Benchmark diesel falls back with no further Mideast conflict

Futures prices for ultra low sulfur diesel (ULSD) on the CME commodity exchange fell 17.87 cts/g on June 23, the first day after it appeared the Israel-Iran conflict was not going to lead to the worst case supply scenario of a closure of the Strait of Hormuz, the gateway to the Persian Gulf and its exports of about 20% of the world’s crude supply. The settlement that day was $2.2851/g.

But prices have since bounced back, helped in part by the weak U.S. dollar. Oil prices, denominated in dollars, tend to move in the opposite direction of strength in the dollar. That helped a rebound that resulted in ULSD settling Tuesday at $2.3269/g.

Beyond the movement in outright oil prices, ULSD continues to strengthen relative to crude.   

On a straight comparison of first-month Brent on CME versus first-month ULSD, that spread at the close of May was about 50 cts/g. But by the last trading day of June on Monday, the spread had widened to either side of 70 cts/g for several days. 

That sort of gain shows up at the pump in price increases that outpace those of crude, and decreases that lag those in the crude market.

Diesel has been increasingly burdened with tight inventories worldwide. Inventories show up in the spread between first month and second month diesel or crude, and tight stocks widen the spread between higher-priced first month ULSD and lower-priced second month.

In a perfectly balanced market, the front month price is lower than the second month price, with the higher price in the later month reflecting the time value of money and the cost of inventory. That market structure is called contango.

But when inventories are tight, the barrel to be delivered the fastest becomes the most valuable. The market then flips into a structure called backwardation, with the front month the most expensive, the second month less expensive and the third month lower still.

The backwardation has blown out in recent days. It closed May at 1.18 cts/g–meaning the front month was that much higher-priced than the second month–but by the final day of June on Monday had widened to 5.95 cts/g. Much of that increase in the spread came in the last days of the month, rising from just under 4 cts/g Wednesday to more than 7 cts/g Thursday before dropping back slightly. 

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