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Diesel faces the morning after the night before

By Tim Worledge & Verena Peternell

For the European ultra low sulfur diesel market, 2009 was the morning after the night before.

The stellar performance of 2008 confirmed the latent strength of the middle distillate, with Europe's burgeoning thirst already attracting the attention of refiners globally.

By late 2008, evidence of the massive investment undertaken by refiners in Europe, India and the US Gulf Coast began to show as yields were teased away from light ends and towards middle distillates, while newly commissioned cokers and desulfurization units brought additional streams of 10 ppm diesel.

The commissioning of new refining capacity in India was the last piece of the supply jigsaw such that, by the dawn of 2009, refinery capacity globally was finally well-placed to meet Europe's ULSD demand.

But that demand was no longer there.

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The European Union's Eurostat arm published data early in the new year confirming that the textbook definition of recession, two successive quarters where GDP falls, had been fulfilled across all 27 EU member states in the third and fourth quarters of 2008.

With diesel demand closely allied to GDP, the collapse in industrial demand set the tone for the remainder of the year, with both Northwest and Mediterranean CIF cargo premiums starting the year at levels they would not be able to recapture.

Diesel 10 PPM Cargo Premium CIF NWE (USD/MT)

Cargo premiums were locked in a tighter and tighter range through the year, with Northwest Europe slipping from the year high of $36/mt over the front month ICE gasoil contract on January 2 to eventually hit a year low of plus $7.50/mt on November 13.

In the Mediterranean, the year high of plus $34.75/mt came at the end of January, but both regions saw similar trends, with premiums progressively showing more pressure throughout the year.

Diesel 50 PPM Cargo Premium CIF Mediterranean (USD/MT)

Mediterranean premiums dipped below $30/mt at the beginning of February, by April they were below $20/mt and by mid-June they were brushing the plus $10/mt level.

And, from June through to November, that's where they remained, firmly rooted in a range between plus $20/mt and plus $10/mt over the front month ICE gasoil contract.

Only the presence of sustained run cuts and a steep contango, which helped ensure that much of the vast US middle distillate stocks remained locked away on the other side of the Atlantic, prevented wholesale collapse of premiums.

Barge premiums in the Amsterdam-Rotterdam-Antwerp region saw support holding up into the new year, peaking at $25.25/mt over the front month ICE gasoil contract in mid March and again early in April as Europe's first refinery maintenance season got underway.

Diesel 10 PPM Barge Premium FOB ARA (USD/MT)

But the pressure of the imbalance between oversupply and idle demand was inescapable, with the barge premium averaging just $12.50/mt over the course of the year, compared to $28.75/mt for 2008.

Mirroring developments on the physical diesel market, European swaps came crashing down from 2008 highs, steadily losing ground and bottoming out in November.

This reflected somber demand outlooks and record-high stock levels on both sides of the Atlantic, leaving reduced and lengthy refinery run cuts unable to bring support.

To depict the 2009 downfall of diesel swaps, front-month 10 ppm CIF NWE cargo differential swaps dropped from $29.25/mt at the start of the year to $10.25/mt on November 6, the lowest level seen since Platts started assessing this swaps curve in October 2008.

Physical barge premiums dipped into single digits even with key refining capacity limited in the late September through November turnarounds, and remained in single digits as German diesel requirements moved from intermediate to the more stringent, and typically more expensive, winter specifications.

For refiners, edging away from the old staple of gasoline and towards the new favorite diesel, the weakening in middle distillate cracks unraveled new refining models to leave many exposed to negative refining margins.

Crack swaps for front-month ULSD NWE cargoes dropped from $20/b on January 8 to below $7/b at the start of the summer and hovered around the $8/b for most of the second half of the year.

Even diesel car sales, which have underpinned the European ULSD thirst, began to show signs of losing out to gasoline once again, as government schemes introduced to stave off the impact of recession favored smaller, cheaper, petrol-powered vehicles.

Through 2009, the diesel percentage dipped below that of gasoline, as only 45.2% of new cars in Western Europe were diesel--a seismic reversal of over a decade's diesel growth.

The outlook for 2010 remains challenging too, with demand still subdued despite the signs that the recession is passing. Alongside that, the region remains ostensibly well-supplied.

"Demand took such a big beating, even if you have [GDP] growth of 2%, it's going to take years to recover," one trader bluntly assessed.

The bleak outlook is evident in the Calendar 2010 10ppm CIF NWE swap.

It hit rock-bottom in November at $14.75/mt, before rallying to $18/mt in early December, as the realization sank in that swingeing run cuts would likely remain a feature of 2010, even that level is still seen as weak.

"The swap structure is very flat, meaning we will not see any recovery soon," a distillates trader said.

"For 2010 to emerge from this year's weakness, we either need demand to pick up or refiners drastically cutting runs...looking at it now I do not think that we will get the needed boost from demand," another trader said.

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