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Low-sulfur mandate sinks Europe gasoil as diesel rebounds

By Victoria Baghdjian & Rupert Rowling in London

January 10, 2011 - The fourth quarter of 2010 brought signs of life to the key middle distillate of diesel, but the recovery in demand that propelled premiums in some areas to their highest levels since mid-2008, came at the expense of the staple 0.1% market. (See related chart: Gasoil 0.1% FOB NWE Cargo (mean $/mt): January 4 - December 31, 2010).

Throughout the year, diesel and gasoil premiums have remained under pressure, as a persistent contango structure -- a key feature of the middle distillate market since the onset of recession -- caused stock levels to be maintained. (Listen to related podcast: 2010 in review: signs of recovery for European oil markets).

The cap of floating storage and land tanks has ensured premiums across all middle distillates have been held in check, but stringent and sustained cuts to refinery runs, and the effective closure of some key refining capacity through the year -- most controversially Total's on-off attempts to shut down refining at its Dunkirk facility -- had set the stage for a gradual drain on the floating tanks.

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Through the middle of the year, the now-expected arbitrage flows from the US failed to materialize on the scale of previous years, while stuttering recovery in demand found distillate inventories across Europe gradually drained.

Through the latter part of 2010, traders' thoughts turned to anticipated specification changes, which helped fuel the expectations of diesel's recovery -- although increasingly the recovery seemed set to come at the expense of the higher sulfur 0.1% gasoil.

In Northwest Europe, Germany's progressive crawl to lower sulfur 50 ppm gasoil reached its first milestone, with the German Heating Oil Association estimating that, by August, 52% of the domestic market had taken advantage of the government's tax incentive and had switched to 50 ppm.

Gasoil 0.1% FOB NWE Cargo (mean $/mt): January 4 - December 31, 2010

For many traders, the start of 2011 is likely to see the bulk of the heating oil market convert to the low sulfur, leaving an uncertain future for 0.1% gasoil.

In the Mediterranean, the initiative was seized by Turkey, which late in the year finally confirmed that all road fuel diesel would switch from 0.1% to 10 ppm effective January 1, 2011.

Gasoil 0.1% FOB Med Cargo (mean $/mt): January 4 - December 31, 2010

The country's Energy Market Regulatory Authority announced at the start of November that Turkey would ban imports of 0.1% sulfur gasoil and move to 10 ppm diesel that will comply with EU EN 590 standards for diesel as of January 2011.

The move sparked concerns that there would be a tightness of availability of 10 ppm in the Mediterranean in Q1 of 2011, concerns that were then magnified by three refineries -- ERG's Santa Panagia Sicily refinery, ExxonMobil's in Fos outside Marseille and Motor Oil Hellas' in Theodori Aghio, Greece -- set to enter turnarounds in the early part of 2011.

In Northwest Europe, with Germany representing some 80% of the NWE gasoil market, the move away from 0.1% showed signs of accelerating, with ExxonMobil's refineries in Antwerp and Rotterdam poised to move to producing the lower sulfur gasoil in 2011.

The changing dynamic saw gasoil barges trading at discounts of up to $9/mt to the ICE gasoil futures contract, their lowest levels since 2009, according to Platts data. So weak has demand for 0.1% in NWE become that for many market participants, the grade's survival is wholly dependent on export demand.

In the diesel market, the CIF ARA ULSD cargo premium to ICE gasoil has reflected the improvements in demand -- bolstered by low sulfur heating oil and slackening US arbitrage movements -- to show some upward momentum during Q4, rising from $19/mt on October 1 to a mid-December high of $35.50/mt over front-month ICE gasoil on December 9, according to Platts data.

Gasoil 0.1% CIF NWE Cargo (mean $/mt): January 4 - December 31, 2010

The strength in NWE premiums is due in part to winter support for prices, as adverse weather conditions across the UK and the Continent have sustained buying interest for diesel, while providing an extra layer to demand from the heating oil market.

Earlier in the fourth quarter, strikes at French oil terminals and ports across France pushed diesel premiums to record highs, with premiums reaching $33/mt on October 25.

But it was in the Mediterranean ULSD cargo market, with Turkey's switch looming, that the year closed at an all-time high for product delivered into the French port of Lavera, as the premium to the front-month ICE gasoil futures contract reaching $40/mt on December 31.

Gasoil 0.1% CIF Med Cargo (mean $/mt): January 4 - December 31, 2010

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