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The manufacturing sector seems to have passed the worst of the downturn in the middle of last year and displays early signs of recovering
Published : 05 Apr 2024, 09:59 PM
US manufacturers have finally pulled out of the long, shallow slump that started in the middle of 2022, which will support petroleum consumption especially for diesel and other middle distillates in the months ahead.
The Institute for Supply Management's purchasing managers index for the manufacturing sector climbed to 50.3 in March (34th percentile for all months since 1980) up from 47.8 (18th percentile) in February.
For the first time in 17 months, the index rose above the 50-point threshold dividing expanding activity from a contraction, putting an end to an unusually prolonged but shallow cyclical downturn.
The production sub-index surged to 54.6 (45th percentile) up from 48.4 (15th percentile) in February and was at its highest level since May 2022.
New orders were also positive at 51.4 (27th percentile) signalling the expansion should have momentum in the near term.
The manufacturing sector seems to have passed the worst of the downturn in the middle of last year and displays early signs of recovering.
In contrast, the much-larger services sector, which has also been much more resilient, showed an unexpected deceleration, after a strong expansion earlier in the year.
The purchasing index for the services sector, including real estate, construction, mining and farming, slipped to 51.4 (14th percentile) in March from 52.6 (20th percentile) in February and 53.4 (27th percentile) in January.
Overall, however, the US economy continued to expand last month, with a greater balance between manufacturing and services.
Reflecting the increase in business activity as well as employment gains and persistent inflation, traders have pared back their expectation for a reduction in interest rates later this year.
Futures prices show a roughly equal chance the central bank will cut overnight interest rates two or three times by a total of 50 basis points or 75 basis points by the end of 2024.
Three months ago, the central bank was expected to cut rates as much as six or seven times by a total of 150 or 175 basis points.
FUEL CONSUMPTION
Stronger manufacturing and the associated increase in freight are likely to boost petroleum consumption especially for diesel and similar middle distillate fuel oils.
More than three-quarters of distillate fuel oil is used for freight transport and manufacturing, so fuel consumption normally tracks changes in the business cycle measured by the manufacturing index fairly closely.
Distillate consumption was down by around 2% in the three months from November to January compared with the same period a year earlier.
But the winter was unusually mild, cutting consumption of distillate heating oil, and growing use of biodiesel and renewable diesel has been nibbling away at the market for petroleum-derived distillates.
Even if biodiesel and renewable diesel are taken into account, total distillate consumption was essentially flat in the November-January period compared with a year ago.
However, if the manufacturing recovery proceeds, distillate consumption should start to rise through the rest of 2024.
DISTILLATE INVENTORIES
Stocks of distillates were 13 million barrels (-9% or -0.73 standard deviations) below the prior 10-year seasonal average at the end of January, according to the latest monthly data from the Energy Information Administration.
Since then the deficit has remained broadly stable with inventories 15 million barrels (-11% or -0.90 standard deviations) below the 10-year average at the end of the week finishing on March 29.
Drone and missile attacks on tankers in the Red Sea and Gulf of Aden have led to extensive re-routing of distillate trade between North America, Europe and Asia, in most cases resulting in longer voyages.
But there has been little or no impact on the actual availability of distillates in the United States, confounding expectations stocks would tighten and prices would rise.
Futures prices for ultra-low sulphur diesel delivered in May 2024 are trading around $30 per barrel over US crude oil delivered in the same month, but the premium or crack spread has narrowed from $40 in early February.
The crack spread has fallen to its narrowest since before Russia’s invasion of Ukraine in February 2022, a sign supply is comfortable for the moment.
Hedge funds and other money managers have sold the equivalent of 23 million barrels of US diesel over the six weeks since the middle of February.
The fund community has moved from a fairly bullish position on diesel in the middle of February to a mildly bearish one by the end of March.
Fund sales have likely anticipated, accelerated and amplified the weakening of distillate prices relative to crude causing the crack spread to narrow.
OUTLOOK FOR 2024
Distillate inventories have not fallen as rapidly as anticipated earlier in the year as the market has adapted to the disruption of tanker routes.
But inventories display a strong cyclical component so the manufacturing recovery is likely to lead to a further depletion of inventories and put upward pressure on spreads and prices later in 2024.
Ukraine's drone attacks on Russia's refineries could also diminish global supplies later in the year because Russia is a major diesel exporter.
The relatively low level of diesel inventories means there is little cyclical slack inherited from the downturn in 2022/23.
Renewed consumption growth in 2024/25 is likely to tighten fuel supplies quickly and lead to early upward pressure on prices.
Together with a tight labour market, the limited spare capacity in diesel and other energy markets is one reason central banks are forced to be cautious in cutting interest rates.
