Brent crude is being driven higher as tight distillate supply in Europe and expectations of low U.S. exports of distillates are making the market look very tight going into winter. Distillate or ultra-low sulfur diesel is the strongest petroleum market as strong global demand and the impact from refinery shutdowns is making that market the tightest it has been in years (see chart below). This tightness should be another supportive factor for oil as refiners must keep running to keep up with demand. This comes as OPEC punts on a decision to extend production cuts until January as it is clear, the global oil market is already in balance.
John Kemp at Reuters points out that U.S. distillate stocks fell to just 139 million barrels by the end of last week, which was 25 million barrels below 2016 and 5 million barrels below the long-term seasonal average. As a result, distillate prices have moved to a significant premium over crude oil to encourage refiners to maximize crude processing and the yield to middle distillates rather than other products such as gasoline. The refining margin for making distillate from U.S. crude oil for November delivery has risen to $25 per barrel up from $19 in late August and $15 in late June. Portfolio managers have also accumulated a record net long position in European gasoil in the expectation that U.S. diesel exports will be cut in the coming month. Kemp warns that if temperatures in the winter are closer to the long-term average that the last two winter distillate stocks could become very tight without very high refining runs.
We have spoken about this distillate dilemma which should be supportive to oil as U.S. shale producers are still cutting back. Despite a post hurricane surge in production the U.S. oil rig count fell by five rigs to 744 rigs according to Baker Hughes. The fall and peak in the U.S. rig count means that projections for U.S. crude production will once again have to be revised downward. The nation’s gas-rig count rose by four to 190 from a week ago, and offshore-rig count was up two from last week at 19, but down one rig from last year.
There is still some oil drama. Reuters reports that Iraq on Sunday urged foreign countries to stop importing crude directly from its autonomous Kurdistan region and to restrict oil trading to the central government. The call, published in statement from Prime Minister Haider al-Abadi’s office, came in retaliation for the Kurdistan Regional Government’s plan to hold a referendum on independence on Monday.
The central government’s statement seems to be directed primarily at Turkey, the transit country for all the crude produced in Kurdistan. The crude is taken by pipeline to the Turkish Mediterranean coast for export. Baghdad “asks the neighboring countries and the countries of the world to deal exclusively with the federal government of Iraq regarding entry posts and oil,” the statement said.
Oil bears are coming out of denial. The peak in oil rig counts and the continued compliance by OPEC and Non-OPEC has shifted the market from a glut to a more balanced market. In fact, when it comes to distillates globally we may be in a supply deficit. The glut is gone or soon will be as global demand exceeds the bearish estimates.
Ethanol producers may get some support as China will expand its ethanol use. The Government is going to require that all gas sold in china must contain 10% ethanol by 2020. This move may also cut into the global glut of corn supply.