Column: Manufacturing and freight drive diesel-led oil recovery

The strong recovery in diesel stands in contrast to a weaker upturn in gasoline and especially jet fuel, which remain hampered by the persistence of remote working as well as restrictions on leisure services and passenger aviation.

Similar distillate-led recoveries are also underway across the major economies of Europe and Asia, driven by the global resurgence in industrial production, raw materials, and merchandise movements.

In November, U.S. distillate consumption was down by less than 3% compared with the prior five-year average, in contrast to a deficit in gasoline of 13% and jet fuel of 30%, according to statistics from the U.S. Energy Information Administration (“Petroleum supply monthly”, EIA, Jan. 29).

Distillate is mostly used in manufacturing, mining, oil and gas production, farming, and freight transportation, in contrast to gasoline and jet fuel, which are mostly used for personal mobility.

Distillate was therefore less impacted by the business shutdowns and stay-at-home orders during the first wave, and has recovered faster, in line with the rebound in manufacturing and consumer spending on merchandise.

More recent weekly data from the EIA confirm distillate’s relative strength continued in December and the first part of January.

Historically, distillate use has been closely correlated with measures of manufacturing, including the Institute for Supply Management’s purchasing managers’ survey and the Federal Reserve’s industrial production index.

Both measures pointed to a continued upturn in manufacturing activity in December and January, which is likely to have supported further increases in fuel consumption in recent weeks.

In its quarterly earnings call last week, Valero, the world’s largest independent refiner, said diesel demand has remained “pretty strong” and is currently running very close to or even above year-ago levels.

“With people spending disposable income ordering things, freight, on-road freight, trucking and rail has been strong as well,” the company noted.

Even in Britain, where lockdowns have been more persistent and diesel is also used by private motorists, as in much of the rest of Europe, distillate has rebounded faster than other fuels.

Britain’s distillate use was down 21% versus the five-year average in November, compared with deficits of 32% for gasoline and 66% for jet fuel (“Energy trends”, Department for Business, Energy and Industrial Strategy, Jan. 28).

With fuel consumption recovering while refiners continue to restrain output, excess distillate inventories that accumulated during the second quarter of 2020 have been drawing down steadily since July.

U.S. distillate fuel oil stocks are currently about 9% above the five-year average, down from 30% in the middle of last year (“Weekly petroleum status report”, EIA, Jan. 27).

As a result, refining margins for distillate, which crashed after the epidemic and lockdowns, have been recovering strongly since the end of the third quarter, especially in the United States.

Based on futures prices, gross margins for producing ultra-low sulphur diesel to be delivered in the United States in June 2021 have risen to $15 per barrel above the cost of WTI crude, up from less than $9 four months ago.

The recovery elsewhere has been weaker, with gross margins for gas oil delivered in Northwest Europe in June 2021 now around $7 per barrel above the cost of Brent compared with $4 four months ago.

If margins continue to improve, however, distillate production is likely to start ramping up in the second quarter, which will provide a boost to global crude consumption.

John Kemp is a Reuters market analyst. The views expressed are his own.