September 19, 2023

Diesel’s fuel surcharge benchmark is up, even as futures suddenly drop


The diesel market is being pulled in all different directions as evidenced by developments over just the past few days.

On Monday, the Department of Energy/Energy Information Administration average weekly retail price increased 9.3 cents a gallon to $4.633. It’s the highest price since Dec. 12, when the price was $3.754 a gallon. That price is used as the basis for most fuel surcharges.

The price is up 86.6 cents a gallon since a recent low on July 3. But the increase is a perfect example of the retail market lagging the futures and wholesale markets, in this case by a considerable amount.

Ultra low sulfur diesel (ULSD) on the CME commodity exchange posted a recent market low of $3.1927 a gallon on Sept. 6, the second day of trading after the Labor Day holiday. 

Prices then climbed as high as $3.4815 on Thursday, an increase of 28.88 cents a gallon in just six trading days.

But in the past two trading days, ULSD has fallen sharply. Its 9.51-cents-per-gallon decline Monday, combined with a drop of 9.81 cents Friday, led to a two-day decline of 19.32 cents, the largest two-day drop in the price since January. The Monday settlement of $3.2883 a gallon brings the price of ULSD on CME below where it was Sept. 8.

That decline suggests that traders, looking at the eye-popping spreads between crude and diesel, decided that a return to a more normal relationship was in the offing. (Though what is normal in diesel anymore is questionable, given the impact of the role of Russian supplies in the market and the structural changes brought about by IMO2020, the international initiative to clean up the sulfur content of marine fuels, which has had the concurrent effect of increasing demand for diesel molecules.)

As former trading executive Ilia Bouchouev said on Twitter, traders may be reacting to those strong diesel margins, the difference between crude and diesel prices. The sharp downward movement in the diesel crack spread reflects trading activity “which one can see in taking profits on diesel length vs. oil after the recent move in cracks.”

https://twitter.com/IliaBouchouev/status/1703783103053939120

But the downward move in diesel came as talk of $100-a-barrel crude was at the center of attention in the market Monday, led by comments from Chevron CEO Mike Wirth. He told a Bloomberg Television interviewer that “it sure looks like we’re moving in that direction” when asked about reaching the century mark.

Brent futures closed Monday at $94.43 a barrel and are up almost $10 a barrel since Aug. 28.

But the closely watched forecast of Citigroup, whose commodities research group is headed by industry legend Ed Morse, was more bearish on the price of crude. 

News reports said Citi released a forecast that $100 a barrel may be reached in the short term but that an increase in supply from several other countries suggests that “$90 prices look unsustainable.”

Citi cited increased supplies in 2024 from Canada, Brazil, Argentina, Guyana and Norway, as well as the U.S., which is projected to be up 900,000 barrels a day this year from 2022 and 400,000 barrels a day next year, according to the latest Short Term Energy Outlook from the EIA.

The weaker forecast of Citi could be getting support from the physical diesel market in the U.S. 

The spread between spot physical ULSD and the ULSD price on CME, which is how diesel is priced in physical trading, has been showing signs of significant weakness in recent days. 

According to data from DTN Energy, the spread in the spot Chicago market for ULSD Monday was negative 50 cents a gallon less than ULSD on CME. On Sept. 1, it was negative 13 cents.

In the all-important Gulf Coast market, the spread Monday was negative 8 cents a gallon. It was negative 5 cents on Sept. 1, not a large move but one that suggests markets may be nearing a top.

The spread in New York Harbor has dropped to plus-1 cent from plus-3 cents on Sept. 1. 

But over in the crude market, prices are signaling more tightness and not just in the outright price.

The spread between front-month Brent and barrels for delivery six months into the future is in backwardation, a market structure created when markets are tight. In a backwardated structure, the front-month price is the highest along the calendar and prices decline into the future. The steepness of the curve is a function of both interest rates — which are key in determining the cost of storage — and the level of inventories. The tighter the inventories, the steeper the price decline out along the curve.

On Monday, the Brent contract for May, six months out from the front-month contract of November and 12 months out into November 2024, continued to fall further behind the front month. That is a sign that inventories are continuing to tighten. 

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