Diesel, marine gasoil, and jet fuel—collectively known as middle distillates—account for more than a third of global oil consumption. Used in road transportation, shipping, aviation, and manufacturing, middle distillates are more closely linked to economic growth than any other section of the oil products market.
Inventories of middle distillates—one of the most important refinery products—are also closely correlated with oil price trends and with the shape of the oil futures curve, so the pace of distillates demand and their stock levels could be the key determinant for the oil price changes through the next two years, Reuters market analyst John Kemp writes.
At times of industrial activity expansion and economic growth, demand for middle distillates jumps, and their stocks decline. If the current global economic growth is sustained, distillates demand will rise, lifting crude oil prices. But higher oil prices would raise inflation and could force an economic slowdown, or the global economy may slow down as a result of trade tensions, leading to higher middle distillate inventories, Kemp argues.
Last year, global middle distillates consumption stood at 35.307 million bpd—the largest share, 36 percent, of the world’s total oil consumption of 98.186 million bpd, according to the BP Statistical Review of World Energy 2018.
Demand for middle distillates is expected to surge ahead of an upcoming stricter regulation on the fuels used by the shipping industry. The International Maritime Organization (IMO) has set January 1, 2020, as the staring date from which only low-sulfur fuel oil will be allowed to be used for ships. The severe restrictions on fuel oil’s sulfur content—aimed at reducing emissions—will drive increased demand for middle distillates such as diesel and marine gasoil, which in turn will push up demand for crude oil, Morgan Stanley analysts say. This would boost crude oil demand by additional 1.5 million bpd, potentially sending oil prices to $90 a barrel in 2020, according to Morgan Stanley.
“Over the next few years, we expect tightness in one particular product — middle distillate — to lead to strength in one particular liquid, crude oil, and especially those crudes that look like Brent,” Morgan Stanley’s global oil strategist Martijn Rats said in May.
While middle distillates demand will be at the core of this new regulation, those distillates and their stock levels also tend to be highly correlated with the Brent futures curve and the spot price of Brent Crude.
According to Reuters’ Kemp, distillates draws have been much more correlated with the Brent curve shifts than gasoline inventory changes.
During periods of middle distillates oversupply, such as in 1998/99, 2001/02, 2006, 2009/10, and 2015/16, economic growth has been slower, and the Brent futures curve has been in a large contango—a market structure in which front-month prices are lower than prices out in the future months—pointing to a crude oil oversupply and making storing oil for future sales profitable.
At times of strong economic growth, middle distillate stocks have been very tight, and the Brent futures curve has been in backwardation—the market situation in which front-month prices are trading at a premium compared to prices further out in the future—a sign of a tighter and undersupplied market.
During the most recent oil price cycle, distillate stocks were high in 2015 and 2016, when the global oil glut was at its height and oil prices at a decade-low. In 2017, when oil prices started to rise, and stocks—including distillate stocks—started to draw down, the Brent curve flipped to backwardation, which was one of the key (and officially communicated) goals of the OPEC production cuts.
Currently, the U.S. distillate fuel inventories are low for this time of the year, the EIA said last week. EIA estimates that U.S. consumption of distillate fuel increased by 5 percent compared to the same period of 2017, largely attributable to an increase in trucking activity, which is the leading use of diesel fuel. “Demand for trucking services tends to be closely correlated to economic growth and industrial activity, both of which have been higher in the first half of 2018 compared with the first half of 2017,” the EIA says.
The upcoming shipping regulation is one of the factors that will determine middle distillates demand growth. The other is the pace of global economic growth. If the current economic expansion continues, middle distillates demand will boom and lead to higher oil prices. But higher oil prices would not be comfortable for too long and would slacken oil demand growth, leading to the next oil price cycle. By Tsvetana Paraskova for Oilprice.com