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Surging Diesel Demand Is Underpinning Crude Oil’s Bull Market

Step aside OPEC, diesel is now driving up oil prices.

With industrial activity surging worldwide, the fuel — known in the industry as ultra-low sulfur diesel or ULSD — is enjoying strong demand, accelerating total oil consumption growth in 2017 well above the 10-year average. 

And just as demand rose faster than expected, diesel supply was hit, prompting a rapid tightening. First in Europe: the Pernis refinery, owned by Royal Dutch Shell Plc and considered one of the region’s diesel machines, suffered a fire in July and shut down for several weeks. And then in the U.S., where hurricane Harvey in late August temporarily knocked out a dozen refineries, disrupting both domestic supplies and distant export markets.

“The oil market is currently driven by four letters: It’s ULSD, not OPEC,” said Olivier Jakob, managing director of consultant Petromatrix GmbH.

The combination of strong demand and refinery outages has drained global diesel stocks over the summer, a rare occurrence as inventories usually build from July to September in preparation for a seasonal uptick in demand with the onset of the northern hemisphere winter. A cold spell later this year or in early 2018 could tighten the market even more, triggering another price spike.

European diesel benchmark prices have surged above the $550 a metric ton level for the first time since July 2015, up from $409.50 just three months ago. In addition, the diesel market has moved solidly into a condition called backwardation — where near-month contracts are more expensive than those for later dates — a sign of market tightness.

“Diesel demand is very strong on the back of industrial demand, freight and construction activity,” David Fyfe, chief economist at commodities trader Gunvor Group Ltd., one of the world’s largest oil traders, said in an interview.

Hedge funds have noticed. In the U.S., hedge funds boosted their net positions on diesel to the most bullish in four years, according to data from the Commodity Futures Trading Commission.

Bullish Outlook

The diesel market has been a key topic of conversation at the annual Asia Pacific Petroleum Conference in Singapore this week, with traders largely agreeing the outlook is bullish. With diesel stocks low and prices rising, refiners are enjoying strong margins, prompting them to buy more crude. That, in turn, is giving a lift to the oil market itself.

Brent crude, the global benchmark, settled near $60 a barrel this week — its highest since level in two years.

Although the refinery outages are starting to ease, perhaps prompting a pause in the diesel market, oil traders and refining executives said the backdrop of strong demand remains for middle distillates — a category that includes diesel, heating oil and jet-fuel.

“When you have strong economic growth, particularly in emerging markets, like today, you are going to have middle distillates up,” Franco Magnani, the chief executive officer of Eni Trading & Shipping Spa, said in an interview in Singapore.

It’s not just strong consumption in Asia. Diesel demand is strong too in Europe and it’s accelerating notably in the U.S., in part due to reconstruction activity linked to hurricanes Harvey, Irma and Maria in Texas, Florida and Puerto Rico, traders said.

U.S. demand for distillates rose to 4.26 million barrels a day for the week ended Sept. 15, about 24 percent higher than the same week a year ago and the highest seasonal level in at least 20 years, according to government data.

Market Tightness

Worldwide oil consumption will expand by about 1.6 million barrels a day this year, far exceeding the average of the prior decade, according to the IEA’s most recent estimates. Traders at APPEC in Singapore anticipate the growth could be as much as 1.8 million.

The refinery outages both underscored how strong the market was and disrupted traditional trade flows. The U.S. Gulf of Mexico ships overseas on average about one million barrels a day of middle distillates, filling the needs of Latin America and Europe. As supplies dried up after the hurricanes, Europe and Latin America had to pull barrels from elsewhere, tightening supplies in Asia. The cascade effect has now drained inventories nearly in every region.

The supply tightness could continue. Diesel stockpiles in the U.S., northwest Europe and Singapore — all key trading hubs — have all slipped below their five-year averages, an indication that the global distillate oversupply is turning into a deficit.

“Gasoil is very tight ahead of winter with low stocks,” said Thibaut Remoundos, founder of Commodities Trading Corp. in London. Given how bullish funds’ positioning is, the fuel’s performance will be key for crude prices for the next several months, he said.

— With assistance by Laura Blewitt

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