# Presentation: 088128

##  Distillate in Depth – The Supply, Demand, and Price Picture

**John Hackworth**
**Joanne Shore**
**Energy Information Administration**
**Winter Fuels Conference**
**October 12, 2005**

***www.eia.doe.gov***

**Notes:**
Even before the hurricanes hit this fall, we were seeing some very unusual distillate prices, which raises the question of what was happening to distillate markets that was different this year.  Then the hurricanes hit, affecting supply severely in the short term.

This presentation will provide background on distillate supply and demand, and then will focus on what has happened since Katrina and Rita and how the loss of U.S. refining production capability may impact the winter fuels situation.

## Distillate and Gasoline Relationships --Temporary or Fundamental Change?

**Unusual distillate and gasoline prices in 2005 – Not just a U.S. issue**
**Explore Europe/US light product supply/demand balance to illustrate market dynamics**
**Europe’s product imbalance**
**U.S. product imbalance**
**How they fit together**
**Current distillate market and supply response**

**Notes:**
The presentation will begin with a brief overview of the unusual distillate and gasoline prices seen in 2005 before the effects of the hurricanes.  The unusual prices consumers experienced were not limited to the United States.

Europe is a key player in Atlantic Basin petroleum markets, and in order to understand what is happening to U.S. gasoline and distillate prices, we need to look at how these two regions interact.  

The last portion of the presentation will focus on the near term affects of Katrina and Rita and discuss some major uncertainties that have arisen for the upcoming winter heating oil season as a result.

## 2005: Continuation of High Product Prices – Especially Distillate

**Note: Gasoline is conventional regular**
**Source: Bloomberg**

**Notes:**
Up until this year, distillate prices generally exceeded gasoline prices for only very brief periods.  But since last fall, we have seen the unprecedented situation in which distillate prices exceeded gasoline until late this summer.  
In past years, gasoline prices only exceeded heating oil and diesel prices in some fall and winter months. 
In fall 2000, distillate inventories were low, and distillate prices rose.  The winter proved cold, and resulted in one of the longer periods when heating oil prices exceeded gasoline, until the fall of 2004 and this year.

Gasoline prices again rose above distillate this September when the hurricanes damaged U.S. refineries on the Gulf Coast. Gasoline supply concerns were more immediate than distillate concerns.  When Katrina and Rita hit, gasoline stocks were relatively low and distillate stocks relatively high because of the summer prices. The large and sudden loss of gasoline production caused gasoline spot prices to spike, especially on the Gulf Coast. 

 This switch in relative prices does not mean that the distillate supply challenge is less than that for gasoline.  As will be shown later in the presentation, the distillate supply situation is deteriorating, and the stock and price picture will change as a consequence.

## Unusual 2005 Distillate Prices Internationally

**Source: Bloomberg NY Conventional Gasoline, No. 2 Heating Oil; NW Europe 0.2% Heating Oil and Regular Gasoline **

**Notes:**
The unusual distillate price strength this past year was not limited to the U.S.  Heating oil prices on both sides of the Atlantic and in Asia (not shown) exceeded gasoline prices through late summer. 

The provocative question is whether this highly unusual gasoline/distillate price situation in summer 2005 stems from a temporary situation or is the beginning of a more fundamental shift in the relative pricing of these primary light refined products.  

We have all been watching the growth in diesel demand, and at some point, price for diesel will have to rise relative to gasoline to produce the incentives needed to shift refinery investment towards more distillate production.  Is this the beginning of that situation?

Europe is highlighted on this chart because it plays an important role in world and in particular Atlantic Basin markets.  

## Atlantic Basin 1995-2004Business As Usual

**Note: European Union-15 (EU-15): Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, United Kingdom**
**Source: IEA**

**Notes:**
Europe and the U.S. represent the major refining centers of the Atlantic Basin.  They both run at fairly high utilization, but this is not unusual.  While both regions have increased utilizations over the drop seen in 2002, in 2004 Europe and the U.S. utilizations were not as high as seen in 1998. 

