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• The distillate market has struggled to absorb unwanted jet fuel supplies in the aftermath of the collapse of airline activity • Diesel cracks steadily weakened in 2020, reaching multi-year lows recently, while RBOB-ULSD spreads rallied to decade highs • Several factors could now help diesel: low crude runs, yield shifts, and positioning. Yet weather may cast the deciding vote Diesel has shouldered the burden of weak jet demand… Each refined product has faced issues in the wake of the pandemic, but diesel has borne the added burden of absorbing a large portion of unwanted jet fuel supply. With little time to respond to the outright collapse of jet fuel demand, refiners were quick to shift yields and blend excess jet fuel into diesel and gasoil, and to a lesser extent naphtha, gasoline, and other fuel pools. This kept diesel production relatively high during the summer even as major refinery run cuts occurred, making it difficult to balance the diesel market. As a result, diesel inventories exploded to multi-year highs and stayed elevated during the summer. Throughout this ordeal, diesel demand fared surprisingly well, contracting by ~8% YoY from January to August, while gasoline and jet demand fell 13% and 38% respectively, according to Woodmackenzie estimates. …pushing diesel cracks & spreads vs RBOB to decade lows In the early stages of the pandemic, diesel and gasoil cracks outperformed many other fuels, climbing roughly $5/bbl over the course of March. Eventually, inventories started to mount, pushing cracks down more than $10/bbl by May-end. Now, gasoil is perhaps the worst performing fuel, aside from jet, since the start of 2Q. The front month gasoil-Brent crack is trading at a decade low seasonal level of $3.80/bbl. Meanwhile, gasoline balances have benefitted from substantial supply curtailments and a swift recovery in demand, which pulled US stocks down from five year seasonal highs recently. Bloated diesel stocks and tighter gasoline balances caused gasoline-diesel spreads to rise to decade high seasonal levels and the cal-2021 gasoline-diesel spread to trade in positive territory across several regions recently. Yield switching and cold weather may alleviate this trend As diesel cracks and gasoline-diesel spreads trade at seasonal extremes, several factors could help these trends reverse course. First, refinery margins are very weak globally and should encourage low runs this fall, especially for diesel oriented refiners. Second, strong gasoline-diesel spreads encourage more gasoline production, even though driving demand has peaked and winter heating season is fast approaching. Winter heating season can make or break diesel and oil markets. Early cold weather would position diesel cracks for upside, but warm weather could be catastrophic. Third, refiners seek to optimize yields, but it takes time to fully react to price signals. So, further shifts towards gasoline may be occur, even if price incentives start to dissipate. Fourth, gasoil and diesel managed money positioning turned net short and RBOB positioning is still long, which may provide fuel for a gasoline-diesel reversal if fundamentals start to turn.
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