General Index Oil Refinery

Global Market Analysis, 25 March 2022

- Oil climbs as pressure mounts on EU to ban Russia imports; CPC outage whips up a storm
- Looming diesel supply crisis over creeping persona non grata Russian exports
- Spike in US diesel spread offers few clues on state of market

Oil climbs as pressure mounts on EU to ban Russia imports; CPC outage whips up a storm
By Nakul Hirani

Russia’s war in Ukraine has entered its second month and, despite hopes of a negotiated settlement, shows little sign on the ground of ending anytime soon. Commodity and financial markets are still reeling from the shock of an event (make that the second in as many years) they did not see coming. From WTI crude and white sugar, orange juice and oats, to cotton and copper, spiralling volatile prices are fuelling already rampant inflation across economies still emerging from the upheaval of the coronavirus pandemic. Soaring gas prices even makes putting the kettle on costlier. But take a modicum of relief from the fact coffee is one of the few commodities to have seen prices fall in recent weeks

General index, crude benchmarks

On oil markets, after receding sharply mid-month, Brent crude rallied once again this week, reaching highs of US$126.615/b on Wednesday, 23 March, before then slipping back a touch. As Russian crudes become persona non grata for a growing number of European refiners, adding to existing tightness in the global supply chain, appetite for light, sweet crude from the North Sea has intensified. The premium for Dated Brent, the physical benchmark, over futures has held above $5/b since the start of February.

The latest rally has been driven by a raft of bullish news:

- Pressure on the EU to join US, UK, Canada and Australia in banning Russian oil
- TotalEnergies joined Shell and BP in stopping buying Russian oil
- Disruption to crude loadings at Kazakhstan's CPC terminal on Russia's Black Sea coast
- US crude inventories fell by 2.5mn bl last week: EIA
- Progress on Iran nuclear deal looks less certain
- Saudi Arabia warning over crude output if conflict with Yemeni Houthi rebels escalates

Pressure grew on the European Union to join its allies and ban Russian oil. But member states remain divided over enacting such a policy which would rule out a quarter of the block’s crude needs. If and when they do, it could be a case of shutting the stable door after the horse has bolted. TotalEnergies joined Shell, BP and a growing list of other oil companies by announcing Tuesday it would stop buying Russian oil.

Such ‘self-sanctioning’ has been triggered by public pressure to stop financing President Putin’s war effort, as well as the indirect impact of banking sanctions. The latest round of European economic sanctions has “tremendously complicated” exports of Russian crude and products, according to Amrita Sen, director of research and co-founder at Energy Aspects. Speaking at the FT Commodities Summit this week, she said production is already being shut in in northern Russia because of insufficient storage, and an estimated 3mn b/d of output will be lost even without not too severe direct sanctions. If China or India want to buy cheap cargoes, she said they would have to do so with “no insurance company, no shipping company, no financing that’s done by anybody in Europe”.

Some analysts think markets have been slow to price in the full impact of Russian oil being excluded by many of the world’s top oil-consuming nations, so the symbolism (and headlines) of an EU ban could well jolt oil on the path to $200/b, which many predict is just a matter of time.

Compounding supply issues, ostensible storm-related repair work led to a total shutdown at the export terminal for Russian and Kazakhstan oil exports at the CPC terminal entirely earlier this week, raising the prospect of 1mn b/d or 1% of global oil production being taken offline, although Kazakh volumes are unaffected by the US ban. The US announced that it will be working with allies to look into releasing emergency stockpiles to help ease the recent sharp increase in oil prices. A partial resumption of CPC exports improved the outlook by week’s end.

Also topping up the bullish momentum was news of another weekly decline in US stocks. The EIA said crude inventories fell by 2.5mn bl last week, while draws of 2.9mn bl and 2.1mn bl, respectively, were seen for gasoline and distillates. Distillate inventories are now 17.7% below their five-year average.

Looming diesel supply crisis over creeping persona non grata Russian exports
By David Elward and Nakul Hirani

Top oil executives at some of the world’s largest traders of diesel lined up this week to warn of a looming supply crisis. Speaking at an industry event in Geneva this week they said:

- "The diesel market is extremely tight. It’s going to get tighter": Trafigura’s CEO
- "The thing that everybody is concerned about is diesel supply": Vitol’s CEO
- "Diesel is not just a European problem; this is a global problem": Gunvor’s chairman

While the problem is global, Europe is particularly under the cosh – even if trade flow data so far suggests imports of diesel and gasoil (distillate) from Russia will be higher month-on-month in March.

Russian exports of diesel and gasoil 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, governments have hesitated following the (less-exposed) US with a swift outright ban.

Among Europe’s largest consumers, the UK will ban Russian imports by the end of 2022; Germany on Friday said it would halve oil imports from Russia by June; while France – not only Europe's but the world’s largest diesel importer – has not ruled out a ban, but it is so far yet to make a move.

However, as discussed at the top of this report, the transition away from Russian exports is already underway. Self-sanctioning by suppliers is happening out of a combination of reputational risk, ethical decisions, and preparations necessary to comply with mandatory government bans already announced (or possibly in) the pipeline. French major TotalEnergies announced this week 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.

Diesel prices in the spot market have rallied, along with the rest of the middle distillates complex. General Index crack spreads for diesel and jet barges in Northwest Europe on 24 March were higher by +197% and +244%, respectively, than the day before Russia invaded Ukraine a month earlier.

