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Much Too Much - Distillate Glut Challenges U.S. Refiners But Offers Contango Opportunity

For the past several months, U.S. refineries have been producing more distillate than demand warrants, resulting in a glut of distillate fuels, especially ultra-low-sulfur diesel and jet fuel. The disconnect between supply and demand has been particularly stark in the Gulf Coast region, where just a couple of weeks ago distillate stocks sat 39% above their 10-year average after coming perilously close to tank tops in August. The culprit, of course, is COVID-19, or more specifically the effects of the pandemic on air travel and the broader economy. Demand for motor gasoline rebounded more quickly than demand for ULSD and jet fuel, and refineries churned out more gasoline to keep up, but that results in more distillate too. Now, finally, there are signs that distillate stocks may be easing back down. Today, we discuss the build-up in ULSD and jet fuel stockpiles, the ways they might revert to the norm, and the potential for storing distillate now and selling it at a higher price later.

This blog is based on research from Morningstar Commodities. A copy of the original report is available here.

The collapse in crude oil prices earlier this year and COVID-19’s negative effects on demand for refined products put an unprecedented squeeze on U.S. refiners — a topic we first discussed back in March in Strange Brew. The net result was a miserable second quarter for the refining sector. As we said in Where Are You Going, not only did refiners produce less diesel, motor gasoline, and jet fuel in the April-through-June period than any quarter in recent memory, their refining margins were sharply lower than the historical range — a one-two punch that hit their bottom lines hard.

Refiners’ troubles didn’t end there. Persistently high distillate inventories this year are compounding refiners' woes by weighing on product prices and constraining processing levels. Total U.S. distillate stocks have been at or near record territory since April, according to weekly data from the Energy Information Administration (EIA), and only dropped below their seasonal 10-year high at the end of September. Total inventory of 172 MMbbl on October 2 was 44 MMbbl higher than this time last year, but down about 1 MMbbl per week from a peak of 180 MMbbl in early August. The 172 MMbbl in storage represented 48 days of supply based on implied demand of 3.6 MMb/d. Total U.S. working storage capacity for distillates is 218 MMbbl, according to an EIA survey from March 31, 2020, meaning that storage was 79% full as of October 2.

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