In August 2023, the US Consumer Price Index experienced its largest increase in 14 months, and a significant portion of this surge was attributed to the soaring gasoline prices. The impact of distillates on the inflation rate. which climbed by 0.6% last month, has raised concerns to the point where the US Department of Energy has stated it is engaging with producers and refiners to ensure a stable supply. Refining issues were noted by ChAI in early August, but the situation has since grown even more complex as oil prices have crossed the $90 per barrel threshold. In this article, we will delve into the current challenges confronting refineries and how the distillate fuel market might evolve in the final quarter of 2023.
Oil Price Rally
First and foremost, it's crucial to acknowledge the extension of production cuts by oil giants Saudi Arabia and Russia. In early July, both nations announced the continuation of their reduced production levels until the end of September. This move sent Brent Crude oil prices on an upward trajectory, increasing by over $10 per barrel from the start of July to the close of August. More recently, Saudi Arabia and Russia have committed to prolonging these production cuts until the end of the year, which has since propelled Brent prices above the $90 per barrel mark. As upstream costs continue their upward trajectory, it is natural that distillate prices follow suit.
Long-Term Refinery Challenges
As part of the wider context around distillate prices, it is worth highlighting the persistent issues faced by refineries since the onset of the COVID-19 pandemic. The pandemic led to the shutdown of numerous refineries globally due to the plummeting demand for fuel at that time. Many planned refinery expansions and new refining projects were also put on hold as a result. Furthermore, refiners in Europe and the US are still grappling with meeting the heightened demand placed on their output since the banning of Russian distillates in many Western countries following Russia's invasion of Ukraine. All of these issues, while varying in significance between different projects, are contributing to the current pressure on refining crude oil into distillates.
Low Inventories and Seasonal Challenges
Distillate inventories are currently well below seasonal averages, creating a supply squeeze. As noted by John Kemp in a recent Reuters column, noted the extent of this issue; compared to the historic ten-year average, current distillate fuel inventories are 16% lower in the US, 8% lower in Europe and 31% lower in Singapore.
The issue of lower distillate stocks will be compounded in the coming weeks, which is typically a time of lower refinery utilization. In the autumn, many refineries enter a maintenance period to adjust their product mix for the winter months, switching from lighter-grade distillates like gasoline to heavier fuel grades. US refinery utilization stood at 93.7% in the week ending Friday 8th September, and although this marked a week-on-week increase of 0.6%, is 1.0% lower than a month earlier. It will be interesting to monitor if pressure from the White House will be enough to encourage refiners to maintain unusually high levels of utilization throughout the coming weeks.
Bullish End to 2023
The combination of all these factors has led to a surge in refining margins. According to data from Finnish-refining company Neste, the Northwest European diesel refining margin has skyrocketed from a low of around $12 per barrel in early May to over $43 per barrel at present. While subdued oil prices during Q2 prevented these increasing margins from significantly impacting consumers, it is evident that the present combination of high oil prices and refinery challenges cannot be ignored. Indeed, the upward pressure on fuels shows no signs of abating in the short term. ChAI's current forecast for both ICE Heating Oil and Gas Oil futures indicates month-on-month price increases for until the end of the year.
