Viewpoint: US Gulf diesel spot demand lower into 2021

US Gulf coast diesel spot markets will face downward demand pressure in early 2021 as movements to the Atlantic coast are likely to remain sluggish.

Higher Gulf coast diesel margins are also incentivizing higher production levels and exports have fallen, contributing to a stock buildup in the region. This build up comes as market structure encourages the use of stored diesel over purchasing new production.

The Atlantic coast traditionally accounts for approximately one-third of total demand for Gulf coast produced diesel, with one-third exported internationally and one-third used within the Gulf coast region.

A strong contango in the Nymex forward structure incentivized diesel storage throughout the summer, leading to record stock buildups in both the Gulf coast and Atlantic coast regions. Gulf coast stocks of ultra-low sulphur diesel (ULSD) peaked at 56mn bl in late August, compared to the previous five-year August average of 37mn bl. Atlantic coast ULSD stocks topped 62mn bl in late July, versus the previous five-year July average of 38mn bl.

Those market conditions have since reversed, encouraging the use of stored diesel. The ULSD Nymex forward market structure is close to flat, meaning future diesel prices are not high enough to cover the cost of storage. The summer stock buildup has left a storage glut in the Atlantic coast in particular that will take time to clear even if domestic and export demand returns to stable, normal conditions.

After a slow drawdown through the fall, both regions saw stocks build up again by late December as export demand slipped for the US overall and Gulf coast production remained steady. Total US weekly ULSD export demand has averaged 1mn b/d through November and December, 17pc lower than the five-year average of 1.2mn b/d.

Stocks of ULSD in the Atlantic coast have averaged 56mn bl for December so far, according to weekly estimates from the US Energy Information Administration (EIA). This is 18mn bl above the three year average on the Atlantic coast for this time of year.

Gulf coast stocks have drawn down closer to average than in the Atlantic coast but remain well above average. December ULSD stocks have averaged 45mn bl, or about 7mn bl more than the three-year average for January.

Gulf coast production of ULSD continued unabated from the onset of the Covid-19 pandemic through August at the five-year average of 2.6mn b/d, as demand for storage compensated for a shortfall in market demand and kept prices and margins relatively strong. Production levels dipped for the next two months as gasoline margins rose to a rare premium over ULSD, but have picked up again over the past several months, averaging 2.6mn b/d for December.

Gulf coast production is likely to stay strong if margins continue to improve: since mid-December ULSD has stayed at a premium over West Texas Intermediate (WTI) crude of $10/bl or better, and touched a one-day high of $11/bl on 29 December, marking the best diesel margins the region has seen since late April.

Little pipeline flow north

The lack of movement between the regions is evidenced by the lack of demand along the Colonial pipeline. For the past four years, the Colonial has allocated, or filled to capacity, during the winter months, when demand is high for ultra-low sulphur heating oil (ULSH), the off-road version of ULSD that is used as heating oil in the Atlantic coast.

The pipeline has failed to fully allocate this winter partly due to a lack of demand for jet fuel, which shares the distillates line with diesel. Even when ULSD shipments rose to a record level of 32.7mn bl in May, the relative lack of jet fuel kept the pipeline out of allocation overall.

More telling is the number of stranded barrel auctions that the Colonial pipeline has held since the outbreak of the Covid-19 pandemic. Diesel auctions are usually rare and occur only when fuel reaches the end of the Colonial pipeline without a buyer. Colonial has so far auctioned off more than 707,000 bl of ULSD and ULSH since March. Of this total 284,000 bl were auctioned off in May, when record shipments were flooding the Atlantic coast region and storage became scarce.

Market participants commented that barrels were becoming stranded for two reasons. First, for a brief period barrels were sent to the Atlantic coast on speculation when the market contango became very wide. Second, shippers continued to send unwanted diesel in order to maintain valuable shipping history on the Colonial pipeline. Colonial shipping history rules require shippers to maintain shipments at the same level as in the past or lose future access to the pipeline space.

By Wendy Dulaney