There has not been a reaction in the diesel market yet because of IMO 2020, but the analytics team at S&P Global Platts doesn't think the transition has played out.
In leading a media briefing this week to lay out its forecast on key oil trends next year, Platts' global director of analytics Chris Midgley (pictured above) noted a few transitions that have yet to kick in, both of which could contribute to market volatility.
Specifically, Midgley noted that shipowners transitioning away from high-sulfur fuel oil to marine gasoil, which is a diesel product, can make that transition easily. "It's a much quicker switch," Midgley said at the briefing. "We expect to see gasoil demand kick in right as we move into January."
IMO 2020 requires ships to burn fuel with a sulfur content of no more than 0.5%. The previous limit for most of the world was 3.5%. Two solutions with direct impact on diesel markets are keys to the transition. One involves the manufacture of a new brand of fuel known as very-low-sulfur fuel oil (VLSFO), which is produced by blending in a significant amount of vacuum gasoil, an existing intermediate product that can be used to produce over-the-road diesel. The transition to VLSFO generally has been seen as more complex because it is a new product and needs extensive testing.
The second is to swap out high-sulfur fuel oil for an existing product called marine gasoil (MGO). There have been estimates by others that MGO demand might increase as much as 1 million barrels/day during the transition, possibly putting a strain on the supplies of over-the-road diesel.
Midgley also noted that the IMO 2020 rules have a "carriage ban" that goes into effect in March. The carriage ban is complex but can be viewed as giving a little bit of breathing room to the Jan. 1 inauguration of IMO 2020. The carriage ban is creating a gray area in the implementation of the rule, but only into March.
According to S&P Global Platts data monitored by FreightWaves, the spread between ultra-low-sulfur diesel in New York Harbor and the price of dated Brent, the global crude benchmark, got as high as roughly $22/barrel in late October. At the time, a significant amount of refinery maintenance was cited as the reason for the higher spread, but a possible fallout was also seen as a possible reason. It has since fallen to as low as $15/b.
According to Midgley, there were several reasons for the weakness in distillate markets, which he referred to as gasoil, another term used in global oil markets to refer to the family of products that includes diesel. In particular, he said, the lateness of the monsoon season in India led to a poor harvest, which cut agricultural demand for distillate products. That in turn led to more exports to markets including the U.S. A similar dynamic is playing out in the U.S., he said, with a late planting season and a delayed harvest in some parts of the Midwest due to bad weather cutting distillate demand there as well.
(A recent surge in diesel demand in the U.S. has resulted in the average of what the Department of Energy refers to as "product supplied" to be the highest for the period from September to early December in several years. A lot of the increase in the average was helped by some strong demand numbers in recent weeks.)
Midgley said distillates demand is "starting to kick in." But refining margins in Asia — a key refining center and in particular the biggest market for marine fuels — are negative. "There needs to be a $10/b swing in the gasoil crack," Midgley said, to incentivize refiners to produce more gasoil in general and more marine gasoil in particular. (Note our earlier reference to the swing in the New York Harbor; it isn't really close to $10/b). "You need to have the demand and the call for it from the marine sector."
Looking to the broader macro picture into 2020, Midgley discussed one of the biggest question markets that everyone in the oil market is pondering: What will U.S. crude production growth be in 2020? The market is coming off a year in which U.S. crude output increased by as much as 1.2 million b/d. Conventional forecasts for a long time had the U.S. tacking on another million in 2020. But tighter credit lines and investor demands are seeing those forecasts pared back.
The Platts forecast now is for shale growth of 800,000 b/d. But to get to a total petroleum number, it also assumes that conventional oil production growth will drop by 150,000 b/d but that production of natural gas liquids (propane, butane, etc.) will rise more than 500,000 b/d. The net total increase in petroleum in the U.S. will be about 1.3 million b/d, Midgley said.
Midgley said S&P Global Platts' forecast for 2020, first revealed in the middle of last year, was for U.S. growth to be 1.1 million b/d. "Everyone was telling us it was too low," he said.
The current U.S. rig count, according to Enverus, is 839. Midgley said if the rig count "flattens" at 660, the growth in shale production will be about 900,000 b/d in the U.S. But if it drops another 40 to 50 rigs beyond that, the growth rate would slow to 800,000 b/d, he added. Either way, Midgley said there is clearly "stricter capital discipline" coming from the financial institutions that have financed the shale boom.
Image by Frank Winkler from Pixabay