No wild ride for diesel in 2019, despite expectations

When the Energy Information Administration of the Department of Energy posted its final average U.S. retail diesel price of 2019 Monday evening, the national average price was $3.069 per gallon.

A year earlier when it posted the final price for 2018, the number was $3.048 per gallon. All those ups and downs, for a gain of just over 2 cents per gallon.

The reality is that it was a remarkably stable year for buyers of diesel. It wasn’t supposed to be. The year was going to be the time when market changes created by the IMO 2020 rule would spill back into the diesel market and push prices higher. Not only that, but in September, a key Saudi oil facility was attacked, likely by forces tied to Iran if not that country directly. The result was a one-week upward blip in the market and then … nothing.

As grizzled market veterans said over and over, can you imagine if an attack like that had happened 10 years ago? What would have been the market reaction? The answer: much higher prices that would take a long time to return to earth.

Diesel buyers did pay more at the pump for about two weeks after the attack — the weekly DOE price jumped about 10 cents in one week — but it proved short-lived. The DOE price did not drop to less than $3 per gallon the rest of the year, but few thought that was because of any lingering fallout from the Saudi attack.

So the diesel market took the hit of an internecine Middle East attack on oil facilities and pretty much shrugged it off. The end result was a year in which the movement of diesel prices was downright boring. That means for companies that consume that fuel, it was a welcome change.

In between those largely status quo end-of-year DOE numbers, the weekly DOE price ranged from a low of $2.965 per gallon in late January, when retail markets were catching up to the collapse in all oil and financial markets of December, to a high of $3.171 per gallon in early May. That’s a range of 20.6 cents per gallon. The prior year, the range was between $3.394 (mid-October) and $2.972 (mid-March). That’s a swing of 42.2 cents. The year before that, 2017, had an even bigger swing, about 46 cents between low and high, but at much lower levels.

How did we get a year in which stability reigned, particularly when it wasn’t expected? The primary reason was that OPEC, mostly in the form of Saudi Arabia, shocked the world by meeting its promised supply cuts and then some. While the non-OPEC countries of the world were tacking on about 2.9 million barrels per day of new supply while demand was only rising about 1 million barrels per day, OPEC slashed its output by about 3.4 million barrels per day. The result was a remarkably stable crude oil market over the course of the year. If you throw out January, which started on a very low level because of December 2018’s collapse in all sorts of financial markets, crude as measured by WTI traded fairly consistently in a range between $55 and $61 per barrel over the course of the year. The formula essentially was non-OPEC growth plus demand growth being mostly offset by the cuts in OPEC supply. End result: stability.

The relationship between crude and diesel stayed mostly steady as well. A simple comparison between the price of diesel and Brent on the CME exchange at the start of the year would have yielded a spread of about $18.30 per barrel. When in October that spread crossed the $20 level, there were two perspectives. One was that heavy refinery maintenance — much of it tied to getting ready for IMO 2020 — had tightened diesel supplies for the short run and you were seeing it in the spread. The other was that a fundamental strengthening of diesel was occuring because of diesel starting to be drained from over-the-road uses to marine usage. On its third-quarter conference call, officials from independent refiner Valero mostly linked the strengthening of diesel markets to that factor.

But as refineries came back online after maintenance, that spread faded back toward where it was earlier in the year. Physical markets did so as well. For example, based on data from S&P Global Platts, the spread between a barge-sized quantity of ULSD in New York harbor and Dated Brent, the world’s benchmark crude, stood at about $23.30 per barrel in mid-October. By the end of the year, it was down toward $16.60 per barrel.

The analysts who saw the spike in spreads as being maintenance-driven were correct; those who saw it as IMO 2020-related were not. Note too that this lack of strength in diesel markets occurred even though the biggest refinery on the U.S. East Coast, Philadelphia Energy Solutions, shut down after a June explosion and fire.

(For an explanation of IMO 2020 and how it could impact diesel markets, please go here.)

So why has IMO 2020 not had an impact on the market? There are some signs that should point to tighter markets. For example, U.S. distillate inventories have been running below five-year averages the past several months. The shape of the forward curve in the ULSD market is in a structure known as “backwardation,” which points to tight supplies. While diesel output in the U.S. is at healthy levels, it isn’t rising to the type of numbers that might have been expected to meet one pathway toward adequate supply for IMO 2020: ramping up refinery runs. That isn’t happening so far.

And yet while the price of ULSD on CME has risen to about $2.05 per gallon recently from $1.91 per gallon on Feb. 1, the spread against Brent — which would be expected to blow out if IMO 2020 were steering the ship — has not. (It’s up about 35 cents per gallon since Feb. 1.)
It may be that the forecasts of a reaction from IMO 2020 in the fall were just premature. Chris Midgley, the chief analyst at S&P Global Platts, said recently he expected a reaction in the coming months. If that is the case, the quiet diesel market of 2019 may be looked at with nostalgia from a consuming sector that could get whipsawed in 2020.