General Index, Global Market Analysis

Global Market Analysis, 22 April 2022 - European Diesel Market Special

This week's special analysis focusses on diesel dislocation in Europe, and what impact the Russia-Ukraine conflict is having on price shocks and new trade patterns.

How to solve a problem like Russian diesel?

By David Elward with additional research by Nakul Hirani

From natural gas to coal, uranium, nickel, aluminium, palladium, and, of course, oil, recent months have highlighted the powerhouse role Russia plays in the global economy as a supplier of commodities.

In the wake of Russia’s invasion of Ukraine – the war has now passed 50 days – governments and companies in the West have sought to decouple from a web of complicated supply chains with Russia which were previously considered essential.

Diesel* fuel quickly emerged as one such valuable commodity supplied to Europe**. The threat of disruption to key diesel supplies to Europe has resulted in unprecedented price shocks and new trade patterns are beginning to emerge as the market considers how to solve a problem like Russian diesel.

Prices soar from spot wholesale to retail pump

General Index retail pump

Europe uses diesel to fuel its trucks and cars, for heating, and to power its factories and heavy machinery.

As the realisation hit this key artery flowing to Europe from Russia could be cauterised, along with crude and other oil products, diesel prices spiked in the wholesale market, rippling through to the fuel forecourts across the continent – it became one of the first most immediate, visible problem for consumers.

More than one-third of Europe’s diesel imports via seaborne routes came from Russia in 2021. Those supplies are yet to slow up, but the market – comprised of governments, fuel suppliers and, yes, benchmark data providers – is already acting to solve the looming diesel crisis

Russian diesel largely a European problem

How did we get to where we are today in Europe’s relationship with Russian diesel?

General Index, Russian diesel

Russian oil refiners underwent more than a decade of extensive modernization pre-Covid. Old production facilities were upgraded, and new ones built from scratch, largely with one commercial (and possibly geopolitical) goal in mind: supply Europe with more of the lower-sulphur fuels such as ULSD it required, being net short, after tighter emissions standards were agreed by members of the European Union.

In 2021, Russia exported around 45% of its total diesel production via seaborne routes. This is largely done via Russian ports, such as Primorsk in the Baltic and Novorossiysk and Tuapse in the Black Sea. Some supply is also exported via third countries, such as Latvia and Lithuania. The share of exports heading to Europe has climbed to 85%.

US, UK announce ban on Russia oil imports; EU divided

General Index, West divided

Canada became the first to signal a ban on Russian oil imports at the end of February. But the news that drew the biggest market reaction came just over a week later.

On 8 March, the US said it would immediately ban Russian energy imports, including oil. The same day the UK said it would phase them out by the end of 2022.

Russian exports of diesel account for around 12% of Europe’s total consumption, by far the single-largest country supplier to the region. Amid this exposure and a lack of alternative immediate suppliers, other European governments have hesitated, and the EU remains divided on the issue.

Germany said it would halve oil imports from Russia by June and try to phase them out by year’s end. France – not only Europe's but the world’s largest diesel importer – initially appeared to leave it to businesses to take action voluntarily. But President Macron has become more hawkish on oil sanctions after recent images showing mass graves in Ukraine, and France is now a leading advocate inside the EU for the bloc to impose an embargo on Russian oil.

US, UK announce ban on Russia oil imports; EU divided

The transition away from Russian exports is already underway. Several oil companies are refraining from buying in Russia – so-called “self-sanctioning” – out of a combination of reputational risk, ethical decisions, trouble securing financing, insurance, and because ship owners are unwilling to load from Russian ports.

General Index, commercial self sanctioning

French major TotalEnergies last month followed Shell, BP and Exxon by announcing it would stop buying Russian oil, including, by the end of the year at the latest, diesel volumes equivalent to 12% of Russian diesel imports into Europe in 2021.

Some traders who’ve long cultivated commercial deals to lift monthly volumes of diesel from Russia are also heading for the exit. Vitol’s decision to completely stop trading Russian-origin crude and products by the end of this year was a significant move, and could signal to others still trading Russian barrels that a safety in numbers strategy is slipping away.

