By John Kingston of FreightWaves
Diesel prices have wrapped up four days of trading in which they are finishing far higher than they were at the start of the business week and have moved up faster than crude and gasoline prices.
It’s a worrisome trend for consumers because it signals that once again, diesel is moving at a pace more bullish than that of the petroleum market as a whole. That it already has done so in recent months is evident in the gasoline-diesel spread seen on price signs outside of retail outlets, and it has a complex set of causes.
Ultra low sulfur diesel for July delivery settled on the CME commodity exchange Friday at $4.2803 a gallon. That marked a gain of 7.19 cents per gallon on the day for an increase of 1.71%. It traded as high as $4.3250.
For the week — which was just four trading days, given the Memorial Day holiday — July ULSD rose 9.6%, posting a gain of 37.5 cents per gallon.
By contrast, the gain in WTI over the four days (from the May 27 settlement through the settlement at the end of this week) was 3.3% for West Texas Intermediate crude, barely any overall movement for global crude benchmark Brent, and 8.6% for RBOB, an unfinished gasoline blendstock that is a trading proxy for gasoline.
Those sorts of numbers suggest that increasingly, the issue in the market is not just the loss of Russian crude supplies but a loss of refining capacity worldwide that is coming home to roost, aggravated by the effective loss of some Russian refining capacity and its output as a result of formal and informal sanctions.
It is most evident in one of the most basic numbers traders watch: the 3:2:1. It’s a rough estimate of refining margins, arrived at by taking the price of either Brent or WTI and multiplying it by 3, and then subtracting that number from the sum of taking two barrels of gasoline and one barrel of ULSD.
The 3:2:1 for both Brent and WTI spent most of the week in the range of $55 to $60 per barrel, depending on how it was calculated. (Even a simple number like this can be the focus of differences in methodology.) At the start of 2021, it was closer to $20 a barrel, a figure that was far more in line with historic norms. A 3:2:1 in the upper $50s is leaving traders searching for new words to describe how unprecedented that is.
That sort of blowout can be expected in a world in which the International Energy Agency estimated earlier this year that global refining capacity had a net decline of 730,000 barrels per day in 2021. While that is less than 1% of the global oil market, in a tight supply/demand balance, the impact of such a decline can be enormous.
A $55, 3:2:1 will lead refiners to process as much as they can. And that is evident in the weekly Energy Information Administration data on U.S. refining operations — mostly.
U.S. refineries operated at 92.6% of capacity in the week ended May 27. While that is a healthy number, it actually was down slightly from the 93.6% from the prior week. And it isn’t that much higher than the average for the final full week of May, which is 91.8% over the last five years of data points, excluding pandemic-impacted 2020.
But the numbers on ULSD production nationwide are disappointing. Total output the last two weeks through May 27 was 4.875 and 4.818 million barrels per day, respectively. Those are the highest in a year, but the bad news for diesel consumers is that it’s still less than the output for the final week of May for the three years before the pandemic. Even with enormous margins, U.S. refiners are making less diesel than they were for this time of the year between 2017 and 2019.
On the U.S. East Coast, refiners have rushed to take advantage of the strong margins in that region. Refiners there over the last two weeks have operated at 97% and 98.2%, respectively, in an industry in which it is virtually impossible to run at 100% for any sustained period of time. Something inevitably breaks down. But the East Coast operating rates are against a base of refining capacity that has lost several hundred thousand barrels per day in the past several years.
The East Coast has been of particular interest to the diesel market given its soaring value relative to the Gulf Coast, which is the major refining center and a key export point for the U.S. and the world.
Weekly inventory figures dropped once again for the week ended May 27. They were at 18.8 million barrels, down from 20.4 million barrels just two weeks ago. And when it was at 20.4 million, it was already well below the roughly 38 million barrels at the start of the year in the East Coast area known as PADD 1, an EIA-designated area.
Despite those tight inventories, the spot market spread between the East Coast price and that in the Gulf Coast reacted counterintuitively.
Through much of May, as East Coast diesel inventories declined steadily during the year, that spread blew out to as much as 70 cents per gallon, according to data provided to FreightWaves by benchmark gateway General Index.
But on Friday, General Index estimated the spread at 7 cts/g, after it declined steadily through the week. It closed last week at 11.5 cents, went to 10.8 cents for Monday and Tuesday and then dropped to 5 cents Thursday before the slight widening Friday.
That odd movement may be a signal that the squeeze seen in the East is no longer the outlier and tight inventories through the country mean the East Coast just got there first. For example, the spread between the Gulf Coast and Chicago ULSD markets stood at roughly 20 cents by Thursday, with Chicago running that much of a premium to the Gulf Coast. That spread also tends to be a few cents during normal periods, much like the East Coast/Gulf Coast spread.