The Perfect Storm Is Brewing In U.S. Diesel Markets

1. Threat of Railways Stike Highlights U.S. Energy Vulnerability

- The prospect of a nationwide railway strike pushed US natural gas futures up above 9 per mmBtu, amidst fears of coal-by-rail disruptions, underscoring the importance of gas in power generation.

- According to the US EIA, consumption of natural gas in the United States is set to rise to an all-time high of 86.6 bcf per day in 2022, amidst retirements of coal-fired power plants.

- Considering that the railway-unions deal is still tentative, a resurfacing risk of strikes would lift Henry Hub futures again as 70% of all coal deliveries to US power plants are handled by rail.

- September is usually the month with some of the largest weekly builds in gas stocks before the winter kicks in - an emergency gas generation ramp-up might disrupt gas injection rates, adding another layer of pressure on prices.

2. Middle East Makes Claim for Europe's Diesel Market

- According to Reuters, the Middle East is poised to become the largest diesel supplier to Europe as regional buyers are preparing for the onset of EU sanctions on Russian products in February 2022.

- The combination of extremely low middle distillate stocks and remarkably healthy diesel cracks, still around $50 per barrel despite the recent price drop, makes Europe a coveted destination.

- Europe's imports of diesel have been increasing in September so far, moving up to 1.65 million b/d, with the Middle East controlling an increasingly larger share of the market.

- Russia used to be the key diesel exporter to Europe but it has seen its share decline from 60% three months ago to 44% in September so far.

3. We Need to Talk About Gas

- European TTF natural gas futures have found some respite around the €200 per MWh mark as fears of inadequate supply have been partially alleviated by the new EU plan to cut consumption.

- Some market optimism has come from Goldman Sachs forecasting that European wholesale prices would halve to below €100 per MWh by the end of Q1 2023, assuming a normal winter.

- On the other hand, the mulled nationalization of Germany's leading gas importers Uniper and VNG has sent jitters across Europe, stoking fears that more might be on the way.

- The European Commission has pledged to work on a more "representative" benchmark than the Dutch TTF, pointing to the ongoing discrepancy between delivered LNG prices and TTF.

4. India's Growth Trajectory Soon to Make it Prime Coal Buyer

- According to the Indian Central Electricity Authority, the Asian country will see an addition of 43-53 GW of coal-fired power generation capacity as it tries to satiate skyrocketing demand growth.

- As such, India is catching up with China in its thermal coal imports and ramping up deliveries from Russia and Indonesia, just as ICE Newcastle futures trade around 430-440 per metric ton.

- According to Wood Mackenzie, India's thermal coal imports will rise 7% this year to 158 million tons and continue edging higher in 2023, totaling 163 million tons.

- China, on the other hand, is cutting imports and is expected to buy only 182 million tons this year, down 64 mtpa year-on-year, suggesting that India might become the largest selling market globally by the mid-2020s.

5. EU Windfall Profit Plan Angers Low Emitters

- The European Commission unveiled a new plan that would cap earnings for power and fossil fuel companies, aiming to garner €142 billion in windfall profits whilst committing to a 5% reduction in peak-hour power demand.

- Whilst so far electricity demand has been fairly in line with 2021 figures, August recording a 1% year-on-year drop, Brussels has targeted a 10% cut in total electricity demand until end-March 2023.

- Power generation companies that are not running on gas will see their profits capped at 180 per MWh and the surplus would become public revenue, i.e. to be reallocated by the EU.

- With this, it seems that the idea of establishing a power price cap has been removed from the agenda as authorities questioned the demand-reducing effect of such a measure.

6. US Diesel Stocks Are Low at The Worst Possible Moment

- Unprecedentedly low middle distillate inventories may create the perfect storm for US diesel prices as the country is heading first into harvest season and then into winter heating oil season.

- Ongoing backwardation is hindering the rebuilding of diesel stocks, leaving inventories on the US Atlantic Coast 41% below the 5-year average, just as refiners are heading into fall maintenance.

- Despite robust cracks, shipping the fuel along the Colonial Pipeline is not attractive for suppliers as the two-week travel time creates unnecessary risks for hedging the backwardated curve.

- Similarly, in the Midwest, where diesel stocks usually peak in August before peak demand starts with the harvest season, inventories right now are below the average post-harvest level.

7. Russian Aluminum Bucks the Sanction Trend

- The United States and the European Union have ramped up imports of Russian industrial metals in 2022, despite logistical constraints and talks of starving Moscow of revenue.

- According to data compiled by Reuters, imports of aluminum and nickel have gone up by 70% across the Atlantic Basin, with sanctions so far sparing the industrial metals sector.

- European smelters such as Norsk Hydro and Novelis have pledged not to purchase any Russian product in 2023, with next-year supply agreements being negotiated right now in what is generally called the industry's mating season.

- Yet without US/EU sanctions, Russian aluminum and nickel are expected to maintain their market share thanks to marginal discounts, in fact, US suppliers are set to ramp up purchases as metals exports out of China have been shrinking.