Russia leading oversees diesel supplier to Europe

A 35% share of Europe’s diesel imports come from Russia. No other producers come close. It’s little wonder then with the sword of Damocles hanging over this substantial resupply route, top oil executives at some of the world’s largest traders of diesel have lined up to warn of a looming supply crisis.

“The diesel market is extremely tight. It’s going to get tighter,” Trafigura’s CEO said at a recent industry event. Vitol’s CEO joined him: “The thing that everybody is concerned about is diesel supply”. While Gunvor’s CEO said: “Diesel is not just a European problem; this is a global problem.”

General Index, Russia leading diesel supplier

It’s true, the ramifications go far beyond Europe’s shores. A rising tide of prices has rippled around global diesel markets. But Europe is particularly under the cosh.

France, UK, Germany to top Russian diesel buyers by volume

General Index, Russian diesel volumes

France’s Russian imports via seaborne routes accounted for 37% of total imports in 2021 – the equivalent of 20% of the country’s total diesel consumption.

For the UK, Russian-origin diesel was 38% of total imports, meeting 18% of its overall demand.In Germany, Russia supply accounted for 11% of total demand but a whopping 69% of total imports.

I’ve included ARA (Amsterdam-Rotterdam-Antwerp) region as a proxy for the Netherlands and Belgium because of its role as a storage hub. 2021 imports from Russia were lower than in previous years, at 18% of the total and 12% of the two countries’ domestic demand. It’s a flow worth noting, as some of these Russian barrels could be blended with other origins and re-exported onto the international market. Traceability is about to become a hot issue.

Eastern Europe most reliant on Russia as share of total imports

Poland’s imports via seaborne routes account for 19% of the country’s overall diesel demand, but its reliance on Russia is much higher when factoring overland deliveries.

General Index, Gasoil Guzzlers

Those overland deliveries play more of a role when looking at Eastern Europe, where the regional reliance on Russian diesel rises. While Eastern Europe is not directly a part of the oil price benchmark mechanisms we’ll discuss later, the oil dependency on Russia goes someway to explain the current divisions at the EU level over widening sanctions to include an outright oil ban.

Backlash by West against Russia fuels diesel price shock

Given the reach of Russian diesel into European markets, it’s no surprise that the West’s decision to start to wean itself off Russian oil has translated into higher prices.

The ULSD crack spread vs Brent is a proxy for diesel’s profitability to refiners. In the immediate days following Russia’s invasion of Ukraine on 24 February, the crack trundled along at around $20/b. But news around the US/UK bans and trading activity toward the end of the March 22 contract on ICE LSGO (Europe’s main ULSD futures) shocked prices.

The rally on product prices has been largely confined to ULSD and the rest of the middle distillates spectrum which includes jet fuel. Rising prices in Europe have been echoed in the US and Asia, where diesel margins have climbed to a 10-year high.

Extreme ARA futures expiry jolts Atlantic diesel ARB

Soaring diesel values led the ICE exchange to raise margin requirements which deterred many smaller investors. Liquidity was already falling heading into 2022, but this accelerated February-into-March, heightening volatility.

General Index, ARA Futures

In the run up to expiry, LSGO liquidity was almost 50% down on 2021. It was in this low liquidity environment the prompt LSGO structure ballooned to a backwardation above $376/MT on 9 March.

This resulted in a sharp dislocation on the arbitrage between European and North American ULSD markets. The freak pricing event ended with the expiry of the March contract on the morning of 10 March, and ‘normal’ business was largely resumed with the US East Coast market once again pricing above Europe.

Steeper costs for prompt delivery as market tightens

The fundamentals for diesel were bullish well before President Putin gave the go ahead to invade Ukraine.

General Index ULSD

Refiners were hesitant about raising production too quickly to avoid choking off their own margins recovering in the wake of the coronavirus pandemic. Inventories were instead being drawn down to satisfy the post-Covid-19 strong demand recovery led by the US.

