Global distillate cracks strong on net bullish paper positions, extremely low stock environment

The USGC remains the most cost-effective arb opportunity into Europe. Past the very front, the Red Sea retains its typical place as Europe’s most cost-effective supply point.

Options for European resupply look increasingly difficult from September onwards, however, with the narrowing of E/W from -$13 to -$10.75/mt over the past week closing EoS options into Europe along the entire curve.

This contrasts with a tight European market which is currently grappling with ongoing distillate shortages, causing sales prices, cracks, and spreads to surge in the last week.

Various factors contribute to this situation, including Shell Pernis CDU issues, Shell Wesseling slowdowns, Donges hydrotreater problems, a fire at Repsol’s Bilbao refinery, and ARA stocks hitting a six-month low last week. Additionally, rumours circulate that European wide distillate stocks are approximately 7% below their seasonal average at present.

Notably, August European GO cracks have reached their highest level since January 2023, at $25.50/mt, pre-dating the tightened Russian sanctions. Interestingly, Russian July ULSD exports are reportedly at an all-time high, though this increase in supply offers no respite to Europe’s supply concerns.

In response to these developments, net ICE GO bullish positions on the ICE exchange have witnessed their most substantial surge since August 2021.

As the demand for diesel remains high in both Europe and Singapore regions, and our Sparta sources in the jet market indicate that European refineries have already been running at maximum diesel versus jet for the past period of time, evidenced by the dip in NWE Jet regrade in May and June, it appears that European resupply will continue to rely on shipments from the USGC.

Consequently, we should anticipate increasing pressure on HOGOs to narrow in the short to medium term, as the European market searches for resupply.

Elsewhere, the USGC continues to be the most cost-effective arb opportunity into Brazil, displacing competition from the AG thanks to the narrowed E/W spread. USGC’s FOB prices and differentials have experienced consistent downward pressure over the past week, leading to some notable fixtures along this route, including 2 LR2s and 1 LR1.

Interestingly, this downward pressure on USGC prices persists despite US distillate stocks currently being at the lower end of their 5-year range, a position which has caught the attention of hedge funds seeking potential opportunities.

US refineries are already operating at 94% of their capacity due to favourable refinery margins, August HO cracks having increased from $33 to $37/bbl this week.

A hesitancy to build stocks in a backwardated market has contributed to ongoing pressure on USGC differentials and HOGOs, to incentivize exports to both Europe and Latin America, a picture we expect to continue in the short to medium term.

Moreover, as FOB prices increase in East Asia, the USGC has solidified its position as the most cost-effective route into WCSAM, outcompeting Transpacific arbs.

Over the past week, AG arbs have followed WCI arbs in pointing towards Singapore rather than the Europe, despite remaining closed on paper. WCI retains its position from previous weeks as the most cost-effective option, despite FOB prices in AG and WCI increasing over the past week, driven in part by the shutdown at the Satorp refinery.

Similarly, physical premiums in South Korea have also ticked higher on maintenance at Hyundai Oilbank’s Daesan refinery.

Our internal analysis shows that Chinese gasoil exports have been slowing since the Q2 2023. Q2 2023 exports averaging 503 KT per month in comparison to Q1 2023 at an average of 1,993KT. However, our Sparta sources indicate that additional Chinese export quotas of 10 million mt of refined products are likely to be awarded soon.

On top of this, an upcoming Chinese economic stimulus package is rumoured, bolstering predictions of Chinese demand and contributing to buoyancy in the East Asian distillate complex.

Singapore distillate stocks now stand at 27% below their seasonal average, contributing to significant gains in Singapore cracks and spreads over the past week. Both Europe and Singapore vie for barrels currently, and therefore it is likely that the E/W will narrow further in the short term. Indications point toward more positive movements in SG10 spreads and cracks in the short to medium term.

Currently, the landscape for jet arbitrage appears limited, with major Asian opportunities closed to NWE, except for the Red Sea refineries.

The tightening jet market in Asia has driven FOB prices higher, with ME prices increasing from MOPAG +$1.5 to +$3 per barrel since the end of May. Meanwhile, the jet E/W has remained relatively stable in the past week.

Sources from NWE and the MED report that while the market remains tight in the first half of August, a notable weakening trend is expected thereafter.

Pressure is anticipated to bear on NWE jet differentials from the end of August onwards, with an abundance of EoS cargoes available in the market. These having been fixed during the previous couple of months when the economics were more favourable.

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James Noel-Beswick is Commodity Owner for Sparta. Before joining Sparta, James worked as an analyst for likes of BP and Shell, and leads our continued development of the distillate product vertical.

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