Just like clockwork, OPEC+ agreed to another output increase of 432,000 bpd in June, in line with an existing plan to gradually unwind supply curbs. The producer group downplayed the prospect of a gaping supply deficit, arguing instead that higher prices do not reflect oil fundamentals but panic among oil buyers. This is nonsensical. The looming EU embargo on Russian oil has the makings of an acute supply squeeze. In any case, OPEC+ is in no mood to help out, even as rallying energy prices spur harmful levels of inflation.

The bullish afterglow of the EU’s Russian embargo plan helped oil prices climb on Thursday although gains were capped by concerns over a lockdown-induced drop in Chinese oil demand. In the latest red flag for the world’s second-biggest economy, China’s services sector recorded the second-steepest drop in activity on record, as tighter Covid-19 restrictions hit the industry. Fears over Chinese fuel demand destruction prompted JP Morgan to cut its 2022 global oil demand outlook by 1 mbpd.

Meanwhile, there were more indications of a weakening global economy. Demand for “Made In Germany” goods plunged 4.7% in March from the previous month. Elsewhere, the Bank of England painted a gloomy picture as its hiked rates to their highest since 2009. The central bank warned that UK inflation is going to hit 10% before the end of the year which will likely tip the economy into recession next year. Clearly, there is no getting away from economic bearishness and cooling demand fundamentals. However, the tightening supply outlook should ensure that the energy complex maintains an upward trend.

It’s a diesel world

Gasoline prices tend to get much of the attention this time of the year as the US driving season gets underway. Not this time around. The price of diesel is on a tear and recently surpassed a record high. NYMEX ULSD is selling for the equivalent of about $175 a barrel, well above the $110-a-barrel Brent futures. Record diesel prices come on the back of an extremely tight middle distillates complex.

US distillate fuel inventories fell by 2.3 million barrels last week to 105 million barrels, leaving stockpiles at their lowest since 2008 and down more than 40% from a lockdown-induced peak in the summer of 2020. The situation is even more pronounced on the US East Coast where distillate fuel oil inventories are at their lowest levels since 1996. This trend is by no means a local phenomenon. For instance, middle distillates stocks in Singapore are at their lowest since August 2013.

This supply-side tightness is reflected in extremely strong crack spreads. The front-month NYMEX ULSD-WTI crack spread reached over $71/bbl this week, a record high. Similarly, the diesel crack in Northwest Europe has quadrupled since the start of the year and in doing so leapt past historical record levels from 2Q08. And distillate cracks look set to be well supported into the coming months. This is because the tightness in global supply will be exacerbated by the EU’s proposal to ban Russian oil imports. The ban, if approved, will have an outsized impact on product markets and especially diesel. Russia exports around 700,000 bpd of diesel to Europe.

There is now growing anxiety that Europe might run out of diesel. OECD Europe middle distillate stocks fell to 246 million bbls in February, according to the IEA. This has left the continent with around 35 days’ supply of the crucial fuel in its stockpiles. In order to avoid a diesel crunch, it will have to source alternative supplies. Demand for US oil from Europe is therefore set to increase as it tries to fully wean itself off Russian supplies. This will be music to the ears for US oil exporters. The US is already exporting more oil right now than ever, so much so that it has become a large net exporter of petroleum. In the week up to 15 April, it exported a record 10.6 mbpd, according to the EIA. Within that, shipments of petroleum product exports regularly topped more than 6 mbpd.

Yet as more oil barrels leave the US for European shores, it will have the undesired effect of draining domestic inventories and keeping prices elevated. By helping stave off a diesel crunch in Europe, it risks creating economically devastating shortages of the fuel at home. Several key industries – logistics, construction, and agriculture – rely heavily on diesel. Another notable industry is the energy sector. Much of the machinery used across America’s shale patch is diesel-powered. The message is clear – a significant diesel shortage could trigger a slowdown in the US economic cycle. Times are currently good for US oil exporters and refiners. But the country may come to rue the day it stepped up fuel exports to a world in desperate need of supply.