While this graphic shows that refinery capacity has not “maxed out” in the U.S. under normal conditions -- dealing with unusual hurricane damage that resulted in an average loss of 12-13% of U.S. crude input capacity for two months is a major problem! 

Stepping back from  the hurricanes, we need to look at the underlying changes taking place in the Atlantic Basin.  The relationship between EU-15 oil product demand and refining capacity has shown little change since 1998, and European concerns about global warming have created efforts directed at demand declines in the future. But beneath the picture of total utilization, there are stresses in meeting the demand for a changing mix of transportation and fuel products.

For many years, both the U.S. and Europe have relied on imports as well as local refinery production for supply of certain products.  Those product imports are an increasingly important component of refined product supply for Europe and the U.S. and will be covered in detail in this presentation.

## Europe Is Unique In Degree of Shift to Middle Distillate

**Note: European Union-25 (EU-25): former European Union-15 plus Estonia, Latvia, Lithuania, Czech Republic, Slovakia, Hungary, Poland, Slovenia (beginning in 1992/93), Cyprus, Malta**
**Source: BP Statistical World Review 2005 **

**Notes:**
This chart illustrates the dramatic product mix change that has taken place in Europe relative to the rest of the world by graphing distillate demand’s share of total demand for gasoline and distillate.  

Distillate in this graph includes diesel, heating oil and jet fuel, but the change in distillate demand share captured in the chart is driven mainly by changes in diesel fuel demand.

While not shown on the chart, the U.S. share of distillate has shifted slightly higher and the rest of the world has actually shifted a bit towards more gasoline.  

Europe’s strong shift away from gasoline to distillate has created some supply challenges that affect the U.S. gasoline and distillate markets.

## EU’s Contribution: Price is Not Just About Volumes, But Quality As Well

**Note: ULSD is ultra-low sulfur diesel**
**Source: Bloomberg NWE Barge**

**Notes:**
In addition to changes in demand mix, changes in diesel quality affect price.  As expected, European ultra-low sulfur diesel (ULSD) has been commanding a premium over heating oil.  That differential has averaged about 13 cents per gallon over the past year.

In the U.S., New York Harbor diesel spot values have averaged about 4 cents per gallon over heating oil.  

The high European prices for ULSD likely helped to pull other distillate fuel prices up as well.  

The question is whether the European differential is being driven more  by transition issues than by longer term factors.  Will the U.S. see these kinds of price differences?  Or will the U.S. ability to supply ULSD help to ease the price difference and result in lower differentials between heating oil and diesel  fuel?  

Because  we are seeing and will see transition issues associated with ULSD this year and next, it is hard to determine how these factors will play out in the long term.  

## Distillate and Gasoline Relationships --Temporary or Fundamental Change?

**Unusual distillate and gasoline prices in 2005 – Not just a U.S. issue**
**Explore Europe/US light product supply/demand balance to illustrate market dynamics**
**Europe’s product imbalance**
**U.S. product imbalance**
**How they fit together**
**Current distillate market and supply response**

**Notes:**
The changes in European demand for gasoline and diesel have created a growing imbalance between refinery production and product demand. Import and exports have been one of the primary means of resolving the imbalance.

The U.S. product markets have been important in balancing European refinery production and European product demands. It’s important to understand the fit between these regions as we look to the future.

## Europe and the U.S. – Example of International Product Trade

**We know the U.S. depends on product imports – especially those from Europe**
**Product trade between Europe and U.S has increased from 1995 to 2005**
**Working together because it benefits both due to different supply/demand balances**
**Distillate product supply concerns may grow more for EU, but impacts U.S.**
**Product quality issues important -- but not part of this presentation**

**Notes:**
Europe and the U.S. provide an interesting example of how international product trade can benefit consumers.

The U.S. depends on product imports – particularly gasoline.  But this is not simply because it is difficult to expand refining capacity in the U.S.  There are some very economic sources of product available as imports – particularly from Europe.

