John Kemp

LONDON, (Reuters) – Shortages in diesel and distillate fuel oils are a major bottleneck on the oil market. This will increase pressure on fuel prices and oil prices until the world economy has a more stable growth rate.

Distillate oil is now the most sensitive to the cycles of oil markets, as it closely follows the movement of freight flows and manufacturing activity.

The U.S. Energy Information Administration reports that middle distillates from refinery processes increased by 1% in America between 1985 to 2019.

After the 1973 and 2008 oil shocks that rocked the world, distillate supply to offices, homes and shops plummeted sharply. The price surge of 2008 and subsequent declines in crude oil prices caused widespread heating system conversions to natural gas.

The heating market’s loss was offset by the increased volumes of diesel fuel that were supplied to railroads, trucking companies, construction companies and marine operators.

Most distillates were sold to motorists in 2019, followed closely by rails (6%), and farms (6%). However, smaller amounts of distillates were also sold to marine bunker fuel (3%) or to oil and natural gas drillers (2%).

Combined sales to residential and commercial users had dwindled to just 9% of all distillates supplied, down from almost 30% in 1985 (https://tmsnrt.rs/3spHrIX).

Only 380,000 barrels per hour were produced by combined residential-commercial sales in 2019. This is a decrease of 795,000 barrels per day for 1985 and a distillate market totaling 4.1million bpd.

The rise and fall of the manufacturing and freight cycles has replaced seasonal variations in heating demand, which have been the main drivers for distillate prices and inventories.

Variations in winter temperatures, heating oil use and overall distillate demand have a very small impact on prices and overall demand for distillates, compared to the 1980s and 1970s.

Instead, the volume of distillate supplied moves closely with changes in manufacturing activity, which can be measured by the manufacturing component of the Federal Reserve’s industrial production index.

The clear pattern of distillate inventory shows a multi-year cycle, which correlates with business cycles. This replaces previous years associated with seasonal heating demand.

Due to strong economic growth in the first months of 2008, 2014, and 2018, severe shortages in distillate emerged. This was manifested by sharp drops on inventories.

When the economy entered recession or experienced a substantial slowdown in its mid-cycle, distillate supply shortages were reversed.

Each case showed that low distillate inventories led to a sharp increase in prices, and an abrupt backwardation of the futures market due to refiners maximising crude processing rates.

Similar events are expected to occur in the early 2022.

U.S. distilate inventories are down to only 123 million barrels from 180 million in Aug 2020. It is still below previous lows for 2018 (116mln), 2014 (113mln) and 2008.

Short-term inventories may shrink further if freight carriers and manufacturers continue to demand more fuel than oil refiners and producers can supply.

As coronavirus travel restrictions relax and international passenger aviation recovers, the pressure on distillates will increase. Jet fuel is made from the same refining process.

The manufacturing cycle may slow down in the medium-term due to inflationary pressures (some of which is arising from oil industries) and rising interest rate, permitting distillate inventories recover.

Other columns:

– Diesel shortage attracts hedge fund attention (Reuters, Feb. 7)

Reuters February 4, 2004: Depleting U.S. Distillate Stocks Show Supply Chain Pressure (Reuters, Feb. 4)

– Fed searches for elusive soft landing (Reuters, Feb. 2)

Reuters: Overheating signs in the oil market (Reuters, January 28).

John Kemp is a Reuters Market Analyst. These views represent John Kemp’s own.