Sanctions Blink, Diesel and Biodiesel Steadies

Yesterday’s much-advertised sanctions D-Day turned into a nothing burger for immediate energy supply. Washington stopped short of the aggressive secondary-sanctions enforcement the market feared, and crude plus products quickly surrendered some geopolitical premium. The risk has been postponed rather than removed. Secondary sanctions against major financial institutions remain threatened as early as Friday, putting China directly in focus because of its purchases of sanctioned crude. Washington is also considering another 7.5 percentage points of tariffs on Chinese goods on top of the 12.5% replacement tariff imposed in July. Canada has answered US trade measures with tariffs ranging from 15% to 50% on C$27.6 billion of US goods effective September 8. This tit-for-tat escalation is negative for trade, logistics and economic activity. Yesterday’s announcement did little. Secondary sanctions that interfere with banking, crude payments and refinery feedstock flows would be another matter entirely.

Heat Crack Margin in $/Barrel

China is now giving me pause on the timing of my distillate call. July gasoline, diesel and jet exports totaled roughly 2.55 million metric tons against a planned program near 2.50 million tons, an execution rate around 102%. Diesel accounted for roughly 810,000 tons, or about 195,000 b/d. The August program has been estimated around 3.6 to 3.7 million tons including Hong Kong and bonded aviation sales. Applying July’s execution rate points toward roughly 3.65 to 3.75 million tons. Using July’s product mix gives a working diesel estimate near 1.16 to 1.20 million tons, roughly 280,000 to 290,000 b/d. The direct increase versus July is therefore only around 80,000 to 90,000 b/d, but the indirect effect matters more. Additional Chinese product supply reduces Asia’s pull on Middle Eastern diesel and jet, potentially leaving more barrels available for Europe and Africa. Atlantic crude is also increasingly moving east as Asian pricing attracts cargoes. I still believe distillate goes higher, but China has become the largest risk to the timing. China does not need to solve the shortage. It only needs to supply enough marginal product to delay the next squeeze.

The market structure still tells us the underlying diesel problem has not disappeared. September ICE gasoil is around $1,233/mt while September/December backwardation remains close to +$127.50/mt. That is still an extraordinary nearby scarcity premium. Arizona diesel has reached roughly $5.79/gal, up around 13 cents in a week, 34 cents in a month and more than $2.18/gal from a year ago. Hormuz traffic also looks better in the headline numbers than underneath them. Outbound crude movements have recovered materially from late July, while laden vessel transits fell last week and sanctioned crossings increased. Russia is still restricting diesel exports. My distillate thesis therefore remains intact, but I would be less aggressive about predicting exactly when the next leg higher starts. I want to see whether China converts its larger export permissions into physical August and September barrels before pressing the diesel position harder.

That change in timing is why I would start buying some BOGO protection rather than abandoning the lower-BOGO thesis. December BOGO is around +$391/mt and remains in contango, yet December soybean oil around 67.9 cents/lb still trades in an isolated US RFS market supported by D4 RINs near $2.02. With 87 days remaining to expiry, I prefer the December 73.5 cent soybean-oil call. Implied volatility is below 29% and the option costs roughly $990 per contract. Spread across 87 days, that is only about $11 per day per contract for protection. The premium is roughly 1.65 cents/lb, equivalent to about $36/mt of soybean-oil exposure. This is not a reversal of my BOGO view. I still expect stronger distillate eventually to pull BOGO lower. I am paying a modest daily premium for time while China creates a credible risk that gasoil pauses and US soybean oil continues higher. The option protects against being early rather than wrong.

ICE Gasoil

Europe gives a similar message of cooling without normalization. Biofuel paper activity has subsided materially from the exceptional Week 32 peak near 792,000 tons, although Week 34 is still incomplete. The decline is uneven. Tuesday alone produced 64,000 tons of HVO paper, including 36,000 tons in Q4/Q1, alongside 12,000 tons of RME and 11,500 tons of UCOME. September RME traded around +$412 over gasoil and UCOME around +$489, while HVO October traded near $1,740/mt and Q4 around $1,705/mt. Chinese UCO exports meanwhile reached roughly 1.77 million tons in the first half, with June alone at 473,100 tons, up 52.5% from May. The Netherlands led the available January-April destination data at 251,000 tons, while the United States became the largest destination in May at 74,500 tons but keep in mind that China customs identifies only the top 3 destinations. . Those molecules are moving rather than disappearing, increasingly changing destination as US and European policy diverge. Put it together and my view today is more nuanced than it was a week ago. The distillate shortage remains unresolved and I still expect higher diesel prices, but Chinese supply building in the East gives the market more breathing room. I therefore remain bullish distillate, less certain about the immediate timing, and willing to spend roughly $11 per day on December soybean-oil protection while we wait for the Chinese export data to tell us whether the East is genuinely loosening.