Refineries will continue to avoid jet output and favor diesel instead: report

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When the pandemic first hit, refiners around the world rushed to shift as much of their operations away from gasoline because of a precipitous decline in demand for that product. The alternative was to both cut back on operations at refineries –  which they did –  and also to produce more diesel than normal, which they did to a degree largely unprecedented in the history of U.S. refinery operations.

Another part of that shift was to take as much of the distillate pool, which includes both diesel and jet fuel, and make as little jet fuel as possible and make as much diesel instead. With flights being cancelled on a massive scale, and the ones that were flying carrying fewer people, the need to maintain jet fuel supplies cratered. And the shift was then to make diesel, since trucks were still on the road.

That shift hasn’t ended. And it’s why the energy firm of Energy Aspects sees a diesel market that is oversupplied and pressured downward for the foreseeable future.

In a report released last week, Energy Aspects said the “implications of this massive shift in diesel yields can not be understated.” And it’s a worldwide situation. The Energy Aspects report said that diesel yields in Japan were probably at 10-year highs in the middle of May, and were at a record high in Europe in March.

A move to keep jet inventories from “exploding”

Moving production into diesel and away from jet fuel has been successful in one sense – it kept jet fuel inventories from “exploding even as aviation demand has crumbled.” But for every action there is an equal and opposite reaction and that has been to send diesel inventories climbing. 

What spurs this is not the demand for diesel, which remains depressed. In the U.S., the weekly reports of the Energy Information Administration shows the decline in diesel demand running from a few hundreds thousand barrels per day to as much as a million barrels per day less than a year ago.

Concurrently, there’s been a shift on to reduce the amount of jet fuel produced and, up until recently, produce less gasoline. Nobody was going anywhere and cars were sitting in driveways for weeks on end. 

Global refineries this month will process about 70 million barrels/day (b/d) of crude. “A single percentage point increase in global diesel yields means diesel output will be (700,000 b/d) higher than it would be under normal circumstances.”

The imbalances in the report are stark. In the U.S., Energy Aspects said the balance in the current second quarter, when the pandemic was in full swing, showed distillate supply of 4.973 million b/d against demand of 3.671 million b/d. The third quarter, EA predicts, will see an imbalance of 5.276/3.8 million b/d. The fourth quarter is less out of whack: 5.039/4.0 million b/d in favor of supply. But it’s still an imbalance.

Remember – this shift to producing more diesel is happening even as refineries are producing less overall. So in the U.S., refineries have been operating at either side of 70% of capacity, when normally one might expect a run rate near 90% or more. 

The end result is that inventories of ultra low sulfur diesel (ULSD) in the U.S. don’t seem particularly high when looked at in terms of barrels.

But the picture is very different when demand is laid up against those inventory numbers and are measured as Days’ Supply.  There, the imbalance is enormous. All distillate inventories –  mostly ULSD but not jet fuel – remain just under 50 day’s supply relative to demand. A number between 30 and 35 would be expected during normal times..

Physical diesel spreads weakening

You see the results of that imbalance in the spread between key crude benchmarks and physical diesel prices. For example, the spread between the S&P Global Platts price of dated Brent crude – the world benchmark – and the price of physical diesel in New York harbor last Friday stood at $6.87/b. On April 15, it was $17.81/b. Those kinds of declines can be seen throughout the various grades of physical diesel.

The outright price of diesel from the perspective of a trucker has several components – it is mostly driven by the direction in the price of crude, but it is also impacted by the crack, or the difference between the price of crude and the price of diesel. As the numbers above show, that crack has weakened significantly. But with crude prices rising, that declining crack has worked to hold the price of diesel at the pump relatively steady. On April 21, dated Brent hit $13.24/b, one of the lowest prices in its history. Last Friday, it was at $34.38/b. But during that time, the price of physical diesel in New York harbor only went up about $8/b.

Meanwhile, the EIA/DOE weekly price of retail diesel last week was $2.39/gallon. On April 20, it was $2.48/g. So the rising price of Brent and other crudes is being more than offset by the weakness in diesel markets, along with the usual lag in retail prices relative to broader market movements. 

The issues in the jet fuel market mean that these imbalances are likely to continue, according to the EA report. 

“What the market needs is demand growth and refinery closures,” according to the report. (Of course, the “need”  for one side of the equation is not necessarily a problem for another; consumers of diesel would be quite happy if refiners produce more diesel than the market can handle.)

“There is unlikely to be much scope for a recovery in diesel until jet markets get on a path to normality,” the report adds. “But since two-thirds of jet demand is connected to international travel, any meaningful recovery will likely have to wait until 2021.”

That’s good news for diesel consumers. As long as refineries want to make gasoline, which they’re doing more of now that economies are opening up, and as long as they don’t want to make jet fuel, they’re going to keep making more diesel than the market can handle. That means that Days’ Supply figure mentioned earlier is likely to stay elevated and keep downward pressure on prices.