European diesel prices have been at record premiums to gasoline in recent days, reflecting how refineries need much more natural gas to produce the former and are struggling to sell the latter to export markets.
Non-Russian diesel cargoes priced $55.23/bl above Eurobob oxy gasoline barges on 26 August and although that spread has come down to around $49/bl this week that is still around the highest since Eurobob prices were launched in 2009.
The widening of the spread was underpinned by a rise in natural gas prices. Refineries extract hydrogen from natural gas for use in some processes, notably in hydrocracking that converts heavier feedstocks mainly into diesel — the corresponding process for lifting gasoline yields does not require hydrogen — and the approximate cost of hydrogen for refineries has roughly trebled since June because of rising gas prices. The spread between gasoline and diesel peaked on the same day as the European benchmark gas price, before both made moderate retreats.
Diesel traders say Europe is relatively well-supplied and the support for prices is coming from higher production costs, a result of the crisis in gas supply. The EU has said it will block Russian diesel supply completely from February, but this is not yet affecting prompt supply. Before the invasion of Ukraine, Russian diesel covered around 10pc of European consumption and this is still the case. Many companies have unilaterally rejected Russian diesel in spot markets, but are unable legally to exit long-term supply contracts.
Meanwhile, persistent gasoline oversupply in Europe has contributed to a sharp fall in that product's margins to crude in recent weeks. Europe relies on exports to long-haul destinations — the US and west Africa — to stay on top of its structural gasoline oversupply, but flows to those regions have been stymied in recent months. Exports to the US were 1.07mn t in the June-August period, according to Vortexa, down from 1.53mn t in the same three months of 2021, laid low by a steep backwardation structure, high freight rates, and poor US demand. Exports to west Africa fell to around 1.39mn t in August from 1.62mn t in July and 1.53mn t in August 2021, with European exporters meeting stiff competition from Mideast Gulf suppliers in that region.
The lack of export opportunities has caused supply to swell, with independently-held inventories in the Amsterdam-Rotterdam-Antwerp (ARA) hub hitting 1.53mn t in the week to 24 August, the highest since Argus began collecting the data from consultancy Insights Global in 2011.
Going in circles
Refiners may now be ramping up crude throughputs to take advantage of higher diesel margins, traders said. This would put extra pressure on gasoline prices, as higher crude throughputs tend to increase output of all products. Refiners will therefore face a balancing act between profiting from high distillate margins and avoiding losses on gasoline output.
The preferred way to increase diesel output without adding surplus gasoline would be to increase hydrocracker throughputs, rather than crude distillation throughputs. This is probably still the most profitable route for refineries, even given the elevated cost of hydrogen. But hydrocrackers have finite capacity and diesel margins have incentivised heavy use of them for the past six months, so some refiners may be forced to distil more crude if they want to raise diesel output further.
Market participants said some refiners are running low-sulphur vacuum gasoil (VGO) through hydrocracking units, a feedstock conventionally used in fluid catalytic crackers (FCCs) to make gasoline. This would help maximise diesel output while minimising hydrogen costs: the less sulphur in the feedstock going into the hydrocrackers, the less hydrogen they need to use desulphurising the diesel.
