Richard Larkin

Hedge Solutions , Inc .

There is a bit of déjà vu in the air as we head into the winter season . When one looks at the distillate fundamentals , specifically on the east coast , there is not much of a deviation in the numbers between now and this time last year . I ’ m writing this around week 1 in September , so per usual the data can shift by the time this gets to print . For now , spot distillate prices are about midrange to where they were this time last year , trading at $ 3.30 . Currently volatility is significantly lower at this point compared to last year when September prices traded to about an . 80 per gallon range . That could change in a week as we all know .

Globally , the distillate fundamentals are still very tight . Yes , traders have pretty much assimilated to the realities of the so-called sanctions and absence of Russia ’ s contribution to both crude and products ; at least to the European and US markets . Regardless , inventories on a global scale are low everywhere you look with the exception of China .

There are a plethora of issues contributing to the deficits . Major cash spot markets are showing tightness and offering a premium to US spot markets , leaving a vacuum for imports there . Gasoil prices in Europe have attracted Gulf Coast cargoes , pulling away from US markets . For the first time in several months , Singapore stocks are significantly below the 10-year average . Typically , a source for exports to Australia and Southeast Asia , they became a net importer last month . The voluntary Saudi cuts , a medium sour crude that produces higher yields in distillates , has resulted in an estimated 1-2 % reduction in distillate output in Northwestern Europe . Irving , a large Canadian refinery that produces 320,000 bbls / day , half of which ends up somewhere in the Northeast US , is shutting down in September for several weeks for planned maintenance . There is a hint of positive news out there . China ’ s economic

slowdown is resulting in lower demand for most products . China ’ s government regulates its petroleum industry by issuing export quotas to the refiners on a monthly basis . Thanks to the slowdown they are expected to see export quotas of around 6.8 million barrels of distillates for September .

Distillate prices have been volatile so far in 2023 , though slightly less than 2022 . The start of the year was laden with pessimism after a warm winter season and an anemic view of the global economies , tempered slightly by hopes that China would wave a magic wand and stage a recovery from lackluster GDP numbers . When this did not materialize , traders went negative , shorting ULSD futures and driving prices $ 1.45 / gallon lower between January and May and placing the forward curve into a contango position for a brief period .

Distillates are a significant economic feedstock , both globally and domestically . It is consumed in large amounts in manufacturing , transportation ( trucks , trains , and airplanes ), construction and of course space heating in the winter . Slight changes in economic activity , either globally or domestically , can move the dial for demand substantially . Any interruption to its supply chains , such as hurricanes , refinery outages , geopolitical events , etc . can spike prices at any given moment . These events are typically unpredictable , which tends to exacerbate the price response . Fear is a catalyst that often brings an overreaction to events and that continues to be the case this year .

In July , traders did an about face from their bearish views of the demand side of the fundamentals to focus intently on the lackluster inventory levels around the world , as well as the bellwether issue that ’ s been out there for several years now ; a lack of refinery capacity . It took only 21 trading days for traders to bail from their net short position and transition to a bullish conviction of the distillate markets , moving prices a whopping . 70 per gallon higher . And because the “ fear of not enough ” is contiguous , we quickly reverted to a backwardated forward curve in the futures market ( see chart A ).

Chart A

The sudden rise in both the ULSD prices and the crack spread that doubled between April and now is hardly without merit . There is a preponderance of evidence to suggest that the distillate markets could face a supply problem in the coming months .

PADD 1 inventories ( East Coast ) are slightly better than last year , however still near all-time lows and well below the 5-year average , according to EIA data . PADD 1A stocks ( New England ), the primary geography for heating oil demand , are nearly as low as last year and also are at all-time lows ( see Chart B ).

The overriding challenge , and this has been the case for over 2 years straight now , is the backwardation . The inverted position of the forward curve makes it impossible to build inventories and thereby provide a buffer to any potential supply disruptions . That said and as we witnessed firsthand last winter season , fundamentals can change quickly . Last December , when New York Harbor developed highest price point status in

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