Surging prices for refined products, especially distillate fuel oil, led crude prices higher between June and November, but now fuels are slipping and putting crude under pressure.
Gross refining margins for producing distillate fuel oil from U.S. crude rose from $14 per barrel in June to more than $25 per barrel in the middle of November.
The U.S. distillate market started the year in substantial oversupply, with inventories well above the long-term average (http://tmsnrt.rs/2joA5Cw).
But as a result of strong demand, primarily in export markets, the market has moved into an increasingly large deficit as the year has progressed.
Distillate stocks have moved from a surplus of 33 million barrels over the 10-year average in February to 7 million barrels below the average at the start of December.
Stocks have fallen by more than 33 million barrels since the start of the year compared with a ten-year seasonal average fall of 3 million barrels.
As stocks have shrunk, distillate prices and margins have risen to encourage refiners to produce more of the fuel, with a clear uptrend since the end of June.
U.S. refiners have responded by increasing crude processing and distillate production to unprecedented levels to meet demand.
Runs in the most recent week were 800,000 barrels per day (bpd) higher than at the same point in 2016 and 1.8 million bpd above the 10-year seasonal average.
At the end of November, U.S. refineries were processing crude at rates that had only ever previously been seen during the summer peak driving season.
There has been a clear tilt towards maximising the production of distillate fuel oil to take advantage of higher margins than on gasoline.
U.S. refineries produced a record 5.4 million bpd of distillates in the last week of November, which was 280,000 bpd higher than the year before and almost 480,000 bpd above the 10-year seasonal average.
Most of this extra distillate is being exported to Latin America and other overseas markets with only a modest increase in domestic consumption.
Strong worldwide distillate consumption reflects the synchronised economic expansion across most advanced and emerging economies and the acceleration in global trade and freight.
Distillate is set to remain the main driver of oil demand in 2018, unless there is a recession in the United States
But with refineries focused on maximising throughput to make distillate, gasoline, which is a co-product, will remain relatively more abundant.
Gasoline stocks, like distillates, have drawn down this year, but the reduction has been far smaller and stocks remain above the decade average.
In the most recent week, U.S. gasoline stocks rose sharply by almost 6.8 million barrels, much faster than the seasonal average.
In the last four weeks, distillate stocks have also stopped tightening compared with the seasonal trend, as record refinery runs and distillate production have finally caught up with demand.
Distillate and gasoline prices and margins have been under pressure since the middle of November, amid signs that fuel markets are no longer in deficit, which has effectively capped crude oil prices.
Signs that the distillate and gasoline markets are no longer under-supplied point to less frenetic refinery runs in future and a moderation in crude demand.
In the near term, downward pressure on product and crude prices has intensified because of the record or near-record bullish positions held by hedge funds in distillates, gasoline and crude.
Portfolio managers have become very sensitive to any indication that inventory draws may be ending and that prices and margins have peaked and might be about to fall.
In the longer term, with developed and emerging markets on track for expansion next year, strong demand for distillate fuel oil should keep margins firm and impart an upward bias to crude prices in 2018.
By John Kemp