In the following slides, the presentation will illustrate how these two regions work together to balance supply and demand. 

The presentation will highlight why distillate is probably more of a concern for Europe than for the U.S., but how Europe resolves its issues will affect the U.S.

Product quality changes are also important.  Both Europe and the U.S. are moving to low sulfur products.  These changes will likely play an important role over the next few years, but how that will evolve is highly uncertain.  As a result, we will not address that topic further in this presentation.

## EU-15 Demand Mix Projected to See Declining Gasoline Demand

**Source: History IEA; Forecast Purvin & Gertz**

**Notes:**
While a previous slide showed the ratio of distillate and gasoline demand in Europe, this slide shows the volumes.  Diesel-fuel demand has been growing in both the United States and Europe.  But in Europe, diesel-fuel demand is growing rapidly while gasoline demand is declining.  In fact, diesel-fuel demand today exceeds gasoline demand.

Looking ahead, European diesel-fuel demand is expected by many forecasters to continue to grow, while gasoline demand will continue to decline.

Generally, total demand for distillates and gasoline in Europe is growing very little, which has been part of an ongoing effort to stem transportation demand in order to reduce CO2 emissions in response to greenhouse gas concerns.  

## European Preference for Diesel Grew Quickly since Late 1990s 

**Source: ACEA  **_[www.acea.be](http://www.acea.be/)__ _

**Notes:**
The reason for diesel-fuel demand growth has been the result of a shift by car buyers from gasoline to diesel-fueled vehicles.  Diesel-fueled vehicles are about 35% more efficient than gasoline-fueled vehicles, which helps Europe to reduce its transportation fuel demand.  

Using various tax and purchase incentives, Europe’s diesel-fueled vehicle sales have seen a rapid penetration in recent years.  European new car registrations went from just over 20% in the mid 1990’s to almost half of the new car sales today. 
New vehicle registrations showed new diesel-fueled vehicles at almost 50%  of new light-duty vehicles in 2004.  
This compares to 1-2% in the United States.

However, the shift from gasoline to diesel has been occurring over many years, which set the stage for the recent surge over the last seven years.  

## EU Distillate Refining Yield Growing as Gasoline Yield Shrinks

**Gasoline Yield**

**Distillate Yield**

**Note: Distillate is heating oil and diesel.**
**Source: IEA **

**Notes:**
Europe’s refiners have responded to the change in demand by increasing their distillate yield – both by operating changes and with some process investments.  

However, this shift has not been sufficient to match the demand shift from gasoline to diesel.

European refiners are at the point where additional process facility changes are needed to further increase distillate yields and reduce gasoline production.

## EU Hydrocracking Growing, But Not as Fast as Diesel Demand Shift

**Note: FCC -  Fluid Catalytic Cracking**
**Source: EIA, Oil and Gas Journal**

**Notes:**
The major process in which European refiners are investing to significantly increase distillate yields is hydrocracking.  Fluid catalytic cracking units (FCC), which many refiners in both Europe and the U.S. have, take heavier materials from distillation units and produce mostly gasoline.  The hydrocracking units use heavy feedstocks, and can generate more distillate.  

As this slide shows, European refiners have been increasing hydrocracking capacity to increase production of diesel compared to gasoline.  Since 1990, hydrocracking as a percent of distillation capacity has increased from 2% to almost 7%, while FCC capacity as a percent of distillation has leveled at about 16%. 

Despite the growth in hydrodcracking capacity, the deficit in diesel production and the excess in gasoline production compared to demand have continued to grow.  Additional planned hydrocracking investments would increase average European refinery distillate yields by perhaps 2 percent.  However, even this increase in distillate yield likely will be insufficient to keep up with the gasoline-to-diesel demand shift.  

This implies that Western Europe may be able to provide the United States with higher gasoline imports in the next few years.  