The market had also been through a period of refinery consolidation, with almost a dozen sites closing permanently in Europe and a handful in North America. China too had redirected diesel supply away from exports to quell inflationary pressures in its domestic market.

The emerging Russia problem – i.e. finding alternative supply for more than three quarters of a million barrels per day of diesel – was to, excuse the pun, like pouring fuel on the fire. The steepening and higher ULSD price curves demonstrate the tightening market reaction.

Northwest Europe more at risk than the Mediterranean

By a ratio of more than 2:1, Northwest Europe imports more diesel from Russia than the Mediterranean. Product exports from Russia, particularly of diesel, will be difficult to replace. The dash for diesel is underway.

So far, Europe is seeing a sharp spike in cargoes arriving from East of Suez. April imports are expected to be more than double that recorded in March, with Saudi Arabia, UAE, Kuwait and Qatar all sending more supply, according to Kpler. France and the UK are the main destinations attracting more of the supply. Looking further ahead, refinery capacity additions coming online in the Middle East are likely to offer fresh resupply options for Europe.

Elsewhere, exports from the US to Europe are slated to triple in April, with the UK and Belgium taking more deliveries. As for exports from Russia, high-frequency weekly data shows diesel flows so far predicted at around 480,000 b/d versus 825,000 b/d last month, with a little over a week left for departures to be counted.

Kpler data snapshots were taken at 1600 BST on 21 April.

Russian diesel underpins NWE, MED cargo benchmarks

Commercial and political actions carry implications for the oil benchmarks which underpin pricing.

ULSD 10ppm and Gasoil 0.1% pricing in Europe is largely focused on six markets: one apiece for Northwest Europe and Mediterranean CIF cargoes and one each basis FOB ARA barges. It’s the cargo benchmarks we’ll focus on in this section.

General Index publishes indexes for the ULSD 10ppm CIF NWE Cargoes, Gasoil 0.1% CIF NWE Cargoes and the equivalent markets for the Mediterranean. We apply the industry-standard Market-on-Close (MOC) methodology and our indexes are timestamped to 4.30pm London time.

The pool of trade data for these assessments is focused on 34 import locations in the NWE and 38 in the MED.

General Index ULSD
General Index ULSD

There are certain rules governing this trade for price discovery. Supply delivered must be merchantable and fungible to all ports – that’s to say, supply must be acceptable to the prevailing standards of the region (e.g. grade, quality, specification) and be interchangeable (e.g. cargo and vessel sizes) across all ports.

Many of these European ports are only able to receive smaller vessels – known as Medium Range (MR) or General Purpose (GP) tankers. These can carry from a few thousand tons up to 40,000-50,000 tons. Russia’s diesel export program tailors to these standards with cargoes shipped typically between 30,000-40,000 tons apiece. Diesel and gasoil cargo methodology considers 10,000-40,000 MT, with 30,000 MT the basis standard.

General Index analysis of Kpler trade flow data (see above) shows, in 2021, around 75% of deliveries from all origins into the NWE MOC locations were on smaller tankers (MRs/GPs) versus 70% for the MED. Those are shares for total deliveries in the spot market and not just transactions as part of the MOC process.

Closer analysis shows the regions’ heavy reliance on Russia, as well as intra-Europe flows, to provide for the most fungible deliveries on those GP and MR vessels. In NWE last year, almost 55% of deliveries into the locations covered by the MOC on those vessel types were from Russia, while intra-Europe flows accounted for 40%. For the Med, the Russian share on GP or MR deliveries was 25%, while Europe and North African origins on those vessels totalled 62%. That means the other diesel-producing regions capable of substituting Russian supply account for a minority share of the vessel types which typically offer traders the most optimisation opportunities.

Shipping company The Signal Group told us the importance of MR tankers for the Russian clean-loaded cargoes is “highly significant”. Some 77% of clean product cargoes exported from Russia tend to be on MR1 tankers which are typically sized between 30,000-40,000 DWT, and more than 75% carry diesel.

