IMO boost so far elusive for US diesel

Effective January 2020 sulphur emissions from most seagoing vessels must comply with the use of fuels with 0.5pc sulphur, down from 3.5pc, per new International Maritime Organization (IMO) rules.

The switch was widely expected to cause a sharp increase in demand for ultra-low sulphur fuels to be blended into marine fuels in the run-up to the 1 January compliance date. That would directly eat into commercial, industrial, agricultural diesel supply and home heating oil supply, in turn pushing prices higher for light, sweet crude, ultra-low sulphur diesel (ULSD), VGO, gasoline, and a variety of adjacent products and feedstocks in between.

To prepare for this switch, US refiners and suppliers have been expected to increase distillates yields and begin building low-sulphur distillates stockpiles well ahead of January 2020.

Few of those things have borne out so far in the US market.

US Gulf coast Colonial pipeline diesel prices — the benchmark for US diesel domestic markets and the pricing basis for exports — have been range-bound at 4¢-6¢/USG below Nymex ULSD futures since February this year. Before that, differentials were several cents lower for the winter season. ULSD differentials have been a couple cents lower on average so far this summer compared to last year.

While diesel margins have maintained their position over gasoline, there has been no significant increase. US Gulf coast diesel margins have been range-bound in the mid-teens/bl for most of the past two years, while gasoline margins have ranged widely from over $20/bl to -$3/bl.

The relative strength and stability of diesel margins has to do with exports, which have remained robust. This happened even as the US' biggest diesel buyer, Mexico, sharply reduced its demand for such imports this year as a result of slower economic growth and cheaper alternative blendstocks. Brazil and other Latin American buyers stepped in to fill the gap left by Mexico, which helped allow US refiners to continue producing at high rates.

While exports supported prices, US domestic distillates demand has fallen, averaging 4mn b/d since the beginning of the year, down by 4.05mn b/d during the same period in 2018, according to data from the US Energy Information Administration (EIA).

The dip in US domestic diesel demand partly resulted from widespread flooding across the midcontinent earlier this year, which slowed planting progress and cut diesel consumption significantly from the agricultural sector.

These factors have ballooned the midcontinent's diesel supplies, which grew to 7.1mn bl last week, or 7.3pc above the five-year average. High production in the region has compounded low demand, with midcontinent refiners raising distillates production rates to a seven-month high of 1.3mn b/d last week. Market participants point to full stocks and the midcontinent's relative geographic isolation as reasons for limited effects caused from the pending marine fuel change.

Despite an overhang in the midcontinent, total ultra-low sulphur diesel (ULSD) stockpiles in the country remained 1.9pc lower than five-year averages.

Those lower stocks could lead to a boost in diesel prices in the coming months.

A wider contango could also facilitate future buying. The Nymex ULSD contango going into the end of the year has averaged 1.99¢/USG so far this month, up from 1.7¢/USG during the same period last year. The contango in Nymex ULSD futures extends into Janaury, which settled at $1.91/USG today, 0.04¢/USG above the December contract. The forward curve is backwardated from January through July, 2020 as of today.

US refiners are prepared for potential demand increases and have been steadily increasing distillates yields, averaging 29.64pc during the 12 months ended 30 April, the latest month for which data is available from the EIA. This is up from an average of 28.92pc from the 12 months prior.

Distillates yields averaged 29.98pc from January to April this year, exceeding EIA's March 2019 projection of 29.5pc for overall 2019 yield.