Low ULSD inventory in US/Europe but also low demand, AG ULSD arbs continue to point West

The most cost-effective source of ULSD supply for NWE and the MED regions remains the Red Sea, discounting the relatively small East Coast Canada arb.

However, the Red Sea ULSD arb to NWE appears to be closed at the front, which can be partially attributed to reduced runs of the Yasref ULSD hydrotreater since June 30th, according to our Singapore based Sparta colleague Thomas Cho. These reduced runs, down from 430 kb/d to approximately 300 kb/d, are expected to continue for the next 10 days to 2 weeks.

AG arbs continue to point to Europe, as mentioned in our previous article, while WCI ULSD arbs currently marginally favour Singapore, but this should be expected to change very soon.

Europe’s ULSD market remains tight, with the front ICE GO Swap spread increasing from approximately +3.5 to almost +5.5 $/mt this week. We have been informed by our sources that “the front overhang of US ULSD vessels has cleared, market participants bidding the barges to pretty high levels and EoS re-supply is not due to arrive until the 2nd half of July”.

On top of this, Germany’s Bayernoil refinery has halted diesel deliveries since June 30th due to a lightning strike. Europe has suffered many refinery outages of late including Austrian OMV’s Schwechat refinery, UK’s Fawley refinery, France’s Donges refinery, Romania’s Rompetrol and OMV’s Burghausen refinery.

July ULSD cracks have as such remained at their highest levels since early April 2023 over the past two weeks, further reflecting the market’s tightness.

Furthermore, the MED ULSD differential is at its highest levels since early March in a further sign of the effect of the reduced EoS ULSD arrivals of late. The lack of EoS arbs into Europe, coupled with low inventory levels, have contributed to the tightness in the European market.

However, market participants expect this situation to be partially resolved in the second half of July when several EoS arrivals are expected in Europe. In the meantime, elevated US arrivals in the first decade of July have partially filled the gap, but this is not set to continue as the USGC arb to Europe remains firmly closed currently.

Despite lacklustre demand in Europe due to the ongoing recession since late summer 2022, low gasoil inventory levels need to be addressed through two mechanisms.

First, European gasoil cracks need to remain strong to incentivize gasoil production. Second, the E/W spread needs to remain wide enough to attract AG/WCI ULSD barrels to Europe. However, market participants will be unwilling to build significant stocks in such a backwardated market.

The USGC has maintained its position as the most cost-effective ULSD arb into Northern Brazil. The situation is more mixed in Southern Brazil and Argentina, where AG and WCI barrels provide stiff competition for the USGC. The Raffles Horizon ULSD LR2 was booked this week to perform the route from the AG to Brazil.

It is important to note the competition from Russian ULSD barrels, which have continued to be a large part of the imports to Brazil. Market participants report a significant increase in Baltic and Black Sea ULSD exports in June 2023 compared to May. 

On the positive side, Brazilian ULSD demand has been showing strong growth due to an improving economy. In May 2023, Brazilian ULSD demand outperformed May 2022 by 3.5%, and demand over the past three months has reached its highest levels in five years.

US ULSD inventories are currently towards the lower end of their five-year range. However, US ULSD demand is also low, reflecting concerns about the ongoing recession; US manufacturing activity has declined to its lowest levels since the start of the Covid pandemic.

The inventory position is reflected in HO cracks, which are currently at their highest levels since early April. Sustained elevated cracks will be necessary to prevent reaching critically low ULSD inventory levels as we approach the third quarter of 2023 and winter.

The low demand levels in the US are also evident in the HO spreads, which have narrowed from +1 cpg to almost 0 cpg this week. This trend is expected to continue in the short term unless there are significant changes.

The HOGO spread has widened over the past week, effectively shutting down the USGC ULSD arb to Europe. Currently, there doesn’t appear to be a need for the US to open this arb, so the HOGO spread is expected to remain relatively stable in the short to medium term.

South Korean ULSD LRs have once again become the most cost-effective source of re-supply for Singapore, surpassing WCI.

This trend was predicted in previous articles as South Korean refineries resumed operations after maintenance, in early July. Additionally, there are rumours of increased Chinese gasoil exports in July compared to June, driven by improved export margins resulting from weakening internal gasoil demand.

The Front Tyne VLCC having loaded ULSD at Ruwais, is now preparing to discharge in Singapore. Singapore Middle Distillate stocks have risen to a two-week high of 7.980 million barrels, driven by declining gasoil exports.

Indian diesel demand reached record levels of 1,991 kb/d in May, showing growth once again. However, there is typically a dip in demand during the Indian monsoon season beginning at the end of July, potentially opening up more ULSD production for exports.

There are two potentially positive factors for the Singapore/Asian ULSD complex. First, there is continued demand for Australian ULSD imports due to ongoing issues at the Geelong Refinery. Second, the AG /WCI ULSD arbs currently favour westward movements.

However, the overall picture for the Singapore ULSD complex is negative. SG 10 spreads are expected to lose their recent gains and follow SG 10 cracks in a downward trend in the short to medium term. It is important to note that we are currently in a low global ULSD inventory position, so the direction of AG/WCI ULSD arbs significantly influences the current dynamics between Singapore and Europe.

The July/August NWE Jet CIF spread has experienced significant gains this week, nearly tripling from +6 to +16 $/MT.

Similarly, the Jet E/W spread has widened from +23 to +35 $/MT over the past two weeks. Market participants are reporting a high demand for jet fuel in the Mediterranean region, coupled with low jet stocks throughout Europe and limited availability. 

As a result, the jet arb opportunity is currently open from all major Asian jet sources to Europe. With Chinese jet exports projected to increase from 1.3 million MT in June to 1.7 million MT in July, and South Korean refineries resuming operations after turnarounds, a significant number of fixtures to Europe are expected in the coming weeks.

Global jet demand is not a concern at the moment, as the Official Airline Guide (OAG) predicts that global airline seat capacity in 2023 will surpass pre-pandemic levels from 2019 by the end of August. Therefore, the Jet E/W spread is likely to remain wide until the European arrivals of EoS barrels start impacting the market.

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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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