* Positions liquidated after Sandy smashes U.S. demand
* Stocks build in Europe as refinery maintenance ends
* Correction seen as overdue, contango eyed
By Claire Milhench and Julia Payne
LONDON, Nov 2 Superstorm Sandy has ended months of heavy speculation in gasoil futures on the back of a tight middle distillates market, with traders now expecting stocks to build as European refineries return from maintenance and Sandy crushes U.S. demand.
Middle distillates inventories, which include heating oil, diesel and jet, had been running at multi-year lows in both the United States and Europe - threatening to ramp up heating bills for households in the event of an early cold snap.
"A lot of the market length was on a speculative basis because distillate stocks were low in Europe and the U.S," said Mark Thomas, head of European energy at Marex Spectron.
The front month ICE gasoil futures contract pushed up to trade at a wide premium to the second month, getting up to $25 a tonne in early October.
But the spread LGO-1=R between the ICE gasoil November and December contracts has collapsed this week to around $2.50 a tonne, down from over $18 a tonne on Monday.
The premium, or backwardation, began widening out in September after a series of unplanned outages due to fires and explosions at refineries in the United States and Venezuela just as European refiners were going into seasonal maintenance.
In Europe, this created shortages of diesel and jet, which are also priced off the ICE gasoil futures contract, while globally it encouraged investors and traders to hold large long positions in the front month contract.
The wide backwardation has proved stubbornly persistent, but in just three sessions the November/December spread gave back 76.4 percent of the rally from mid-June to Oct. 29, said Harry Tchilinguirian, head of commodity market strategy at BNP Paribas.
"However, the move in the timespread still looks overdone to us, even in view of the Nov. 2012 contract coming up to expiry soon," he said.
Traders linked the collapse to a liquidation of positions following Superstorm Sandy and stock builds in northwest Europe as refineries return from maintenance.
"It's a consequence of demand destruction and therefore greater Atlantic basin bearishness since Sandy," said one.
"U.S. is very long diesel with zero demand on the East Coast," said another. Disruption to infrastructure continues to prevent frustrated U.S. motorists from filling up at the pumps as terminals are unable to supply petrol stations.
On Thursday the Energy Information Administration said that U.S. distillate stockpiles, which include heating oil and diesel, had fallen by less than expected week-on-week. They slipped 93,000 barrels, compared with forecasts for a 1.3 million barrel draw.
Other traders linked the sudden collapse to stock builds at the Amsterdam-Rotterdam-Antwerp hub. Gasoil inventories independently stored at ARA leapt 8 percent on the week to 2.032 million tonnes, according to data from Dutch oil consultant Pieter Kulsen.
"Some traders thought there would be a squeeze in November on high sulphur gasoil but there is plenty of supply in ARA," said Christopher Bellew, a broker at Jefferies Bache.
Several traders said this was because seasonal refinery maintenance is coming to an end.
"A lot of refineries were in turnaround in Russia, Europe and Skikda (in Algeria) so the fact that a large number have come back has altered the supply situation," said Thomas at Marex Spectron.
Another trader said the market might also be anticipating lower water levels along the Rhine. This can make it difficult for barges to travel fully loaded into Germany and Switzerland so heating oil stocks begin to build in the ARA hub.
BNP Paribas's Tchilinguirian added that the relatively light damage to U.S. East Coast refining meant that expectations of a strong demand pull from the U.S. on European supplies had disappeared. "Equally, in Europe, we do not have cold weather conditions to support additional gasoil demand."
The correction is seen as long overdue but some were still caught out by the rapidity of the collapse. Some traders now think selling pressure on the front month contract could push it down so much that it starts to trade at a discount to the second month contract - a situation described as contango.
"It happened fast and I didn't see it coming," said one distillates trader in northwest Europe. "But then again, I have been saying for some time that we need to go into a contango when you look at the global market, but that is still not happening." (Additional reporting by Jessica Donati, editing by William Hardy)