## Europe’s Growing Product Imbalance

**Source: IEA**

**Notes:**
This chart combines the gasoline and distillate imbalances in Europe.  Distillate products (diesel, heating oil, and jet fuel) are imported in increasing quantities, and excess gasoline is exported in increasing quantities

 Note that in 2004, distillate imports grew less than gasoline exports. Is that a situation that is likely to continue? Does it reflect growing difficulty in finding economic distillate imports? Perhaps.  

Looking to the future, imports are likely to be more difficult to locate as European sulfur specifications are lowered.  This could mean a larger price incentive for diesel supply, and a resulting push to produce more distillate at the expense of gasoline production.  Still, this may not happen quickly.  

## Europe Using Imports and Exports to Balance Product Supply: 1995-2004

**Diesel/gas oil imports increased 400 MB/D with 3/4 from Former Soviet Union **
**Kero/Jet imports rose 200 MB/D with 56% from Middle East **
**Even with large distillate imports, had to export about 400MB/D gasoline to balance**
**Three quarters of gasoline exports went to U.S. and 10% to Africa**

**Source: IEA**

**Notes:**
This slide summarizes some of the key sources for European imports and exports.  Several regions dominate these flows.

The countries of the former Soviet Union are the source of 3/4 of the additional 400 thousand barrels per day of diesel and gas oil imports in 2004 compared to 1995. 

Meeting Increased jet fuel needs has involved more and farther-removed sources.

The U.S. East Coast provides a market for 3/4 of Europe’s excess gasoline production.

In place of investments in refinery process changes to produce more distillate and less gasoline, Europe has found a combination of economic distillate import locations and economic markets to send excess gasoline.  But that could change in the future.  

## Europe: 1995-2004 -- Summary

**Diesel demand growing and gasoline demand declining**
**European refiners production mix -- too much gasoline, too little diesel **
**Hydrocrackers being built to increase diesel yield, but not keeping up with demand shift**
**Historically, Europe achieved balance by finding economic import sources for distillates and export destination for gasoline **
**Future: Still see increasing gasoline exports for some time – but will economic distillate imports be available – especially ULSD imports?  **

**Notes:**
 This slide summarizes what we have seen in looking at the European side of the Atlantic before turning to the U.S. and the connections between these two regions.

As we look to the future, Europe’s challenge will  be how best to continue meeting its distillate demand growth.  Its traditional  sources of imports (Former Soviet Union and Middle East)  may be limited in their ability to increase supply, particularly now that Europe has moved to low sulfur diesel.  Europe is a major market force in the Atlantic Basin, and as its need for distillate increases, the relative price of diesel and gasoline may change, and any price pressure will be felt in the United States.  

## U.S. Demand Growing for Both Gasoline and Distillate

**Gasoline**

**Distillate**

**Source: EIA, Annual Energy Outlook 2005**

**Notes:**
Gasoline and distillate demand growth in the U.S. is very different compared to Europe.  Not only is gasoline demand higher than distillate (and diesel), but in the U.S. both products are growing at similar rates.  
Actually U.S. distillate annual growth from 1995 to 2004 averaged 2.1% and gasoline demand increased annually at 1.7%. 
As a result, distillate’s share of the light product market increased slightly.  

In spite of similar growth patterns, the increased demand for gasoline and distillate was supplied in different ways.

## U.S. Refinery Throughput Has Increased to Help Meet Demand

**Gross Inputs**

**Operable Capacity**

**Source: EIA**

**Notes:**
Both increased production and increased imports can contribute to meeting demand growth.  First we focus on refinery production.  Increases in refinery production comes from 2 sources – an increase in crude runs and an increase in the yield of gasoline or distillate.  

This graph shows that refinery throughput, or gross inputs, has increased – both due to refinery capacity running at increased utilizations and increases in that capacity.

Now we turn to yields on the next slide.

## U.S. Middle Distillate Yield Has Increased  While Gasoline Stayed Flat

**Source: EIA**

**Notes:**
U.S. refinery light product yields have increased since 1990, even as the quality of crude oils being run in refineries has been declining.

