Diesel market faces limited prompt upside as Middle East risks fade and US pricing adjusts to curtail exports

Commentary summary: 

• E/W coming off on reduced risk premium helping keep EoS barrels in the East
• USGC to Europe arbs slammed shut on spiking TC14 and USGC fob premia, but may need to widen once TC14 corrects if PADD-3 is to limit exports
• European diesel market looks precarious with pathways to both a rally and a more sustained grind lower clearly possible
• On balance, October and November look to have limited upside potential in the absence of further Middle East escalation, but December onwards can be more constructive

The last week has seen now the rise and fall of an initial pricing response to fears of further escalation in the Middle East, with the latest moves on both flat prices and East/West spreads leaving us essentially back to where we were a week ago.

Whilst there are certainly still important fundamental drivers that we will look into here that will be key to the direction of E/W spreads and the EoS market in general, the largest sustained move over the last week has actually revolved around the US distillate market.

(Sparta Global ARBS – ARBs Comparison)

Econs on prompt arbs from both PADD-1 and PADD-3 into Europe have fallen sharply since the start of the month, driven by an uptick in FOB premia (PADD-1 in particular) and more importantly TC14.

It would appear that open PADD-3 arbs through September to both Europe and LatAm coincided with a potentially unexpected downturn (at least vs expected turnarounds) in crude intake in the region to drive PADD-3 diesel inventories to the bottom end of their seasonal range.

The outlet to Europe has now shut on the basis of higher freight without a need for the HOGO to do all the work.

However, with expectations that ballasters moving out of a weak TC2 market and towards the currently strong TC14 will stabilise freight rates, we would expect the HOGO to widen further through the rest of this month in order to keep PADD-3 exports lower.

(Sparta Live Curves)

A wider HOGO is already helping to bring increased competition into the ECSAM distillate market, where US-origin barrels are beginning to come under pressure from alternatives out of WAF or even the EoS. Depending on the trajectory of US crude runs and diesel yields (which have also not been overly high in recent times), it may indeed be necessary for US pricing to give up some of those LatAm outlets in the short term.

The implication here being that a wider HOGO means higher US distillate cracks, and with that helping to offset some of the margin pressure from a weak gasoline market that looks set to continue or even worsen.

This solver for tight US distillate stocks therefore works on multiple levels and would likely turn around that picture quite quickly, which probably explains why there may be some reluctance to move the forward HOGO wider (Jan-25 levels have been trading significantly lower than previous years all through 2024).

(Sparta Historical Forwards)

(Sparta Global ARBS – ARBs Comparison)

Returning to the East, aside from higher FOB premia out of India pointing to prompt tightness there potentially, the wider complex continues to appear under some pressure to keep balances from lengthening.

Whilst SG10 timespreads and cracks have moved slightly higher over the last week or so, both remain at the bottom end of their recent seasonal ranges and margin pressure is expected to persist.

Swing barrels out of both the AG and WCI continue to point East (open arbs on paper to ECSAM will struggle to become reality given cheaper alternatives out of Russia, US), and with the E/W having narrowed once more, there is little sign of an appetite to pull EoS barrels into the west currently.

Of course, much of this can change quickly if potential escalation in the Middle East becomes a topic once more, but for now we see a hard ceiling on the SG10 complex with distillate cracks continuing to be the leading signal for the required lower refinery utilisation across the region.

(Sparta Global ARBS – ARBs Comparison)