Diesel Margin at 14-Month High on Rail, Farming: Energy Markets

Profits from making diesel reached a 14-month high as railway shipments gain and U.S. farmers plant spring corn at the fastest pace on record, increasing demand for the fuel.

The crack spread, the difference between the price of crude and heating oil, rose to $12 a barrel on the New York Mercantile Exchange, the highest level since February 2009 and up from a 2010 low of $5.58 on Feb. 25.

Freight shipments by rail, most of which are powered by diesel, have risen 16 percent from a year ago, according to the Association of American Railroads. About half of the corn crop was planted as of April 25, compared with 20 percent at the same time last year, the Department of Agriculture said yesterday.

“We’re seeing farm demand, railroad demand very strong,” Bill Klesse, chief executive officer of Valero Energy Corp., the largest U.S. refiner, said today during the company’s first quarter earnings conference call. “Distillate demand in the world is going to grow at two to three times the rate of gasoline.”

The U.S. economy is forecast to grow 3 percent this year, according to the median of 64 responses in a Bloomberg survey. Total fuel demand increased 3.9 percent to 21.3 million barrels a day in March, according to the American Petroleum Institute.

Oil Contango

Some of the strength in the heating oil margin is because of the premium on crude oil for further-out delivery, or contango, rather than strength in diesel, said Walter J. Zimmerman Jr., vice president of market analysis at United-ICAP, a broker in Jersey City, New Jersey.

Oil for June delivery was $2.56 a barrel lower than for July today, the widest spread for the contracts nearest to expiration since April 20, 2009. Inventories of crude at Cushing, Oklahoma, where New York-traded West Texas Intermediate oil is stored, surged 5.8 percent in the week ended April 16 to 34.1 million barrels, the most since Jan. 8.

The heating oil crack today topped its $2.30-to-$11.22 trading range of the past year. The spread reached an intraday record of $36.89 a barrel on May 23, 2008, as diesel exports soared on demand in Europe, South America and Asia.

“It’s a little early to draw analogies with 2008, but it does appear that expectations of growing Asian demand are driving prices again,” said Gene McGillian, an analyst and broker at Tradition Energy in Stamford, Connecticut.

Exports Rising

Valero expects its exports of distillate fuel to jump to an average 185,000 barrels a day during May from 80,000 barrels in the first quarter, according to Joe Gorder, the company’s vice president of marketing and supply.

The increase in exports stems from improved demand in South America because of refinery shutdowns in the region, a reduction in supplies stored offshore on tankers and higher prices in Europe than in the U.S., said Gorder.

The heating oil margin may drop from its three-month high as refineries return from seasonal maintenance. Supplies of distillates have increased for three weeks as refiners boosted rates to the highest level in almost seven months on the higher margins and prepared for the U.S. summer, when gasoline demand typically improves.

Supplies of distillate fuel, which includes heating oil and diesel, rose 4.6 percent from a year ago as of April 16, the Energy Department reported last week. Production, which on Feb. 5 was the lowest since September 2008, rose to a six-month high.

“The heat crack is vulnerable,” said Andrew Lebow, senior vice president for energy at MF Global Inc. in New York. “As these margins widen out, refiners are going to gear more toward distillates and as prices rally, there will be an impact on demand.”

Chinese Demand

China, the world’s second-biggest energy user, may increase fuel consumption by 5 percent in the second quarter, the government said last week. China’s industrial output expanded 18 percent in March as the economy grew in the first quarter at the fastest pace in almost three years.

In other energy markets, the premium of gasoil over Brent crude on the ICE Futures Europe exchange widened to $11.23 a barrel, a one-year high.

The premium of gasoline over heating oil may not widen as much as earlier in the decade, as economic indicators show the U.S. economy is improving, which should boost diesel demand for trucking. The spread narrowed to 8.87 cents a gallon from 18.37 cents March 8.

The U.S. unemployment rate was at 9.7 percent in March, down from 10.1 percent in October.

“People are looking at diesel as a transportation fuel that will get traction before gasoline,” said Peter Beutel, president of trading adviser Cameron Hanover Inc. in New Canaan, Connecticut. “As the economy improves, we’re more likely to move goods than add jobs.”

To contact the reporter on this story: Barbara Powell in Dallas at bpowell4@bloomberg.net.

To contact the editor responsible for this story: Dan Stets at dstets@bloomberg.net

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