But yields for gasoline and distillate have changed differently.  Distillate yields increased more than gasoline, rising about 3.5% since 1990.  

Gasoline yield from crude oil input has changed very little, but it is up about 2% due to the addition of oxygenates from outside the refinery.  

## Gasoline Imports Have Supplied Half Demand Growth in Recent Years

**Gasoline Imports Have Supplied Half Demand Growth in Recent Years**

**Source: EIA**

**Notes:**
Now we turn to gasoline, where imports are critical to meeting demand. This chart focuses on the increases in supply from domestic refineries and from imports.  From 1998 to 2004, the increases in domestic production and imports have been similar, each meeting about half of the growth in demand.  As this chart shows, each source of supply increased about 400 thousand barrels per day.

Increases in imports are not necessarily bad for consumers.  In the last decade gasoline imports have been very competitive in the U.S. gasoline market, as demonstrated by the growth in gasoline imports compared to the increase in supply from domestic refineries.  Suppliers have purchased imports even when U.S. refiners could have increased production, because the price of those imports was more economic than increased domestic production.  

## Gasoline Import Sources

**Nearby dedicated suppliers**
**Canada**
**Virgin Islands**
**Venezuela**
**Nearby economic sources**
**Western Europe – symbiotic relationship**
**Eastern Europe**
**Latin America**
**Africa**
**Other incremental supply**
**Middle East and Asia**

**Notes:**
The next few slides are going to explore gasoline imports further to build the groundwork for helping to understand international product market dynamics.

Gasoline import sources can be grouped based on several important attributes

The US is a major market for the refineries in Eastern Canada, the Hovensa refinery in the Virgin Islands, and, to a lesser extent, the Venezuelan export refineries.

Western Europe has become a growing source of US gasoline as the US has been the market to absorb their excess gasoline production resulting from the growth of diesel demand in Europe.

For the “other” sources, the economic relationship weakens as the distances between these sources and the U.S. market increase.  Also, alternative markets are available to compete with the U.S. for these other available gasoline exports.

## Western Europe Growing Source of Gasoline Imports

**Note: Total gasoline is finished product plus blending components.**
**Source: EIA, Form EIA-814**

**Low-Sulfur Years**

**Notes:**
Not surprisingly, as Europe’s excess gasoline supply has grown, much of the growth in gasoline imports to the U.S. during the past few years has come from European sources.

Fuel quality may also have been a factor influencing growth in volumes from Europe.  Europe’s low-sulfur gasoline program is similar to the U.S. program.  Note that when we began the Tier 2 program in 2004, European gasoline import volumes (January through July) increased by 128 thousand barrels per day (46%) from the same period 2003.

At the same time, we saw a drop in volumes of 39 thousand barrels per day from Brazil and Other Latin America.  

## Distillate Imports Become Critical During Cold Snaps: Relief from Different Locations

**Source: EIA, Form EIA-814**

**Winter 99-00**

**Winter 00-01**

**Notes:**
Distillate imports play a different supply role than gasoline imports.  Generally Eastern Canadian refineries, Hovensa in the Virgin Islands and Venezuela provide a rather steady inflow of product.  In some years, these sources represent most of the imports, but when we get a cold winter, the picture changes dramatically.

This slide compares two winters where we have had cold weather surges: the winter of 1999/2000, when we had a brief cold spell and supply pinch, and the winter of 2000/2001, which was a more protracted, tight supply/demand balance.  These two examples illustrate that, with sudden demand surges brought on by cold weather, distillate imports begin to flow from Eastern Europe, Latin America, Asia, and Western Europe.  Monthly imports levels can double in these cold winter situations.

Many of these regions do not have low sulfur fuel specifications yet, so much of the product that arrives during these cold snaps can be high sulfur.  

## United States: 1995-2004 -- Summary

**Gasoline:**
**Gasoline demand growth met almost equally by increased throughput and increased imports**
**Europe is major source of increased gasoline imports **
**Distillate:**
**Increase in distillate supply mostly from refinery production -- higher throughput and higher yield**
**However distillate imports are critical during unexpected cold snaps**

**Notes:**
Before moving to the summary of how the U.S. and Europe fit together, this slide summarizes the U.S. situation.

