A strong contango in the Nymex futures forward market structure is again driving diesel stocks toward record highs, prompting traders to once more seek offshore storage solutions.
"The contango is the only thing making people money right now," one market participant said.
A contango, or carry market, occurs when the prompt month futures price is lower than the next month's price.
A carry market is normal, but before the outbreak of the Covid-19 pandemic with the associated lockdowns and travel restrictions, a typical forward contango in the Nymex was fractions of a cent. The Nymex contango widens in situations where the market perceives either widespread excess supply or that current demand is lower than it will be in the future. With the continuation of the Covid-19 pandemic, both apply to the current market.
After the contango on Nymex ultra-low sulfur diesel (ULSD) surpassed the 2¢/USG mark in early April, demand for storage skyrocketed as traders and refiners began holding on to inventories.
"This is how we make money," a former trader said. "This contango means you're buying low and can sell high later."
The drive to store diesel for profit can be seen in Gulf coast distillate stocks, which have added approximately 20mn bl since early April and reached 30-year highs by the end of July.
The inventory surge was driven by the forward Nymex ULSD spread, which by late April had widened to 10¢/USG, a situation some called a "super contango." With diesel prices in late April in an historic decline — diesel prices in the Gulf coast were at 18-year lows — and the forward spread predicting higher future prices, the demand to store rather than sell diesel grew stronger. At the same time, freight rates fell to multi-year lows, allowing offshore storage to become feasible. Even as refinery utilization rates in the Gulf coast fell as low as 74pc, output remained focused on diesel, and diesel production continued at near-normal levels.
In at least one case, a refinery's trading arm was profitable enough to cover losses for the rest of the company during the second quarter.
"The situation means the market expects diesel demand to come out of Covid really strong," one trader said in late June. "If it doesn't, they'll push the contango out."
Holding barrels
As domestic diesel demand began to recover in mid July, the contango narrowed again to less than 1¢/USG and traders cashed in at historic profits. But in late July, Covid-19 cases surged in states across the US, dampening optimism for a quick economic recovery.
As predicted, a wider contango has re-emerged over the past two weeks, with the spread in forward Nymex months holding above the 2¢/USG mark since 7 August.
"There's nothing available to buy," another trader commented regarding the Gulf coast diesel spot market. "Anyone who has a place to store product is holding onto their barrels."
A perceived current low value for diesel and an unwillingness to part with actual product while the contango is so wide is contributing to the scarcity, one broker said.
"Refineries are trading forward rolls instead of physical product," he said.
The same broker noted that spot market demand over the past several weeks has been heavily centered around companies that own storage facilities: "Storage is driving demand right now."
A storage broker confirmed that interest in off-shore storage is increasing again, as on-shore storage has remained tight since April and is becoming scarce and expensive once again. Traders are seeking whole cargoes with the intention of "parking them in the Gulf."
Freight rates, as reported by cargo brokers, are still high relative to April-June, but have been slowly declining since late July.
"The contango follows the cost of storage," one trader said. On-shore storage will remain expensive due to scarcity but "the contango will widen if freight costs go down."
Lower freight costs mean that off-shore storage becomes more feasible as traders hope to profit from the carry market, and that will push stocks even higher.
The contango market may be profitable for traders now, but it may not end well, one Gulf coast diesel broker warned.
"This market actually looks bearish to me," the broker said. "When will everyone come out of storage — and what happens then?"
