TOCOM Energy

Earlier this week, oil prices maintained July’s firm upward momentum and held their ground above 80 $/b underpinned by supply-side constraints, soaring refining margins and an improved demand outlook.
The optimistic view of oil demand growth stems from likely fiscal stimuli by China to kick-start the economic recovery as well as falling inflation which could signal an end to interest rate hiking cycle.

This Wednesday however, oil prices edged significantly lower on signs of profit-taking as the macro risk trade is starting to rear its head again.

New numbers from the government’s Fiscal Data system show that the country’s total public debt hit $32.6 trillion by the end of July. That’s an increase of $276 billion in the last month. Fitch Ratings downgraded its US debt rating from the highest AAA rating to AA+. It is once again unnerving those in financial markets who say these “unsustainable” deficits could trigger a dollar crisis, a steep rise in interest rates, a sharp depreciation in the exchange rate, and a wave of high inflation.

In the physical markets, due to OPEC cuts, the prompt Dubai structure held up at firmer levels over the week with the Oct23/Dec23 hovering at around $2.20/b. Benchmark Dubai continues to trade at a premium to Brent. Coming into focus this week is a Aug. 4 meeting of OPEC+ ministers to review the market.

Crude oil market has also been underpinned by a surge in refining margins although the strength in margins appears to be more supply-driven at the moment. After adjusting for the impact of inflation, real margins are at the highest levels for almost eight years since 2015 which will encourage high levels of crude intake.

The initial strength in margins was driven by middle distillates. Middle distillates have started to tighten since early July on falling European stock levels, refinery outages and a plunge in China’s export, underscoring its vulnerability to supply disruptions since cutting off imports from top supplier Russia.

Whether we look to Europe, the US, or Asia, middle distillates stocks are low, causing sales prices, cracks, and intermonth spreads to surge in the last two weeks.

There is not much scope for rebuilding depleted diesel stocks totally from the west as U.S. refineries are already operating at a rate of around 94%, the highest since 2015. It’s more likely that China and India or the middle east producers could provide some relief.

Improved export margins especially gasoil for Chinese refiners is supporting the incremental outflow. Oil products exports are estimated to jump 64% month on month to about 3.8 million mt in July. Refineries have been increasing output, with the average operating rates at around 80% in July, up 2.5 percentage points from June. However, accelerating refinery processing will simply push the shortage upstream from the fuel market to the crude market. As a result, it’s likely that the benchmark Dubai will continue show its relative strength compared with other crude oil benchmark prices.