## Summary of European and U.S. Balances

**Source: EIA, IEA**

**United States**

**European Union 15**

**Notes:**
This chart summarizes the supply changes that occurred since 1995 to meet changing demand for both gasoline and distillate in the U.S. and Europe.  

Demand changes are met by changes in net imports and changes in refinery production. Refinery production changes are broken down into the volumes affected by changes in yield, and those resulting from changes in crude runs.  The yield changes stem from combinations of changing refinery unit operations, changing types of crude oils, and installation of new processing units.  

On the left, the chart shows that the U.S increased gasoline demand has been met by increasing refinery input and imports, with yield changes making a very small contribution. By comparison, increased refinery production from yield improvements played a large role in helping to meet distillate demand.  U.S. refinery distillate yield improvement ranked a little below increased refinery inputs and well above imports as a supply contributor.

In EU-15 countries, refinery production’s contribution to European gasoline demand remained almost unchanged, as production from increased refinery inputs were counter balanced by declines in production from declines in yield.  Excess product was exported.  For distillate, increased refinery production from both increased throughputs and yields provided about half the added product need, and the other half came from imports.  

## Distillate and Gasoline Relationships --Temporary or Fundamental Change?

**Unusual distillate and gasoline prices in 2005 – Not just a U.S. issue**
**Explore Europe/US light product supply/demand balance to illustrate market dynamics**
**Europe’s product imbalance**
**U.S. product imbalance**
**How they fit together**
**Current distillate market and supply response**

**Notes:**
We will now look at U.S. distillate supply for last fall through this fall and the prospects for the next few months and how that will leave us prepared (or possibly somewhat unprepared) for the coming winter.

Of course, a key aspect of this discussion will be the impacts of hurricanes Katrina and Rita on U.S. distillate supply and what distillate supply may be as we move into the winter fuels season.

## In Response to Price, U.S. Distillate Yields Have Been Unusually High

**Source: EIA Weekly Data**

**Notes:**
With distillate prices remaining higher than usual as we moved from winter into the summer driving season in 2005, U.S. refineries responded.  U.S. refineries have been running with unseasonably high distillate yields – more like winter yields.  

As the chart shows, refinery, distillate yields this summer were about 2% above normal, which translates to about 300 thousand barrels per day more distillate production.

These high distillate yields allowed distillate inventories to recover from the winter.  And strong gasoline imports supported gasoline supply.

High summer gasoline demand caused gasoline inventories to draw down in July and August, and during August, refiners began shifting distillate yields down and gasoline yields up.  Then Katrina and Rita severely reduced refinery production, and refiners increased gasoline yield to maximum levels by further reducing jet and distillate yields. 

## PADD 3 Estimated Lost Crude Refinery Input Volumes from Katrina and Rita

**Notes:**
This plot shows our latest estimates of the loss of crude input to the Gulf Coast refineries that were shutdown because of hurricanes Rita and Katrina. The refinery crude input levels were based on historic fall levels for each refinery when its operations were not affected by maintenance activity. 

The peak week is the week ending September 30th, with over 4 million barrels per day of crude input lost.  Actual crude input was 11.7 million barrels per day compared to a level that would have been about 15.8 million barrels per day.

The result of the low crude input was a drop in gasoline stocks of 4.4 million barrels and in distillate stocks of 5.6 million barrels for the week ending September 30..

Despite the fact that gasoline production is normally twice that of distillate, the stock drop was greater for distillate than gasoline. This was because gasoline supply was increased to a much greater extent by increased imports, the beneficial impacts of waivers, and the yield shifts from distillate and jet to gasoline.

For the months of September and October, the average estimated lost crude input is 2 million barrels per day. The associated lost product production will have to be made up from increased imports, reduced demand, increased yields (helped by waivers), deferred refinery maintenance, and a draw down of inventories.

