Viewpoint: USGC diesel output to rise, reopen shut arbs

OREANDA-NEWS. August 15, 2016. Falling regional distillates stocks and softening Argus RVO values could shift US production from jet fuel to diesel in the coming months, reopening diesel arbitrages out of the Gulf coast region.

Gulf coast diesel prices have been relatively high all summer in part because refiners have been tilting towards jet fuel production to avoid the high cost of meeting renewable fuel obligations, from which jet fuel is exempt.

But the value of Argus Renewable Volume Obligations (RVO), which measure the cost to produce on-road fuels, has retreated from a record high in mid-July back to late May levels by early August. Increased ethanol blending and higher imports could see RVO prices continue to fall, despite a structural shortage.

Factoring in the RVO, jet fuel remains the higher-value product compared with diesel. But jet fuel's premium over diesel has eroded from July's average of 2.24?/USG down to less than a penny in early August, which may lead to a break from the recent focus on jet fuel production.

Data from the Energy Information Administration (EIA) showed that Gulf coast jet fuel output hit the highest level since 2000 in mid-July, and has remained at 17.5pc above year-ago levels in early August.

In contrast, Gulf coast distillates stocks have been dropping steadily to a year-to-date low in early August, largely thanks to Latin American demand. Gulf coast distillates inventories tested five-year highs earlier this year as margins approached the mid-teens.

All this could prompt Gulf coast refiners to increase diesel yields which could potentially improve the region's arbitrage opportunities. The diesel arbitrage from the Gulf coast to New York Harbor has been unworkable since mid-April. The distillates glut on the Atlantic coast hit 20mn bl above ten-year averages in early August, according to the EIA. The transatlantic arbitrage has been similarly unprofitable for much of the summer.

The cost of transportation on these arbitrage routes have softened subsequently. The price of Colonial pipeline space on the spot market has fallen to historic lows over the past month, with shippers paying others 1?-1.5?/USG to take their allotted line space in order to maintain shipping history. The transatlantic freight rate has dropped to 7.58?/USG, the lowest level since Argus began tracking it in 2007.

Latin America has remained the one bright spot for Gulf coast diesel sellers. But Gulf exporters face increasing competition from Europe, Asia and the US west coast. The US west coast diesel market is facing a surplus worsened by the return of PBF's 150,000b/d Torrance, California, refinery after more than a year of reduced output. Los Angeles diesel price fell to discounted levels to the Gulf coast market in early August, compared with an average premium of 4.71/USG in July.