General Index ULSD
General Index ULSD

This all poses a headache for traders, charterers, and benchmark data providers, as the market seeks alternative diesel suppliers to Russia which can also offer the same optimization and fungibility characteristics to support healthy trading options, as well as bolster liquidity for price benchmark creation.

The most likely replacement supply could come from locations where cargoes are typically loaded onto larger vessels, known as Long Range tankers or sometimes even new VLCCs (very large crude carriers) used to transport products on their maiden voyage. This would include the Middle East (the Gulf Cooperation Council states such as Saudi Arabia and the UAE), India and Far East Asia.

It’s only exports from the US that overwhelmingly come on MRs. But diesel exports from the US to Europe have been in decline since 2017. The US surplus has instead gone to Latin America. In order to change this trend, Europe will have to price more competitively. Keep an eye on future term contract negotiations to see if European buyers can catch the attention of US producers.

Demand for MRs is likely to ratchet up. Maria Bertzeletou, an analyst at Signal, told us: “Demand for MR tankers has grown during the first quarter of this year compared to a similar period last year from all areas worldwide.” She estimates: “If clean volumes imported from Europe now have to be imported from the US or Mideast Gulf, resulting in an incremental increase of 2% in ton days for these specific voyages, this could have an impact on MR tanker demand of the order 5%.”

Oil majors carve out second tier to diesel market

There has been a quiet revolution in the diesel spot market over the last 50 days.

The MOC daily pricing window was founded on transparency. But the glare of the public eye has become its Achilles heel, as traders opted to stay out of the limelight as they either continued to trade Russian barrels or considered how to adjust their trading tactics to adhere to their companies’ new corporate and commercial strategies.

Liquidity in the 10ppm diesel cargoes MOC plummeted in March. The number of bids/offers/trades fell by 85% in the NWE window and 13% in the Med. On the 10ppm NWE (ARA) barge market, liquidity dropped by 58%. The NWE windows have been more severely affected, in line with its greater exposure to Russian diesel as discussed earlier.

General Index oil majors

The first sign of the new paradigm emerging, where participants no longer wanted to handle Russian-origin diesel, came on 21 March. Shell placed a bid in the ULSD MOC featuring – after the normal details around delivery date, volume, pricing and fuel grade – a non-standard clause which asked sellers to not deliver Russian-origin. The bid was withdrawn and not used for that day’s index, but within 24 hours a MOC rule change meant such clauses would now be permitted. Shell has since returned to bid with the clause, and others followed with versions of their own, including BP, Totsa, Repsol, Addax, Valero and Petroineos.

How to solve a problem like Russian diesel?

So, we return to the question posed at the outset: how to solve a problem like Russian diesel?

The status quo for price benchmarking reflected a situation where all participants were willing to buy/supply Russian fuel in the spot market under the so-called ‘open origin’ model, where the market was in essence blind to origin. However, this is no longer representative of the rapidly-evolving market, where some of the largest suppliers and buyers are now unwilling to handle Russian fuel.

The market is in flux. The ground has shifted under the whole basis for the assessment of 10ppm diesel and 0.1% gasoil prices in Europe.

Price reporting agencies S&P Global Commodity Insights (Platts) and Argus Media, which General Index, as an FCA-regulated benchmark data provider, competes with on oil pricing, have proposed some alternatives:

- On 29 March, Argus unveiled a new price serving the non-Russian ULSD cargo market in NWE.
- On 11 April, Platts launched new “restricted origin” ULSD assessments for NWE to “reflect the value of non-Russia material”. These would be exclusive of Russian origin, while its long-standing open origin assessments would remain inclusive of Russian origin. A few days later, Platts announced a broader review of the open origin element of its existing 10ppm and 0.1% methodology. It asked “whether its basis definition of open-origin for its diesel and gasoil assessments should continue to include Russian-origin material, or whether it should reflect the market move towards trading non-Russian material.” It also appealed for feedback on what constitutes non-Russian origin.

This is a fluid situation. New pricing solutions announced one day could become redundant the next. The place of Russian ULSD 10ppm and Gasoil 0.1% in the market is yet to settle around a new standard.

