Rising distillate margins signal cyclical upturn: Kemp
Global refinery margins for producing road diesel, jet fuel and other middle distillates have started to rise as industrial activity and trade recover in the wake of the coronavirus epidemic and lockdowns.
Most of the excess distillate inventories that accumulated during the first wave of the coronavirus and lockdowns between March and June have been digested, with stocks in the United States returning to their five-year range.
And successful vaccine trials have raised hopes most public health controls on business activity and international passenger air travel will be lifted in the third quarter of 2021, spurring a further increase in distillate consumption.
Distillates are mostly used in road and rail freight, shipping, aviation, manufacturing, mining, oil and gas drilling, and agriculture (in contrast to gasoline, which is mostly used by private motorists).
Distillates are therefore the part of the petroleum market most closely correlated with the business cycle as well as the international movement of freight, tourism and business travel.
Following the epidemic-driven recession and introduction of quarantine controls, distillate futures prices fell to their lowest margin over crude oil since 2004 .
In Europe, margins fell to less than $4 per barrel, down from $16 at the start of the year, while in the United States, margins shrank to less than $7, down from $24 at the start of the year.
But margins have been recovering since the start of the fourth quarter, amid signs excess distillate stocks were being absorbed.
And the increase in margins has accelerated significantly since the announcement of successful vaccine trials at the start of November.
Forward distillate margins for distillates made and delivered in 2021 have increased by $2-4 per barrel or 35-70% since Nov. 2.
Margins remain extremely low and are not high enough to cover refiners’ costs for labour, energy, catalysts and capital.
But the market is starting to see a cyclical upswing mirroring hopes for a broader recovery in the economy and oil consumption next year.
In response, hedge funds and other money managers have purchased the equivalent of 52 million barrels in the two major futures and options contracts linked to distillate prices.
Portfolio managers’ combined position in U.S. diesel and European gas oil has climbed to the 45th percentile for all weeks since the start of 2013, up from the 14th percentile on Nov. 3.
Fund positions remain relatively low, with purchases outnumbering sales by a margin of 1.6:1, compared with 4.0:1 at the start of the year and a high of 14.5:1 in 2018.
There is therefore significant scope for fund buying to accelerate the rise in distillate prices and margins if stronger evidence emerges for a cyclical economic recovery and a resumption of international air travel.
Source: Reuters (Editing by David Evans)