By Devika Krishna Kumar
NEW YORK (Reuters) - U.S. diesel futures have soared about 40 percent in the last two months, prompting independent refiners to pounce, selling future output on the view that resurgent domestic demand and higher exports may turn out to provide only a brief boost.
The surprise rally in U.S. diesel futures has put prices on track for their biggest quarterly percentage gain in seven years. Money managers and hedge funds have invested heavily in the fuel as stronger-than-expected demand has helped draw down record inventories.
Diesel typically enjoys strong seasonal demand in these months from farmers fueling tractors and equipment during the spring planting season. But prices this year have gotten an extra boost from robust exports to Europe and Latin America.
Strikes in France have slashed European supplies for almost two weeks, boosting demand for U.S. diesel. But the announcement that one French refinery would restart hit U.S. diesel margins on Thursday. The distillate crack spread had jumped 7 percent, then gave up most of the day's gains.
Refiners such as Valero Energy Corp (NYSE:VLO) and Phillips 66 (NYSE:PSX) typically look for big price rallies to sell future output. These refiners were presented with a rare opportunity to lock in profits when diesel prices and margins popped in April and May.
Producer short positions in NY Harbor Ultra Low Sulfur Diesel (ULSD) have soared to levels not seen since November 2010, data from the Commodity Futures Trading Commission show.
Refining margins, represented by the U.S. diesel crack spread, have jumped by about 70 percent since early April and are on track for their biggest quarterly percentage gain since 2013. Margins widened to $14.94 on Thursday, their highest since mid-February, but then gave back most of the day's gains on the French refinery announcement.
Locking in $13 to $14 per barrel of profit through the rest of 2016 was better than the single-digit margins earlier this year, a trader at a U.S. East Coast refiner said. But they remain a far cry from the record hit in 2012, which exceeded $45 a barrel.
"Refiners are systematic, because they need to lock in margin," said John Saucer, vice president of research and analysis at Mobius Risk Group. "Anytime there's an uptick in a crack or a margin they're going to capitalize on it."
The rally could fade if hedging gathers pace and speculative buying wanes.
In a further sign of selling into next year, the average for the 12 futures contracts expiring in 2017, called the calendar strip, has not kept pace with gains in this year's prices.
Since early April, the 2017 strip has risen 21 percent to $1.64. Over the same period, the 2016 strip has gained about 29 percent, while the front-month contract has jumped about 40 percent.
The picture for refiners has improved dramatically since the bleak outlook this winter, after margins fell as low as $8 a barrel in late January. Soon after that, many refiners shut capacity due to weak profits because of a big glut in diesel.
But refiners are skeptical that margins will remain strong, because U.S. crude is on track for its biggest quarterly percentage gain since 2009. Fear for tighter margins going forward has encouraged them to hedge.
The heightened activity in diesel is surprising for this time of year, when typically the market buzz surrounds gasoline, heading into the busy summer driving season.
INVENTORY DRAWS
Speculative investors turned bullish on diesel early in May for the first time in about two years, after inventories that had been bloated by a mild winter started to decline.
Distillate stockpiles, which include diesel and heating oil, have now fallen for seven weeks straight, hitting the lowest level last week since early December 2015, data from the Energy Information Administration showed.
"The bullishness is kind of the market's expectation that the oversupply that has been built up is turning a corner and that we have reached an inflection point," said Rob Smith, director of refining and products markets at IHS.
"People are trying to time it right."