U.S. Refiners Struggle to Meet Distillate Demand
U.S. refiners are struggling to meet the strong demand for heating oil and other distillates despite operations returning to near normal after Hurricane Harvey.
Stocks of distillate fuel oil fell by another 2.6 million barrels to 135 million barrels last week, according to the Energy Information Administration (http://tmsnrt.rs/2yZN43X).
Stocks have declined by 27 million barrels since the start of the year compared a 3 million barrel increase in the same period last year and an average rise of 4 million barrels over the last decade.
Inventories, which were 11 million barrels above the prior-year level and 31 million above the 10-year average at the end of January, are now 26 million barrels below 2016 and 8 million below average.
Distillate stocks continued to dwindle despite near-record run rates by U.S. refineries as operations returned to normal along the U.S. Gulf Coast.
U.S. refiners processed an average of over 16.0 million barrels per day of crude last week, only just under last year's seasonal record of 16.1 million bpd.
Refiners ramped up distillate production to more than 4.9 million bpd, only just under last year's seasonal record of 5.0 million bpd.
But with domestic demand running at a relatively high 4.0 million bpd, and exports at almost 1.4 million bpd, refiners were unable to prevent a further slide in inventories.
As the winter heating season and peak distillate demand approaches, many traders are speculating heating oil stocks will be tight and prices will rise further.
Hedge funds and other money managers had amassed a record net long position of 62 million barrels in heating oil futures and options on the New York Mercantile Exchange by Sept. 26.
Hedge funds' long positions outnumbered short positions by a ratio of 4.9:1, according to records published by the U.S. Commodity Futures Trading Commission.
Current hedge fund bullishness towards heating oil and other distillates marks a sharp turnaround from the end of June when they held a bearish net short position of 32 million barrels.
Refiners now have a strong incentive to maximise distillate production. The gross refining margin for making heating oil from U.S. light crude for delivery in December has climbed to more than $24 per barrel from $15 in June.
In another sign of a tight market, the calendar spread between heating oil futures for delivery in December compared with April, after winter is over, has swung from a small contango in June to a large backwardation.
The distillate market stands at a crossroads.
The concentration of hedge fund positions will be a clear source of downside risk to prices when fund managers try to realise profits by selling some of their long positions.
Refiners have a very strong incentive to maintain run rates at a high level through the next couple of months by postponing discretionary maintenance which could help rebuild stocks.
If refinery run rates remain elevated instead of the normal slowdown in October and November, stocks could rise.
But stocks are already low and resurgent demand from the freight sector will make it harder to rebuild them even if run rates remain elevated.
Last winter was exceptionally mild. Heating demand was 12 percent below the long-term average between December and February in the areas of the United States where fuel oil is the most prevalent form of heating.
Mild temperatures helped limit heating oil demand in 2016/17, but this winter is likely to colder, on the balance of probabilities, which would boost demand.
The outlook is for La Niña conditions in the central Pacific this winter, according to U.S. government forecasts, which could also bring colder temperatures in the northern states, where most heating oil is consumed.
The volatile state of the market is evident in recent gyrations in crack and calendar spreads, both of which had softened recently, but jumped higher again on news of the continued fall in stocks reported on Wednesday.
By John Kemp
