The anticipated surge in over-the-road diesel prices because of IMO 2020 has not occurred. But that doesn't mean that there aren't impacts in other parts of the oil supply chain because of the new rule that goes into effect Jan. 1.
In its wide-ranging monthly report that covers the entire sweep of supply, demand and markets, the International Energy Agency spelled out where the oil market clearly is reacting to the mandates of IMO 2020. The rule will require all marine transportation to burn fuel with a sulfur content no more than 0.5% worldwide. The current limit is 3.5%. Shipowners can get around it by using scrubbers that remove the sulfur from higher-sulfur blends.
There had been a surge in some physical diesel markets for a few weeks in October, measured as the price of physical grades of middle distillates (including diesel) relative to dated Brent, the world's crude benchmark. But that has been reversed — and then some. For example, based on data provided by S&P Global Platts, the price of ultra-low-sulfur diesel (ULSD) in the third week of September was about $17.25/barrel more than the price of dated Brent. It's now about $15.10. New York harbor ULSD was $19.55; now it's $18.42. Even marine gasoil (MGO), a diesel product that is expected to get a surge in demand because of IMO 2020, was $52.37 more than dated Brent in late September on the U.S. Atlantic Coast. It's now about $2 less than that.
The most basic spread of all, that between the price of Brent on ICE and CME and the price of ULSD, peaked out at about $22.55/barrel in mid-October. It's now down to about $18.30/b.
But the IEA sees movement beyond this. The agency, made up of nations that are considered consuming countries with Western-style economies, sees the transition so far going smoothly as measured by getting ready to supply compliant fuel to shipowners. It notes that coming out of a heavy maintenance season this fall that cut a significant amount of refining activity, the return to action of a lot of capacity "sets the stage for a hopefully smooth implementation in January of the … regulations," the monthly report said. "Ports, shipowners and refiners have stepped up their preparations. Major bunker hubs such as Fujairah, Rotterdam and Singapore are reported to have large volumes of compliant fuel available."
The report also notes that high-sulfur fuel oil (HSFO) prices have plunged relative to the rest of the barrel. HSFO is the current fuel of choice for ships, but it will be noncompliant under IMO 2020. The spread between HSFO and LSFO is "nose-diving," according to the IEA, blowing out to a $30/b level in Rotterdam, the widest in more than 10 years. About a year ago, it was $3.
So what does all this mean for where the market stands just six weeks or so until IMO 2020 is the law of the world? Where is the reaction in the diesel market?
The adequate supplies that the IEA refers to of compliant fuels could not have been produced without some input from diesel. There is an intermediate product called vacuum gasoil (VGO) that is going to be one of the key blendstocks to produce compliant VLSFO. That, combined with greater consumption of MGO, was always seen as the likely way to transition into a new 0.5% market from the current 3.5% standard.
But if VGO is being used, why isn't there a drop in diesel supplies and a concurrent rise in diesel prices relative to crude? VGO can be used to produce diesel or gasoline, as well as the new blends of VLSFO.
That's a tough one to answer, but that doesn't mean there aren't some things going on in the diesel market that might be pointing to higher prices eventually.
For example, just this week S&P Global Platts reported that the market price for barges of ULSD in the Amsterdam-Rotterdam-Antwerp hub were at a six-month high against the benchmark contract on the ICE commodity exchange for gasoil (which is a middle distillate, like diesel). The spread was $1.75/metric ton, up from $1 just a day earlier. It's the highest since May, but note that back then the spread was $2.50. So it has moved up, but it isn't in never-before-seen territory.
One of the reasons cited for the increase in European ULSD prices was a report from a company called Insights Global that ULSD inventories were at eight-month lows in that Rotterdam region. That would be keeping with other inventory numbers showing tight diesel supplies. U.S. total distillate inventories — which are mostly ULSD — are 14 million barrels less than the five-year average. That's about a 12% deficit.
Back to the IEA report: It sees tight inventories of middle distillates all over the world. The IEA reported that in September, the last full month for which it has data, inventories of all petroleum products drew 25.8 million barrels compared to a usual September decline of 5.7 million barrels. But it was the distillates that drew the hardest: 16.9 million barrels, which the IEA says is "over three times the usual decrease owing to the a counter-seasonal fall in the Americas and a larger decrease in Europe driven by the lower refinery runs."
Refining operations worldwide did have a heavy maintenance season in September and October. That certainly contributed to the lower inventory levels. The question is whether it was just maintenance that led to those significant draws in inventories or whether a diversion of feedstocks like VGO into making compliant marine fuels played a part. (U.S. distillate production numbers published by the EIA are not showing that.)
Although we noted that the price of ULSD on the CME had weakened relative to Brent, a sign that IMO 2020 was not hitting prices, the market is in a relatively steep backwardation. A backwardation is a market structure in which the highest price is found in the contract for the most immediate delivery, in this case December. And it's a structure that develops if inventories are tight. (A perfectly balanced market has the price rise over the course of the calendar, to reflect the cost of storage and the time value of money. That structure is known as contango.)
On Nov. 15, the spread out to next January was about 7 cts, with December 2020 priced about 7 cts less than December 2019. That is a fairly steep backwardation. It steepened by about 1.5 cts just over the course of the week, a move that also could be considered significant.
Truckers and other transportation professionals concerned about IMO 2020 have every right to be breathing a sigh of relief so far. There were predictions that the market might be shooting up by now. It hasn't happened and it might not. But there are still plenty of things to keep an eye on and watch for the danger coming over the hill.