## U.S. Weekly Distillate Production

**Notes:**
This graph shows the dramatic decline in U.S. refinery distillate production in the final week in September when the refinery outages had reduced crude input by over 4 million barrels per day. That’s a reduction of about 25% of crude input, and distillate production fell a similar 25% from a normal level of over 4 million barrels per day to 3 million barrels  per day -- a drop of over 1 million barrels per day.

The plot also shows the impact of Ivan in 2004. But the hurricane decline was greater this year from Katrina and Rita, and the production volume will only again reach 4 million barrels per day at the end of October or early November. For the month of October, distillate production is estimated to be about 400 thousand barrels per day below what it would have been if the hurricanes had not damaged the Gulf Coast refineries.

While we lump heating oil and diesel together when we talk about distillate, the products are not interchangeable. The Gulf Coast refineries produce high fractions of diesel fuels and provide almost all the diesel needs of the markets in Southeastern U.S., which may mean that the lost diesel production impacts are disproportionately reflected in the Southeast.

## Gasoline Inventory: Fall 2004 and 2005 Are Quite Different

**Gasoline Inventory: Fall 2004 and 2005 Are Quite Different**

**Source: EIA**

**Estimates**

**Notes:**

Looking back into 2004, gasoline stocks began the year low, but supply outpaced demand the last part of summer, and stocks rose to very high levels before the fall season.

As we began 2005, gasoline stocks were unusually high, which normally would keep refinery runs down somewhat.  But expectations were for gasoline prices to increase in the future, mainly due to expectations  for higher crude oil prices.  This encouraged high refinery input rates, which, combined with strong gasoline imports, counterbalanced the low gasoline yields, and kept gasoline inventories in the upper range for much of the summer.     

By mid summer, gasoline stocks had begun to decline and were on the low side at the end of August. Because of the hurricane impacts, and despite unusually high imports, gasoline stocks will remain below normal until October. Rebuilding should occur in the November to February timeframe.

## Distillate Stocks Impacts: Ivan- 2004, High Distillate Margins- 2005, Katrina & Rita

**Distillate Stocks Impacts: Ivan- 2004, High Distillate Margins- 2005, Katrina & Rita**

**Source: EIA**

**Estimates**

**Notes:**
In fall of 2004, while gasoline stocks were rising to unusual levels, distillate stocks were experiencing an unusual decline.  At the end of August, distillate stocks were on the high side before large drops in September and October brought levels to the bottom of the band. 

The drops can be traced partly to Hurricane Ivan, which occurred in late September and resulted in reduced refinery input.  
Refinery data for September and October clearly indicate that refinery input levels were unusually low in those months.  
Distillate yields were at reasonable levels, but low crude oil inputs kept distillate production depressed, requiring stocks to help meet demand.

But did Ivan keep refinery runs low until mid-November when input picked up enough to build stocks?  Why did gasoline not experience the same drawdown in September and October, and why did gasoline stocks remain so much higher than distillate stocks?  The answer goes back to the international situation and the time of year. Strong gasoline imports were depressing the need for high U.S. refinery run levels. 

The situation with Katrina and Rita is very different this year than we saw with Ivan.  The loss of refinery production is much larger than with Ivan.  All the crude oil that can be input to refineries will be run.  Until more refineries are back in production, refinery yields will favor gasoline over distillate since even high gasoline imports will not turn the situation in October.  

This means that distillate will not be moved forward again until November and December to recover the ground lost in September and October.   In short, the distillate picture going into winter looks challenging.  

## Pre Katrina: 2005 Distillate Not Flowing In or Out of U.S. in Unusual Amounts

**Notes:**
The last slide’s estimates of distillate inventories include estimates for imports and demand. We have yet to see much increase in distillate imports in EIA’s weekly data, and very few refiners have indicated to us that they planned for increased distillate imports.  This is partially because the shortfall so far is in low sulfur diesel rather than heating oil.  However, we are still early into the hurricane recovery period, and changes could occur. But  at this point our estimates for supply include only small increases in net distillate imports.

