LONDON — U.S. inventories of diesel and other distillate fuel oils have failed to replenish significantly despite a downturn in manufacturing and freight activity that has so far lasted eight months.
Distillate fuel oil inventories amounted to just 118 million barrels on July 14, according to data from the U.S. Energy Information Administration
Stocks were 21 million barrels (-15% or -1.15 standard deviations) below the prior 10-year seasonal average and the deficit had narrowed only modestly from 27 million barrels (-19% or -1.65 standard deviations) a year ago.
Distillate stocks have increased slightly from last year when they were just 113 million barrels, but otherwise they are at the lowest level for the time of year since 2004.
Chartbook: U.S. distillate fuel oil inventories
There is not much scope for rebuilding depleted diesel stocks by running refineries harder, shifting them away from producing gasoline, or drawing down diesel inventories in other regions of the world:
- U.S. refineries were running at 94.3% of their maximum capacity in the week ended July 14, which was 2.2 percentage points above the 10-year average and the highest rate since 2015.
- U.S. gasoline stocks are also depleted at almost 13 million barrels (-5% or -1.31 standard deviations) below the prior 10-year seasonal average, making it difficult to boost diesel yields at their expense.
- In Europe, distillate inventories are 30 million barrels (-7% or -0.90 standard deviations) below the seasonal average while the deficit in Singapore is 3 million barrels (-27% or -2.52 standard deviations).
U.S. distillate consumption and inventories are both closely geared to the business cycle since more than three-quarters of distillate fuel oil is consumed by trucking firms, railroads and manufacturers.
In recent decades, inventories have normally been reset after a period of depletion by a mid-cycle slowdown or a cycle-ending recession, but so far the slowdown has not been deep enough to rebuild them.
If the U.S. economy avoids a recession and industrial activity starts to rise, inventory depletion will resume and stocks will quickly fall to critically low levels, putting upward pressure on fuel prices and inflation.
Distillate prices and refining margins have already strengthened over the last three months as inventories have remained lower than expected.
Futures prices for diesel delivered in September 2023 have risen by more than $16 per barrel from their recent low near the end of April.
Prices for diesel have been rising faster than crude with the gross refining margin (the “crack spread”) widening by $10 per barrel over the same period.
The actual and prospective tightness of diesel supplies has started to draw interest from hedge funds and other investors.
Money managers have increased their combined position in futures and options linked to middle distillates in eight of the most recent 10 weeks by a total of 76 million barrels since May 2.
There have been increases in both U.S. diesel (+27 million barrels) and European gas oil (+49 million barrels) over the period.
As a result, the combined position is now in the 43rd percentile for all weeks since 2013, up from just the 6th percentile at the start of May.
If the U.S. economy avoids recession, this position-building will likely anticipate, accelerate and amplify the rise in distillate margins and prices.
Adjusted for inflation, U.S. heating oil prices were close to the long-term average in June (48th percentile for all months since 1990).
So far, positions and prices reflect a delicate balance between upside risks from depleted inventories and downside risks from a faltering global economy.
But if the economy avoids a recession, diesel prices could escalate relatively rapidly.