Numbers continue to show how diesel inventories are rapidly declining in the U.S. and around the world, including a relationship that most oil traders will tell you is far more indicative of what’s being held in storage than various weekly or monthly reports.
Although the weekly Energy Information Administration inventory report over the past two weeks has shown a build in U.S. diesel inventories after weeks of declines, it is the forward price curve as well as the size of the market relationship known as “contango” that traders are keeping their eye on.
In a perfectly balanced market, the price for diesel on any commodity exchange, including the CME where ultra low sulfur diesel is traded, rises as the calendar goes out. That is the structure of contango. So if the first month price is $1.50 per gallon, the second month might be $1.503, and so on. It needs to do that to reflect the cost of storage and the time value of money.
When that spread blows way out, it’s a sign of two things: Inventories are building and the incentive to put diesel into storage is high. A trader or a commercial user of diesel, or any commodity, can buy the product today, find storage for 12 months or more (or less), sell it at that higher price and pocket the difference, as long as the difference is more than the cost of storage and the cost to finance the inventory.
To illustrate how much things have changed, the spread between the first month ULSD price and the 12-month price opened this year at negative 5.45 cents a gallon, a situation described as “backwardation.” It’s the sign of a tight market, one where the demand for product with short-term delivery is so strong that it discourages storage. That’s why the forward price is lower than the spot price. (The outright price of diesel on that day was just over $2.02 a gallon. It settled Wednesday at $1.4779 a gallon.)
On April 27, that 12-month spread had swung by more than 50 cents a gallon, to the forward price being 46.5 cents a gallon more than the spot price. (The market settlement that day was 64.67 cents a gallon, one of the lowest of the year).
When there is a spread that wide, it will be big enough to incentivize traders and commercial interests to store diesel, and that’s just what they did: By early July, inventories were so high that they could cover well more than 50 days’ worth of U.S. consumption, a level breached only a few times in the 30-year history of the data. This year, that key number stayed over 50 days for 10 out of 11 weeks of statistical reports, an unprecedented amount.
And where is the key spread now? It dropped under 5 cents a gallon on Monday, the first time it had been there since late February. What that sort of number means is that there is a strong disincentive to store diesel, because buying diesel now and storing it for 12 months will incur costs far greater than 5 cents per gallon.
Since the spread doesn’t incentivize storage, the logical market reaction has been to cut the cost of sticking diesel in inventory, according to Ernie Barsamian. Barsamian is a longtime industry executive who several years ago founded The Tank Tiger, a brokerage firm dedicated to matching storage with those who need it.
The cost to store diesel is now about 1 cent per gallon per month. With a 12-month spread of less than 5 cents, he said, “there isn’t any incentive to store oil for the long term and not move it” — “move it” being a term to describe shifting to another destination for commercial purposes as opposed to just sitting on it, waiting to complete the profitable sale made on the back of the wide spread between current oil and future oil.
That 1-cent spread contrasts sharply with what was going on when the days’ cover was headed to 50 days. “Back in the spring, when no one was leaving the house, someone looking to store the oil that they had no place to put it would have had to pay close to 3 cents per gallon per month,” Barsamian wrote in an email to FreightWaves.
That doesn’t mean that no oil is being stored. Any sort of supply chain needs some product in inventory, and as Barsamian said, “There may be a strategic value in having the optionality to have the oil sitting in place, near where you’d like to sell it.” But to just store it, do a deal that locks in a profit because of the spread and wait a certain period of time to cash in the profits, that is not doable at these levels.
As noted, there has been regular data coming out on diesel inventories in recent days. The weekly EIA report released Wednesday showed that days’ cover of diesel inventories at the end of last week stood at 39.4 days, up from an earlier low of 35.9 days two weeks ago. It was also up from the prior week’s number of 38.8 days.
But given how large inventories were, a decline that large set some records along the way. It is still way down from the 54.3 days set on June 12.
Although diesel stocks are up in the U.S. the past two weeks, the first-to-12th-month spread that Barsamian said is a much better indicator of inventory levels has been headed down. It was at 4.74 cents per gallon on Monday and popped up slightly to 4.98 cents on Tuesday. On Wednesday, as the data from the EIA was released showing inventories holding roughly steady after a huge build last week, the spread for the day settled at 4.68 cents, the lowest since the start of the pandemic.
The lesson for somebody in the trucking sector who doesn’t have access to a wide range of data is that he or she does have access to the first-to-12th-month spread in the diesel market. If that spread is tightening significantly, or it has dropped negative, it’s a sign of tightening inventories. If it’s doing the opposite, it’s a sign of growing inventories, like the market saw in the spring and summer. No matter what the data says, the market will reflect the reality of the inventories before that.