Looking back before  the hurricanes when distillate prices were hovering well above gasoline prices in Europe and elsewhere during 2005, speculations arose whether those prices might draw distillate away from the U.S. While that didn’t happen, the U.S did see relatively greater price strength for distillate products versus gasoline.

Exports, while larger than last year over this time period, have not been unusually large, and Latin America remains the primary export destination.  

## While All Fuel Prices are High, Natural Gas Gains Favor Fuel Switching

**Notes: Transco Z6 Spot Natural  Gas, NY Harbor No. 2 and Resid (.31-1.0% S)**
**Source: Reuters**

**Notes:**
The demand estimates behind the prior distillate inventory picture also did not  include any unusual fuel switching, which may occur.

The loss of natural gas production on the Gulf Coast is affecting prices relative to petroleum products.  With both the need for portable generators running off of diesel in the areas affected by power outages and the reduced natural gas volumes and price differential encouraging early fuel switching in the Northeast, we could see higher distillate demand than assumed.

Thus, we still are in a precarious position for winter heating oil.  Even though refineries are recovering even as we speak, the story is far from over for heating oil supplies.

## U.S. Distillate Market Leading Up to Winter

**In 2004, excess gasoline supply developed, while the distillate market tightened **
**The two products returned to similar balances by mid Summer 2005**
**High distillate prices in 2005 provided incentive to increase distillate yields to winter levels, and resulting increased production caused inventories to build **
**High availability of gasoline imports kept gasoline inventories high, despite strong demand and high distillate yield**
**But the Hurricanes Katrina and Rita have caused major gasoline and distillate supply problems**

**Notes:**
In 2004, we saw the gasoline and distillate market balances diverge, with distillate tightening while gasoline inventories moved from low to high levels.  

Gasoline imports remained strong in 2005.  On the other hand, the distillate price premium over gasoline caused refiners to increase distillate yield and move toward a better product balance.  Distillate stocks were at a comfortable level at the end of August, looking like we were on the way to being well set for the winter fuel season. 

Then hurricanes Katrina and Rita have caused an unprecented level of refinery outages. We are now seeing distillate stock fall as we speak  -- 5millon barrel decline in distillate stocks last week, possibly another 4 million this week, another 3 million barrels next week and the situation is transformed from a comfortable to an uncomfortable situation.

## Winter: Low Stocks Likely; High Prices; Considerable Uncertainty

**Low distillate stocks **
**Reduced refinery distillate production from hurricanes**
**Diesel & jet supply affected more than heating oil**
**But heating oil supply and prices affected by other distillates**
**Uncertainties in distillate supply and demand**
**Timing of refinery restarts uncertain**
**Challenge to increase diesel fuel imports in competitive Atlantic Basin **
**Potential for fuel switching distillate demand increase**

**Notes:**
Now as we look ahead to this winter, we are faced with even more uncertainty than usual for this time of year.  Not only did we have an unusual underlying distillate market leading up to this fall, the hurricanes wreaked havoc with supply in general.

This time of year we normally are seeing the last builds in distillate inventories in October and November before the winter heating fuel season hits its peak in December through February.  Instead, because of the low refinery production resulting from the hurricanes, distillate4 inventories are being drawn down.  

The main distillate supply affected by the hurricanes was low sulfur diesel and jet fuel, which is not easy to replace with imports.  Although heating oil inventories in the  Northeast did not drop like diesel fuel inventories, they will be affected by the general loss of distillate product none the less.

U.S. refinery production is still damaged and struggling to come back; import availability of low sulfur diesel and jet is uncertain; and there are signs that demand for distillate may increase more than usual from fuel switching due to the loss of natural gas supply on the Gulf Coast.

Unfortunately, most of the uncertainty points towards tighter supply this winter rather than looser supply, which translates to high prices.  Even warmer weather may not ease prices much under these circumstances.