John Kemp

LONDON, (Reuters) – The U.S. crude oil inventories are expected to drop significantly between now and mid-2019, creating the conditions for a spike in fuel and crude prices unless freight demand falls.

Distillate inventories slipped by another 2 million barrels last week to 120 million barrels, according to data from the U.S. Energy Information Administration (“Weekly petroleum status report”, EIA, Feb. 16).

Stocks currently stand at 28 Million Barrels (8% below the five-year pre-pandemic seasonal average of 2015-2019) and are the lowest for this time period since 2014.

Trucking companies, railroads, and shipping companies purchase three-quarters (75%) of the distillate fuel oil to transport farm products, industrial materials, and manufactured goods.

Low inventory levels are an indication of the strong demand for freight in a fast recovery from coronavirus recession that was led by the manufacturing industry.

DEPLETION

Normally, distillate inventories decrease during the first two-thirds of the year. However, they reach a low point before June to allow for maintenance.

If inventories don’t fall in line to the average of the 10 years prior to the pandemic they will drop to 105 millions barrels before June ends. They can range from a comfy 118million barrels to as low as 94.9 million barrels which is extremely tight.

Even the average projection for inventories in 2022 could see them dip to the lowest level for any year since 2007 (https://tmsnrt.rs/3oV0eec).

Not all trajectories will result in inventory levels that fall below those experienced over the last fifteen years.

A diesel shortage could cause prices of gasoline and crude to rise, which may lead to a spike in their price over the coming months.

RAMPING UP

A low level of distillate stocks in mid-year could cause refiners to race for rebuilding them before next winter’s heating season.

This will make it difficult for refiners to reduce the use of gasoline, and to produce more diesel fuel.

But, the gasoline inventory is already six million barrels below its pre-pandemic seasonal mean (-2.5%). It limits their ability to extract them for rebuilding distillate stocks through downstream processing.

A shortage of distillate has impacted the gasoline market and driven up gasoline prices to make sure that refiners are able to produce gasoline instead of switching to diesel.

The only way refiners can rebuild their distillate stocks is to continue processing crude oil over the next six to 9 months. That will increase the output of light and medium distillates.

The implied increase in refiners’ demand is likely to tighten global crude inventories even further and continue exerting upward pressure on oil prices through September.

After inflation adjustment, diesel prices on roads, including taxes, are higher than ever since 2014. They average more than $4 per gallon, which is equivalent to $168 per barrel.

To limit consumption and keep inventories from falling to critical lows, prices may need to go up even more.

A shortage in distillate caused the record-breaking $148 barrel price by July 2008 (equivalent of $187 today, after inflation adjustments).

Central bankers and elected policymakers will be concerned about rising fuel costs in the first half 2022.

A significant rise in crude production, or a drop in freight demand due to a slowdown of the manufacturing process would help avoid cost inflation.

Other columns:

Reuters: Global oil stocks are extremely tight (Reuters Feb. 15).

– Diesel is the U.S. economy’s inflation canary (Reuters, Feb. 9)

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

Reuters Feb. 4: Supply chain pressure is evident in depleted U.S. distillate stock (Reuters Feb. 4)

John Kemp works as a Reuters analyst. These views represent John Kemp’s own.