For example, participants are defining Russian origin in more than one way (I wrote about the approaches to have emerged so far on CIF cargo markets on this Twitter thread). Some will allow a blend comprising as much as 49%, while others won’t allow it “in all or or part”. Alongside what the product is materially, there are also differences around where the product comes from. Some define this as oil “that has loaded at a port/berth/STS location that is within the Russian Federation”, while others specify oil that “shall not have been loaded in or transported from RF”. Does the former leave open the possibility of taking delivery of oil produced in Russia but exported via a third country?

Such variations in trade preferences could impact the price a buyer/seller is willing to transact at. These variations also need to be accommodated by indexes where a so-called ‘normalisation’ factor is applied to adjust non-standard indications in line with the benchmark standard. But determining the precise value of such normalisations is often an art rather than a science, particularly when there is little unanimity among market participants.

The market has so far been left to define its own rules. Neither the US nor UK oil ban announcements offer guidance on what constitutes Russian origin. If the EU were to join the UK and announce an oil ban it would in one fell swoop render, under law, Russian origin persona non grata in all 34 locations eligible for the NWE cargo benchmarks, more than half of the 38 locations covered by the Med cargo windows, and the ARA barge trading hub. The matter of how to define non-Russia origin could still remain. But the European Commission has form in providing much greater detail on such policy areas.

On the question of merchantability, an EU embargo would greatly simplify the process for updating price methodologies. But has the change already happened at the market level? The growing list of companies who have moved to non-Russia origin purchases signals self-sanctioning has triggered this transition across a substantial share of the spot market, and by extension the market further downstream. General Index understands this is happening on both cargo and barge markets. If Russian origin is no longer merchantable in the mainstream of European markets via the region’s three largest oil majors, excluding Russia diesel and gasoil from the existing open origin assessments would be a far simpler solution than adding new indexes to the mix.

If Platts decides to exclude Russian origin from its long-standing physical assessments, will it also apply the changes to the associated swaps which are listed by exchanges including the Intercontinental Exchange?

There are also other factors to consider, such as how benchmarks are used in contracts. There is the matter of if/how existing term deals done on a Platts basis are updated to reflect the new "restricted origin" preferences. Will buyers who’ve previously agreed terms basis the open origin benchmarks but who now are restricting their purchases to non-Russian origin be prepared to reopen those contracts to reflect new benchmarks which are likely to enter at higher price points?

As for future market evolution, there’s the prospect of a new diesel landscape where more supply is brought in from producers East of Suez on larger vessels which can only fit into the smaller number of deeper ports. Deliveries off ship-to-ship transfers/lightering are permitted under current MOC methodology. It’s open to question if that would be sufficient to make larger deliveries a part of the existing benchmark. Could the alternative be new CIF benchmarks confined to a smaller number of delivery locations, akin to jet fuel?

Liquidity in the daily MOC has picked up from the lows of recent weeks, but only a little. The change to allow participants to bid with non-standard clauses requesting non-Russian origin encouraged some to return. However, activity remains well below pre-Russia crisis levels. Clarity around new standards will be necessary to give traders the confidence to return.

On 1 April, General Index asked for feedback on how distillate benchmarks should evolve to reflect the impact of changing trade flows. We will continue to follow developments and engage market participants to gather input. We invite feedback to

*Diesel is used as a shorthand for gasoil/diesel, aka distillate. In Europe, this is a section of the oil barrel which compromises a range of lower and higher sulphur fuels such as 10ppm ULSD (ultra-low sulphur diesel), 0.1% gasoil (heating oil) and some volumes of higher sulphur grades. Trade flow analysis of products is not always able to pinpoint the exact diesel/gasoil grade, but a majority of flows out of Russia to OECD Europe are typically for ULSD. Unless otherwise stated, we’re using diesel as an umbrella term.

**Europe refers to the region, not just the EU. It does not include the Russian Federation.

Zulfadhli Kader
David Elward, Senior Pricing Analyst
Virginia Bridgewater
Nakul Hirani, Energy Analyst
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