The oil price rally has really cooled down over the past two weeks, with oil prices declining to levels last seen prior to Russia's invasion of Ukraine. Brent oil (CO1:COM) prices fell ~2% Thursday to trade below $100/b, while the price for a barrel of Brent for June 2022 delivery has fallen from $127/b one month ago to $99/b today. Pandemic-related lockdowns in Shanghai, slowing U.S. oil demand growth, and a historic strategic petroleum reserve release have all contributed to the selloff. Interestingly, medium-term prices have hardly budged as near-term oil prices have fallen by over 20%, indicating a still-bullish longer-term outlook.
That said, whereas it's crude markets that have been hogging the limelight, the most dramatic action in global oil markets has been happening in a more hidden corner of the market: distillate fuels.
The price of diesel and jet fuel in Europe hit a record in early March amid unusually tight supplies. Both commodities have since pared some of their gains, but refiners are still making a killing.
Indeed, in another sign of impending distillate fuel shortages, jet fuel traded at ~$320/b in New York on Monday ($7.61/g), a massive ~$200+ premium to crude feedstock prices. The jet fuel premium is currently ~10x larger than any premium seen in the past 30yrs.
High Fuel Margins To Last
There's a good chance that high fuel prices will ultimately lead to demand destruction. However, Goldman Sachs says distillate fuel demand is likely to remain strong and margins to remain high due to these factors:
- Diesel and jet fuel stocks are at historic lows, and seasonally-adjusted inventory draws are large and accelerating.
- Jet fuel consumption is poised to accelerate into summer with a return to international travel.
- High natural gas prices will lead to "gas-to-oil" switching in Europe and Asia.
- The Russia / Ukraine war will reduce distillate supply, as Russia exports ~900kb/d of diesel fuel and ~900kb/d of residual feedstocks, which are largely upgraded into diesel by European and Chinese refiners.
- Refinery operating costs are increasing, particularly in Europe.
In fact, Goldman sees current record margins sustaining through at least year end. In the U.S., names like Par Pacific (NYSE:PARR), Valero Energy Corp. (NYSE:VLO), Marathon Petroleum Corp. (NYSE:MPC )and Phillips 66 (NYSE:PSX) stand to benefit from higher refining margins while in Europe, Saras (OTCPK:SAAFY) is most exposed.
Meanwhile, during its Q1 earnings preview, Shell (NYSE:RDS.A) mentioned improving refining margins, with indicators nearly doubling quarter over quarter.
Falling Russian Exports
Another reason to be bullish about fuel margins: falling Russian exports.
Russia is a key source of distillate fuel for Europe and the world. Shortly after the war began, BP Plc (NYSE:BP) and Shell (NYSE:RDS.A) stopped selling spot diesel in Germany. Last week, Argentina’s YPF Sociedad Anónima (NYSE:YPF) cited diesel "scarcity" in the seaborne market. Jet fuel margins in New York harbor rose to $200/b earlier in the week, a ten-fold increase from historic averages.
Attempts to measure the impact of self sanctioning on Russian exports have seen mixed results, with some studies suggesting that exports have largely continued to flow unchanged while others say they could have declined by as much as 3.0mb/d. Thus far, the only measurable impact on exports has come from a terminal outage—a terminal that primarily carries Kazakhstani crude to market.
So far, Russia's pivotal energy sector has been largely spared from sanctions. But damning evidence of serious war crimes coming from Ukraine suggests that Russia could very well face more severe sanctions, including a ban on its oil by European nations.
Since Russian forces withdrew from northern Ukraine, turning their assault on the south and east, grim images from the town of Bucha near Kyiv, including a mass grave and bound bodies of people shot at close range, have prompted international outrage.
Commodity analysts at Standard Chartered estimate that a move towards explicit EU sanctions on Russian oil imports would keep Russian output below 8.5mb/d for several years, good for a 3mb/d decline compared to pre-invasion levels, and introduce further downside to already low expectations for Russian oil output. According to StanChart, the EU's most likely immediate measure--i.e., imposing sanctions on coal--will do little to placate member states and public opinion for a significant ratcheting up of the pressure on Russia.
Further, EU sanctions on Russian oil and gas would send a strong signal that Russian oil is unlikely to regain its former market in Europe for an extended period, if ever. EU sanctions will also likely increase the pressure on key countries, and particularly India, not to increase their imports from Russia above pre-invasion levels; up to now, part of the pushback from other users of Russian oil has been that they could not be expected to refrain from extra purchases if EU governments were not explicitly limiting their own use.
In other words, fuel margins might remain elevated for many months, if not years.
By Alex Kimani for Oilprice.com
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