While oil demand expanded at an average 1.8 million b/d in the past couple of years, the demand growth this year is underwhelming, in part explaining why crude oil prices and refining margins have sold off sharply recently, a report said.

Global oil demand should recover somewhat soon as some negative factors, such as the demonetization in India or the sharp recessions in Brazil and Russia, are receding, according to the report titled “Global Energy Weekly: No gain without pain for diesel” from Bank of America (BofA) Merrill Lynch Global Research.

 Interestingly, the composition of this demand growth is also set to enter a new chapter, as we now see diesel returning to positive demand growth this year and next, from declines last year. The US has chiefly been leading this trend, with demand averaging 4.2 million b/d over the past five weeks, compared to 3.9 million b/d over the same period a year ago.

Other major cyclical indicators are also positive, with container loadings, air traffic and PMIs across many emerging markets improving lately.

The recovery in demand does not in and of itself suggest a short-term bullish outlook for distillate margins as the additional diesel demand can be met from current surplus inventory. In addition, refinery activity in the US remains exceptionally strong on healthy margins, boosting output of all refined products, and creating a high level of exports. The issue of diesel over-production is not just confined to the US, as increased supplies have come from North West Europe, China, Saudi, and Russia.

“In our view, mid-distillate cracks need to continue to retrace near-term to send a signal to refiners to slow down their activity and allow consumers to draw down their inventories. We thus remain cautious on complex refining margins near-term and distillate cracks in particular,” BofA Merrill Lynch said in the report.

“However, if this view plays out and inventories start to move lower, we believe the market will be set up for a somewhat more constructive outlook later this year and going into 2018. On the demand side, we believe that diesel demand globally will structurally outperform gasoline in coming years,” the report said.

Eventually, diesel demand is also set to benefit strongly from new IMO bunker regulations which will likely see a switch to diesel for marine fuel. On the supply side, the crude oil slate is becoming lighter on the back of a return of US shale oil production and a cut to Opec's heavy barrels.

While the fortunes may eventually turn for diesel, BofAML thinks any recovery will likely be gradual. “We stay short diesel cracks near-term but are getting more constructive farther out in the curve,” it said. – TradeArabia News Service