ago.
In real terms, current gas oil prices, at around US$167 per barrel, are already in the 97th percentile for all months since 1990, but still well below the inflation-adjusted peak of US$226 in 2008.
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Ultra-high prices are a signal for refiners to maximize crude oil processing and distillate production, and for consumers to reduce diesel consumption as much as possible to rebuild depleted inventories.
In the next three months, diesel production needs to accelerate significantly, consumption growth to slow down and the market to avoid a significant loss of Russian exports.
If this is not possible, the result will likely be a sharp rise in prices, which will force a reduction in consumption through a slowdown in the business cycle.
Related columns:
– Global diesel shortages raise risk of oil price spike (Reuters, March 11)
– US diesel inventories set to fall to critical low (Reuters, February 17)
– Global oil supplies are exceptionally tight (Reuters, February 15)
– Diesel is the US economy’s inflation canary (Reuters, February 9)
John Kemp is a market analyst at Reuters. The views expressed are his own (editing by Jane Merriman)
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