(John Kemp is a Reuters market analyst. The views expressed are his own)
* Chartbook: tmsnrt.rs/2QN4usW
LONDON, Nov 16 (Reuters) - Global oil markets are increasingly over-supplied with light distillates, such as gasoline, while there are not enough middle distillates, such as diesel, which has opened a big price differential between the two fuels.
To keep meeting healthy demand for mid-distillates, refiners are processing high volumes of crude and creating a glut of gasoline.
U.S. gasoline prices for delivery in June 2019 are trading just $7 per barrel above benchmark Brent futures for the same month, compared with a premium of $18 per barrel for low-sulphur distillate fuel oil.
Early in October, the gap in cracking margins was much narrower, with premiums of $14 and $17 per barrel over Brent respectively, but since then gasoline prices have slumped amid fears of over-supply.
Gasoline prices have been hit by a combination of record refinery processing in the third quarter and flattening consumption from U.S. motorists which have left the market carrying record stocks for the time of year.
Diesel prices, on the other hand, have been supported by strong demand from the freight, manufacturing and mining sectors as well as from oil and gas drillers themselves.
Distillate prices are also being supported by the prospect of even higher consumption from the start of 2020 when new pollution regulations on bunker fuels used in the shipping industry come into force.
Regulations adopted by the International Maritime Organization will require shipping firms to switch from using heavy fuel oil to middle distillates unless they install expensive scrubbers to clean up their sulphur emissions.
Differential growth in light and middle distillate consumption is not a new problem (tmsnrt.rs/2QN4usW).
Gasoline and diesel consumption are driven by different factors which means that growth rates differ more often than they are the same.
Gasoline consumption is more weighted towards private motorists while distillate is geared towards commercial freight transport, aviation, manufacturing, farming, mining and oil and gas production.
Gasoline is weighted regionally towards the United States and Japan while distillate is weighted more towards Europe, Latin America, Africa, Asia and the Middle East.
As a result, gasoline use tends to be steadier across the business cycle while distillate consumption varies much more with the state of the economy.
In a typical expansion, gasoline consumption tends to dominate in the early stages while distillate growth takes over as the cycle becomes more mature.
If the expansion or contraction is synchronised globally, the impact on distillate demand becomes much more pronounced than if it is concentrated in only a few regions.
Late-cycle growth in distillate demand during 2017 and 2018 has left inventories relatively low while the introduction of new IMO regulations threatens to tighten them even further in 2019 and 2020.
Like any commodity market, even small imbalances between the production and consumption of individual fuels can have an outsized impact on prices.
But gasoline and distillate are co-products from the same refining process, so refiners have no option but to cope with the resulting large swings in margins.
Refiners have some flexibility to change the ratio in which they produce light and middle distillates by altering the slate of crudes they process and running their fluid catalytic cracking (FCC) units in max-distillate rather than max-gasoline mode but the flexibility is quite limited.
For the most part, the market for individual fuels is made to balance through changes in prices and consumer behaviour.
Rising distillate prices will force the freight transportation sector to focus on improving fuel economy by trimming schedules, consolidating loads, switching from air freight to ocean shipping, and slow steaming.
Freight and logistics firms have considerable scope to cut fuel consumption by reducing part loads, minimising empty backhauls and switching away from air freight, sacrificing delivery speed for improved fuel economy.
Shipping companies can also achieve large reductions in fuel consumption by making even a small reduction in sailing speed.
In a period of high fuel prices, shipping companies can trade increased sailing times, smaller schedules and larger fleets (higher capital costs) for reduced fuel consumption (lower operating costs).
The growing gap between diesel and gasoline prices will also accelerate the shift away from diesel towards gasoline for private motor cars and fleet vehicles especially in Europe.
Government regulations and taxation policies are already favouring the sale of gasoline and electric vehicles rather than diesel cars, but the fuel price differential will speed up the shift.
In Britain, for example, the average retail price of diesel is now more than 8 pence per litre (6 percent) higher than gasoline and the gap has almost doubled since the end of August.
British sales of diesel cars have already fallen by almost 31 percent in the first 10 months of 2018 compared 2017, accounting for just 32 percent of new sales down from 43 percent the previous year.
Petrol car sales rose by 9 percent over the same period and their share grew to 62 percent from 53 percent, according to the Society of Motor Manufacturers and Traders.
Reduced diesel consumption in favour of gasoline in Europe will play an important role in helping make more middle distillates available for the shipping industry in 2020.
GLOBAL ECONOMIC CYCLE
The biggest source of uncertainty for both refiners and middle distillate consumers is the outlook for the global economy in 2019 and 2020.
Synchronised global growth provided a big boost to middle distillate consumption in 2017 tightening the market considerably.
But global freight volumes have grown much more slowly in 2018 as the economy has lost momentum, easing some of the pressure on distillate supplies.
If the global economy continues to slow or tips into recession in 2019, the looming distillate shortage will largely disappear, and distillate margins will soften.
If the global economy accelerates again, however, then strong freight demand coupled with the new IMO regulations will likely push the premium for distillate fuels even higher.
- Oil prices fall as economic outlook deteriorates (Reuters, Oct. 30)
- Maritime rule change stirs fears of diesel shortage (Reuters, Oct. 26)
- Fuel markets confirm global growth slowdown (Reuters, Aug. 16)
- Distillates hold key to oil prices and global growth (Reuters, Aug. 1) (Editing by Edmund Blair)
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