U.S. Diesel Demand Poised for Freight Driven Recovery

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Posted by Joseph Keefe

Freight movements across the United States are
showing signs of sustained growth, which should help push
domestic diesel consumption higher this year.

Freight was hit hard in 2015/16 by the switch from coal to
gas-fired power generation, the slump in oil and gas drilling,
and more generally by an unplanned build up in business
inventories.

The seasonally adjusted volume of freight moved by road, rail,
pipeline, barge and air declined by 3.4 percent between December
2014 and March 2016, according to the U.S. Bureau of
Transportation Statistics (http://tmsnrt.rs/2lVAuey).

Nearly all freight transport is powered by diesel so the freight
recession caused a corresponding drop in distillate fuel oil
consumption.

Lower freight demand was exacerbated by the record warm winter in
2015/16, since distillate is also used to heat homes, offices,
and other buildings.

Distillate consumption declined by 4.7 percent between 2014 and
2016, according to the U.S. Energy Information Administration
("Short-Term Energy Outlook", EIA, Feb. 2017).

U.S. refineries have coped by switching to gasoline production as
far as possible and ramping up diesel exports to the rest of the
western hemisphere.

U.S. refineries have exported surplus distillate to Central and
South America, where local refineries have proved unable to meet
strongly growing demand.

U.S. diesel demand has remained depressed even as gasoline
consumption has passed the previous peak set back in 2007.

But the improvement in the freight outlook should ensure domestic
diesel consumption returns to growth in 2017
(http://tmsnrt.rs/2lOJ9DD).

FREIGHT MOVING AGAIN

Coal deliveries should rise significantly in 2017 now power
producers have run down excess stocks that accumulated during
2014/2015 (http://tmsnrt.rs/2lOwOzs).

Power producers are also expected to run coal-fired units for
more hours in 2017 and burn more coal thanks to the rise in gas
prices, which will give an extra boost to rail movements.

In the first six weeks of 2017, the number of rail cars loaded
with coal increased by 15 percent compared with the same period
in 2016, according to the Association of American Railroads.

The sustained recovery in oil and gas drilling evident since the
middle of 2016 will also drive an increase in diesel demand in
2017.

Most drilling rigs an pressure pumping systems use
diesel-electric motors and rely on diesel generators for all
their auxiliary power needs.

And the movement of equipment and supplies to drill sites,
including deliveries of fracking sand and water, is a significant
source of freight demand.

The number of rigs drilling for oil and gas across the United
States has risen by more than 330 (80 percent) since the end of
May 2016.

The active rig count is currently increasing at an average rate
of around 20 per week and is expected to continue rising through
the remainder of the year (http://tmsnrt.rs/2kNiIdk).

Finally, U.S. manufacturers, distributors and retailers have at
last arrested and begun to reverse the unplanned increase in
stocks of raw materials, work-in-progress and unsold products
that built up in 2014/15.

The economy-wide ratio of business inventories to sales surged
from 1.30:1 in July 2014 to peak at 1.41:1 between January and
March 2016, according to the U.S. Census Bureau.

As a result, freight fell during 2014/15 as manufacturers,
distributors and retailers all cut new orders in an effort to
reduce the stock overhang.

But the inventory-sales ratio has dropped consistently since
April 2016 and by the end of the year had fallen to just 1.35:1
(http://tmsnrt.rs/2lOJ2rP).

Freight deliveries are currently running below the level needed
to replace sales, resulting in the biggest decline in the
inventory ratio for more than five years.

Inventories remain somewhat elevated but the current draw down is
unsustainable in the medium and long term.

At some point, manufacturers, distributors and retailers will
have to increase orders and deliveries to stabilise stock levels.

REMAINING RISKS

Rising coal deliveries, increased oil and gas production, and the
end of the destocking cycle should all combine to produce a
significant increase in diesel consumption in 2017/18.

The U.S. Energy Information Administration currently projects
distillate consumption will rise by around 80,000 bpd in 2017 and
another 110,000 bpd in 2018 ("Short-Term Energy Outlook", Feb.
2017).

The main uncertainties surrounding the freight outlook come from
the macroeconomic side, where the economic policies of the Trump
administration remain unknown.

The White House has hinted at an ambitious agenda of tax cuts,
increased government spending and deregulation, which should
provide a strong economic stimulus in the medium term.

But it remains unclear how much of this agenda will actually be
enacted and the possible introduction of a border-adjusted tax or
targeted tariff protection could all have a negative impact on
freight.

The Federal Reserve system also appears poised to embark on the
first tightening of monetary policy since 2004-2006.

The political-economic cycle will remain a source of significant
uncertainty for some time but the underlying freight outlook is
stronger than it has been for over two years, which is a positive
for distillate demand.

By John Kemp

Feb 16, 2017

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