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Red Sea Tensions Threaten to Disrupt Diesel Market Stability

Published 12/20/2023, 09:01 AM
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  • Increased distillate production and slowing economic activities have led to rising diesel stocks and falling prices.
  • Weak manufacturing activity in the U.S. and Europe contributes to reduced diesel demand, easing the market.
  • Geopolitical tensions near the Red Sea present potential disruptions, threatening to impact diesel supply chains and market stability.

Diesel and other distillate inventories are higher now than they were this time last year, suggesting that a tight global diesel market has started to ease, in part due to slowing construction and manufacturing activity in the United States and major European economies.

Refiners produced high levels of distillate volumes in the third quarter of 2023, adding to stockpiles, while the economic slowdown is weighing on diesel consumption.

U.S. diesel prices have dropped in recent weeks and are now at their lowest since July—welcome news for the Fed’s continuing fight against inflation as the prices of goods are closely linked with the price of diesel.

While the previous diesel tightness is showing signs of easing, manufacturing and construction activity going forward could determine how the supply-demand balance in distillate markets will look.

Relentlessly rising interest rates have slowed construction activity and factory output globally, but the recent Fed pivot signaling three rate cuts next year could reinvigorate the U.S. economy after a “soft landing” and a rise in manufacturing could lead to renewed tightness in distillate markets.

U.S. distillate fuel inventories increased by 1.5 million barrels in the week ending December 8, 2023, but are about 12% below the five-year average for this time of year, the latest weekly inventory report from the Energy Information Administration (EIA) showed.

Below-average distillate stocks suggest that an uptick in manufacturing and construction next year could cause another concern about a tight diesel market.

For now, the diesel crunch is easing.

But the geopolitical risk near the Red Sea, which prompted major shippers to seek alternative routes, could increase the voyage length for shipments of petroleum products from the Middle East and India to Europe and from Russia to China and India, creating chaos on the oil and product markets.

Diesel Stocks Rise

Globally, stocks have risen over the past year and have narrowed the deficit to ten-year seasonal averages, according to estimates by Reuters senior market analyst John Kemp.

Distillate stocks in the U.S., Europe, and Singapore either increased or tracked seasonal averages between September and November after narrowing in August the deficit to ten-year averages compared to August 2022, Kemp notes.

However, as diesel consumption is the most sensitive of all the refined products to economic growth and the business cycle, weak manufacturing is easing the diesel crunch.

The price of diesel has just fallen below $4 per gallon for the first time since July, Patrick De Haan, head of petroleum analysis at GasBuddy, wrote on Monday, noting that it is “also very welcome news for the economy as nearly all goods are impacted by the price of diesel.”

Weak Manufacturing

Still, part of the diesel price decline—apart from lower crude oil price, of course—is continued weakness in manufacturing activity.

U.S. economic activity in the manufacturing sector contracted in November for the 13th consecutive month, according to the latest release from the Institute for Supply Management (ISM).

The Manufacturing PMI registered 46.7% in November, unchanged from the 46.7% recorded in October.

“The overall economy continued in contraction for a second month after one month of weak expansion preceded by nine months of contraction and a 30-month period of expansion before that,” said Timothy R. Fiore, Chair of the Institute for Supply Management Manufacturing Business Survey Committee.

However, ISM’s December 2023 Semiannual Economic Forecast from last week is bullish in many ways, with positive expectations about manufacturing in 2024. Importantly, the more bullish responses and data for the manufacturing sector were collected before the Fed’s signal that rate cuts are coming next year.

Weak Europe

But economic prospects for Europe, especially for its largest economy, Germany, do not look so good.

Real gross domestic product (GDP) in Germany is likely to decline again slightly in the fourth quarter of 2023 due to weak demand in industry and construction, Bundesbank, the central bank, said in its monthly report on Monday.

If Q4 GDP falls after the drop in Q3, it would mean a technical recession for Europe’s biggest economy.

Business sentiment is also weakening, the Ifo data showed on Monday.

“In manufacturing, the Business Climate Index fell noticeably. Companies assessed their current business situation as significantly worse. Their expectations also grew more pessimistic. Energy-intensive industries are having a particularly tough time,” the ifo Institute said, commenting on Germany’s flailing business confidence.

Oil Flows Change As Shippers Avoid Red Sea Route

The flows of crude and refined products could change in the coming weeks as some of the largest companies in the oil and shipping industries have started to adjust operations to avoid transit through the Red Sea following daily attacks on commercial vessels near the Yemeni coast.

Since the EU embargo on Russian oil and products, volumes of diesel and crude oil sailing northbound in the Red Sea have jumped, which has boosted the importance of flows via the Red Sea, Jay Maroo, Head of Market Intelligence & Analysis (MENA) at Vortexa, said on Monday.

If vessels moved to alternative waypoints such as the Cape of Good Hope in Africa, the voyage duration on the main routes from the Middle East to Europe, from India to Europe, and from Russia to India and China would increase by between 58% and 129%, according to Vortexa. The biggest increase, 129%, in the time it takes for a cargo to arrive at its destination would be on the Middle East Gulf to Mediterranean route, which would take 39 days instead of 17 days, Vortexa says.

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