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European diesel margins sag before new shipping fuel rules

Commodities Dec 11, 2019 07:17
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By Ron Bousso and Ahmad Ghaddar

LONDON (Reuters) - European diesel refining profit margins have tumbled as a slowing global economy has hit fuel demand harder than forecast despite expectations of a boost from new fuel shipping rules.

Refiners have raced to produce more low-sulphur fuel to meet the new standards set by the International Maritime Organization (IMO), known as IMO 2020, that take effect on Jan. 1.

The rules require ships to use cleaner fuels, such as very low sulphur fuel oil (VLSFO) and marine gasoil (MGO), or to install equipment known as "scrubbers" to ensure they pump out less sulphur oxide pollutants.

But instead of the switch causing a demand spike and boosting returns for makers of diesel, which is used as a blending stock for low sulphur marine fuels, inventories are now bigger than expected and margins are under pressure.

Benchmark European diesel refining margins have fallen from a 2019 high in October above $19 a barrel to below $15 in mid-December.

The front-month December contract (LGOc1) has in recent days traded below the January contract, creating a market structure known as contango, associated with oversupply and rising stocks.

"Diesel margins have been rather soft into the fourth quarter due to weak global activities, lower refinery turnarounds and a warm start to the winter, while initial demand for transition to IMO 2020 is likely being met by inventory build for low sulphur fuels through 2019," Goldman Sachs (NYSE:GS) said.

The bank said in its a note that refiners would have to wait until 2020 to see a boost from the shipping industry as global trade picked up.

Alongside a global economic slowdown hurting demand more than expected, refinery output has exceeded expectations as turnarounds in maintenance work has been shorter than forecast.

Indian refineries have been exporting near-record volumes of diesel as domestic demand has weakened.

Much of the extra diesel output, particularly from Asia and the Middle East, has headed to Europe, a major importer because of its large fleet of diesel cars.

European middle distillate stocks, which include diesel, rose more than 10% in November from a year earlier to 410 million barrels, data from Euroilstocks showed. [O/EUROIL1]

Morgan Stanley (NYSE:MS) said output of diesel had surged as new refineries had started up this year and existing plants had been upgraded to produce fuel to meet the IMO 2020 rules.

At the same time, it said the broader energy market had seen a slowdown, with growth in demand for crude oil slipping to 680,000 barrels per day (bpd) so far in 2019, compared with a rise of 1.5 million bpd each year in the past five years.

"In particular, the weakness in global trade and manufacturing has been a serious headwind," Morgan Stanley said.

Graphic: European diesel imports (https://fingfx.thomsonreuters.com/gfx/editorcharts/EUROPE-REFINERIES-DIESEL/0H001QXPM9WQ/index.html)

Graphic: European refining margins (https://fingfx.thomsonreuters.com/gfx/ce/7/7755/7737/Pasted%20Image.jpg)

European diesel margins sag before new shipping fuel rules
 

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