OPEC Stuns By Opting Not To Raise Output; Was Diesel A Reason?

Coverage of the OPEC+ group's decision Thursday to not increase crude production even after a more than $45 increase in prices since April inevitably featured one of two words: "shocking" or "stunning."

Diesel markets may have played a role in the path that OPEC took.  

Expectations going into the meeting were that OPEC, led by Saudi Arabia, would decide along with the OPEC+ group to put more barrels onto the market. The most closely watched models on global supply and demand all show demand outstripping supply now, a situation that all agreed was necessary to bring global crude inventories down to a more normal level. The question was how far it needed to go. 

Singapore-based analyst Vandana Hari, writing in VandaInsights, said OPEC+ "had been widely expected to boost supply by 1.0-1.5 million b/d." Instead, the number was zero. 

The supply/demand models show the current imbalance blowing out by the third quarter of the year, which begins in less than three months. Since any restoration of reduced production wouldn't start until April anyway, getting ready for that third quarter would need to begin in the second quarter to ramp up in time to put more barrels onto the market. 

In an interview with Bloomberg Television, Amrita Sen, the chief oil analyst at Energy Aspects, said of the decision that "there is some risk of overtightening. 

"Saudi Arabia needs to start talking about how they will bring back the barrels in the third quarter," she said.

The decision to do nothing caught oil markets by surprise. The price of West Texas Intermediate crude rose $2.55/barrel Thursday, a gain of 2.56%, to settle at $63.83. The lowest settlement for WTI since the pandemic began was $11.57/b on April 21, meaning that the Thursday price, which is the post-pandemic high, marks an increase of more than 550%. (The widely reported negative price on WTI from April was not a settlement price but recorded in intraday trades.) Not only is Thursday's settlement a post-pandemic high, it is the highest settlement since April 25, 2019.

The bull market continued apace on Friday. At 6:15 a.m., WTI was up another $1.44 to $65.27/b.

What role did diesel play in the decision? In an article published in S&P Global Platts, editor Paul Hickin said Saudi Arabia may have been looking at some data on diesel inventories to help propel its decision. 

Hickin referred to "a pool of excess diesel" as being a reason that "should keep oil watchers on high alert."

Citing data from Platts Analytics, Hickin wrote that "global diesel inventories are back close to the highs reached last spring and summer as COVID-19 lockdowns persist."

He also noted data from Insights Global that inventories of diesel and gasoil — a middle distillate like diesel — are approximately 13% more than a year ago.

The picture in the U.S. is more complicated. A large factor hanging over the diesel market in the U.S. is the status of the Texas refining sector, which shut down huge amounts of operations during the mid-February cold snap. 

The weekly statistical report from the Energy Information Administration released Wednesday reported that U.S. refinery production of ultra low sulfur diesel (ULSD) fell last week to a level not seen since early 2010. The ULSD output of 2.748 million b/d was about 26% less than it was the last full week before the deep freeze. In the geographic sector known as PADD 3, which includes the Gulf Coast, the drop in ULSD output over the last two weeks exceeded 44%.

But even with inventories of ULSD in the U.S. down more than 10% since where they were two weeks ago, they are still not far off the five-year average of stocks for the end of February.

Another indicator of the level of inventories is the relationship of ULSD prices down the calendar. In a balanced market, the price for the first month delivery of ULSD will be the lowest along the curve, with prices out on the curve rising to reflect the cost of storage and the time value of money. That is a structure known as contango.

The inverse is backwardation, in which the front month is the most expensive because in a tight market, it is the most desirable barrel. ULSD flipped into backwardation at the start of February, after spending the entire pandemic in an often deep contango as inventories soared over the spring and summer. 

But even though there is backwardation in the diesel market on the CME commodity exchange, the 12-month curve hasn't moved significantly in recent weeks, a signal that inventories are not tightening further. 

That may seem academic to diesel buyers who, based on the weekly Department of Energy/EIA average retail diesel price, are paying $3.072/g in the U.S. That is 17 consecutive weeks of increases in that price, which is now at its highest level since the start of 2020. The 17 weeks is also a record in the history of the data series that goes back to 1994. 

Even if inventories of diesel restrained OPEC from putting more oil onto the market, that doesn't mean diesel is not riding higher on the back of the surge in markets. At approximately 6:45 a.m. Eastern time Friday, the price of ULSD on the CME was up 4 cents per gallon to $1.9360/g, a gain of 2.11%. It is notable that the Friday increase for ULSD percentage-wise was running behind that of crude. In the last several weeks, the spread between diesel and Brent crude on CME has fluctuated in a narrow band, suggesting no particular strength or weakness in diesel relative to crude.

The one piece of good news for diesel buyers is that the market for diesel in Houston has not soared beyond the rest of the world. A tight market created by the refinery outages was likely to show up first in the spot market for diesel traded in Houston and then rapidly make its way into wholesale prices. 

But the wholesale rack price for ULSD in Houston, according to the SONAR ULSDR.HOU data series, after peaking at $2.077/g on Feb. 26, declined to $2.016/g on Thursday. That is a sign that there is a return to normalcy in the market and that further reports on Gulf Coast production may be positive. (By Friday, it had rebounded to near that February 26 level, but that was on the back of the increase in the CME ULSD price.)

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