Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Tight diesel market dominates the spotlight
Ole Hansen
Head of Commodity Strategy
Summary: Crude oil trades higher for a third day supported by a general improvement in risk appetite and the market worrying about the ability and price of fuel products over the coming months. OPEC+ production cuts reducing the availability of higher distillate yielding crude oil, the EU embargo on Russian oil together with a global refinery capacity struggling to meet robust demand, have all helped drive refinery margins and prompt spreads sharply higher, an indication that we could be facing high winter prices for diesel and heating oil.
Crude oil trades higher for a third day supported by a general improvement in risk appetite as the dollar and US yields trade trade softer on increased speculation that the FOMC, following another 75 basis rate hike next week, may slow it’s aggressive rate hike pace in order to ascertain the economic impact of the actions already taken. In addition, the market continues to worry about the availability and price of fuel products over the coming months when OPEC+ cuts production and the EU embargo on Russian crude and fuel imports start.
While crude oil has been mostly rangebound since July, the fuel product market has continued to tighten as supplies in Europe and the US has become increasingly scarce, thereby driving up refinery margins for gasoline and especially distillate products such as diesel, heating oil and jet fuel. Some relief has been provided by China which recently issued its biggest fuel-export quota this year in order to help revive its economy hit by Covid lockdowns and a property slump. The move not only highlighting the slowdown in demand in China but also how incredible profitable refining activity has become. So far, however, the product futures markets in Europe and the US are not showing any signs of relief from additional barrels flowing from China with Asian consumers potentially benefitting the most.
The focus in terms of tightness remains the northern hemisphere product market where low stocks of diesel and heating oil continues to raise concerns. The market has been uprooted by the war in Ukraine and sanctions against Russia, a major supplier of refined products, especially to Europe. In addition, the high cost for gas has supported increased switching activity from gas to other fuels, especially diesel and heating oil. This tight market situation was recently made worse by the OPEC+ decision to cut production from next month. While the continued release of US (light sweet) crude from its strategic reserves will support production of gasoline, the OPEC+ production cuts will primarily be provided by Saudi Arabia, Kuwait and the UAE, all producers of the medium/heavy crude which yields the highest amount of distillate.
The current tightness is being reflected through rising refinery crack spreads and sharply higher prompt spreads, the latter signalling the situation is likely to get worse during the northern hemisphere winter. An example being the Nymex ULSD (Heating Oil) contract where the current front month of November trades at an elevated $410 per barrel, but some $45, or 11% below the next month of December.
As long the product market remains this tight the potential for lower crude oil prices seems low. Several refineries, especially in the US are currently undergoing maintenance which has further depleted stocks at a time where exports are running at a record pace. Yesterday the EIA said US exports of oil jumped to a new weekly high above 5.1 million barrels a day and it helped drive overall shipments of oil and fuel products to a fresh peak at 11.4 million barrels per day. Developments that is taking place while the US government continues to pump crude oil into the market from its Strategic Reserves, an increasingly flawed and politically motivated strategy ahead of next month’s mid-term elections, not only because it reduces the ability to respond to another crisis in the future, and more important from a short-term perspective, it is failing to curb prices of gasoline and diesel to the American consumer.
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