General Index, refined products pricing

M1 LSGO futures, against which physical cash diffs for middle distillates are pegged, are also rising apace and the M1/M2 backwardation is widening. There's more than two weeks before the front-month April 2022 contract expires, so it is plausible gains in recent days reflect inherent diesel market bullishness over any pre-expiry-style machinations akin to last month (see charts). That said, markets are currently highly volatile and erratic movements detached from fundamentals amid lower liquidity cannot be ruled out, at least in part, as a factor in the latest LSGO spikes.

General Index, ICE LSGO

Callum Macpherson, head of commodities at Investec, made some useful observations in a recent podcast on the current dynamics in the swaps market. We’ve reproduced his take here:

“You’ve got to bear in mind that the swap market for jet and diesel relies on market makers, providing hedges to refiners in which they buy the jet and diesel off those refiners that can then be sold onto consumers. Now, of course, if the hedged counterparties that have already got hedges on with refiners when the crack spread widens they then have a credit exposure to those refiners and if it becomes very large they’ll tend to become disinclined to do further deals and then that cuts off the supply of, in the swap market, of jet and diesel which can be sold to consumers. And so there are then challenges in meeting that consumer demand to hedge jet and diesel. Hence that makes the situation a whole lot worse and so we’ve seen this quite extraordinary increase in the crack spread in the swap market last week.”

In the physical markets, trade flow data alone suggests the adjustment away from Russia has not yet happened. Seaborne cargo imports of diesel/gasoil into Northwest Europe from Russia are even predicted to rise in March, in absolute terms, to 2.619mn MT from 2.425mn MT, according to Kpler. On a per day basis, the rate falls to 630,000 b/d from 646,000 b/d because of the longer month. For the Mediterranean Sea, imports are slated to rise to 948,000 MT (228,000 b/d) from 710,000 MT (189,000 b/d).

Traders are, nevertheless, already looking for alternative supply. TotalEnergies said it will turn to its share in the Satorp refinery in Saudi Arabia to replace the side-lined Russian cargoes. Exports from East of Suez to Europe have surged this month. Kpler predicted at 1820 on 25 March the volume would be 1.929mn MT (464,000 b/d) up from 1.056mn MT (281,000 b/d). This would put it on a par with March 2021.

Others have looked west in the search for supplies. US exports of distillate fuel departing for Europe this month surged to 362,000 MT (87,000 b/d) from 49,000 MT (13,000 b/d) in February, according to a Kpler snapshot at 1600 GMT on 25 March – the highest since July 2021.

Looking back to 2017, after the shale revolution had driven an abundance of cheap crude for US refiners to export more than 220,000 b/d of diesel/gasoil to Europe, it is tempting to ask: can the US ride to Europe’s rescue now? Distillate fuel exports across the Atlantic have been in decline every year for five years: from more than 10mn MT in 2017 to less than 3mn MT in 2021. Some refinery consolidation in the US has resulted in fewer surplus cargoes available for export – a trend that cannot suddenly be reversed to meet the current situation. There’s also been increased competition from Latin America buyers.

General Index, diesel spreads

The uptick in exports this month suggests, if the price is right, suppliers will be able to entice US barrels away from Latin America to Europe. But with the exception of a brief period earlier this month in the days leading up to expiry of the March 2022 LSGO futures contract, arbitrage dynamics on paper have not supported such movements. Domestic demand from trucking amid a bullish economic recovery post-coronavirus and restrained refinery output growth has kept US diesel prices elevated above Europe. The diesel supply crisis in Europe is going to have to get a whole lot worse before prices climb to swing the arbitrage in its favour and make this part of the world the most attractive destination for US surplus cargoes.

Spike in US diesel spread offers few clues on state of market
By Jeffrey Bair

The war halfway around the world is pushing spreads for ULSD to what appears to be a favourable arbitrage to the US East Coast from the Gulf Coast. But no one should be in a rush to call the commodity trade healthy yet.

New York diesel was at a US$0.15/gal premium over Houston diesel in trade Wednesday, receding from a 17-cent advantage earlier in the week and up from a US$0.09/gal spread in late February, according to data from General Index.

The gap suggests the arbitrage for shipping between those markets on Colonial Pipeline has become profitable, with the tariff for that journey from the Gulf Coast to the East Coast costing about US$0.06/gal.

It's a bet the market doesn’t seem ready to take yet. The value of pipeline capacity on distillates-only Line 2 out of Houston, known as line space, remains at negative value, suggesting few to none are ready to chase the East Coast value.

General Index, NYB vs CP

If the eastern end of the US ULSD market were heating up, line space should be trading at positive value and increasing in value. It was trading at a fraction below zero Wednesday afternoon. If line space is negative, it means the owner of that commodity is willing to pay to give it away. It ensures the capacity gets used and the original owners of the line space maintain credit with the pipeline owner.

The market is moribund despite fundamentals suggesting the East is the right place to make a diesel play. PADD 1 ULSD stocks are down 16% since the start of the war, and PADD 3 inventory is essentially unchanged in the same period, according to US federal government data.

Virginia Bridgewater
Nakul Hirani, Energy Analyst
David Elward, Senior Pricing Analyst
David Elward, Senior Pricing Analyst
Jeffrey Baird, U.S. Refined Products Pricing Director
Jeffrey Bair, Pricing Director, Americas Refined Products
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