Europe's tanks are running low on diesel, making the market vulnerable to wild price volatility, with sanctions against Russia threatening to deliver the biggest supply shock in living memory in less than four months.
Independent gasoil inventories in the Amsterdam-Rotterdam-Antwerp (ARA) region fell by 10pc in one week in early October. That undid a brief recovery in the region's stocks, compounding a 43pc decline in total Dutch diesel inventories in the year to July 2022. They were 33pc lower in July than in the same month of 2019. These statistics show the problem most starkly because ARA has outsized oil storage capacity, but the trend is the same everywhere.
Germany had 10pc less diesel inventories in July than a year earlier and 7pc less than in the same month of 2019. The UK had 12pc less than a year earlier and 30pc less than in 2019. Overall middle distillate inventories in the 16 major European countries surveyed by Euroilstock were 11pc lower in September year on year and 13pc lower than in 2019. That figure includes kerosine, but mostly reflects diesel and gasoil.
These volumes never get near zero, because of day to day operational needs. But the layer of discretionary inventories on top has been disappearing.
This has been a key cause of high and volatile diesel prices. Without inventories, buyers cannot be flexible. They need to secure supply on a tight schedule to be sure of fulfilling their own contracts for onward sale. When prompt prices rise because of a supply disruption, buyers cannot wait for it to pass and pay whatever it takes.
Traders said there is no incentive for most participants to build or even maintain these discretionary inventories, because of the enormous cost of doing so in such a steeply backwardated market. Backwardation — meaning prompt prices above those for later delivery — signals fundamental pressures on the market. For the past year, the backwardation has reflected the great cost and difficulty of refining diesel. The most efficient way to meet marginal demand has been to draw on inventories instead.
Spiking natural gas prices in autumn 2021 created moderately steep backwardation because they raised refiners' energy costs and the cost of the hydrogen input to some key diesel production processes. Gas prices have soared in recent months. Emissions allowances have grown much more expensive for European refiners at the same time. And as gasoline became oversupplied in Europe in the summer, diesel buyers had to compensate refiners for the losses they were making on other products as they raised crude runs. This dynamic is likely to re-emerge over the winter.
Available refining capacity has shrunk. A wave of wholesale decommissioning and conversion to bioprocessing during the pandemic was followed by fires, explosions and malfunctions this year as refiners tried to maximise middle distillate output under heatwave conditions. Most recently, French strikes have immobilised more than 5pc of Europe's refining capacity for four weeks.
The inventory crunch is not universal. Some firms are known to be stockpiling, in spite of the high financial cost, because they perceive such a severe risk of supply disruption in the coming months. The two German refineries supplied with Russian crude through the northern leg of the Druzhba pipeline are examples of this.
At the national level, European policymakers have dipped into strategic reserves several times already this year. The International Energy Agency (IEA) co-ordinated a multinational release to calm markets in the aftermath of the Russian invasion of Ukraine. Then when refineries in Austria and Hungary shut down unexpectedly over the summer, the governments of both countries released some reserves. When strikes closed most of the French refining system in September and October, the government there did the same.
But all the shocks that have prompted European reserve releases so far are smaller than the one coming this winter, when Europe will stop Russian imports by law. The more reserves that are used in the meantime, the less there will be to stabilise markets later.
