Waving goodbye to its historic symbiosis with Russia, Europe heads into 2023 facing a global tug-of-war for diesel supply.

With low global diesel stocks setting supply and demand balances on edge, Europe is set to face Asia, the US, and Latin America in a battle for diesel barrels that will only add to price volatility in 2023.

Global diesel stocks were playing catch-up even before Russia's invasion of Ukraine Feb. 24, emerging from the pandemic with demand having largely recovered but with immense losses to refining capacity, particularly in Europe.

The Ukraine crisis sparked panic among diesel buyers, tightening the spot market and causing the steepest backwardation on record before a combination of high prices, economic weakness, a tapping of strategic reserves, and continuing consumption of the key industrial fuel restored some order.

But fears of a renewed crisis simmer.

Diesel and gasoil stocks in the Northwest European hub of Amsterdam-Rotterdam-Antwerp sat at 1.716 million mt, 24.9% below the five-year average late November and their lowest since 2008 for the time of year, data from Insights Global showed.

Inventories elsewhere have faced a similar fate as demand outstrips supply, with diesel stocks across the Atlantic around 37% below the five-year average at the end of November and middle distillate stocks in Singapore around levels last seen in 2004 for this time of year, US Energy Information Administration and Enterprise Singapore data showed.

Crisis, what crisis?

Question marks remain over where Russian diesel might go -- and in what quantity -- as trade flows readjust following the start of EU import sanctions Feb. 5 that could halt 2.5 million mt of diesel, which currently continue to arrive each month.

Analysts point to ongoing high prices as global arbitrage routes take time to rejig and potentially limited export destinations constrain Russian diesel production. How much this hits global balances could hinge on the global slowdown, with diesel key to industrial production.

"In Europe, we expect 2023 FOB ARA diesel barge cracks to average well above the five-year range, at $43/b in first-half 2023, and $41/b in H2 2023," Rebeka Foley, an oil analyst at S&P Global Commodity Insights, said. Platts, part of S&P Global, assessed FOB ARA diesel barge cracks versus Dated Brent at $42.13/b Dec. 1, 154% above the five-year average.

Bank of America's Head of Global Commodities Research Francisco Blanch was more bullish for early 2023. "Low diesel stocks, particularly in PADD 1 [US East Coast], and the risk of diesel supply disruptions from Russia point to a very tight outlook near-term, with a risk of diesel spiking to $200/b, from $150/b at present."

BofA forecast European ultra low sulfur diesel cracks to average $57.50/b in the first quarter of 2023 before falling to $30 by the year's end as the economy slows, Blanch said.

S&P Global's latest Oil Markets report showed cracks projected to remain above $40/b through Q4 2023 despite Western Europe's demand for diesel and gasoil contracting by 5.39 million b/d in 2023, with the biggest contraction in the third quarter at 5.52 million b/d.

Russian alternatives

With sanctions choking off Russian supply to EU countries, likely additional volumes will need to come from the Middle East, Asia, and the US.

Sizeable arbitrage flows already come to Europe from the East of Suez, with arrivals in Europe surpassing 2 million mt in September and October, and around 1.75 million mt in November, according to shipping fixtures and Kpler data.

While currently within historical ranges, flows to Europe are expected to increase when Russian supply ends as bullish price forecasts should attract high volumes of Asian barrels and more refining capacity comes online in the Middle East.

Traders expect volumes from Saudi Arabia's Jazan and Kuwait's Al-Zour will help replace Russian volumes, once fully operational. The 400,000 b/d diesel-strong Jazan was initially expected to be fully operational by H2, 2020, but has faced severe delays and has not yet begun exporting diesel. The newly commissioned 615,000 b/d Al Zour refinery exported its first cargo of jet fuel Nov. 28, indicating startup of distillate units, and is expected to ramp up production through 2023.

While the new capacity will eventually help offer some relief to middle distillate markets, "the bulk of this new supply will only become available quite some time after the EU ban on Russian refined products comes into force," said Warren Patterson, head of commodities strategy at ING bank said.

Flows from the US Gulf Coast are also expected to step in to help plug the Russian product gap, but arbitrage economics are typically more unstable than those from East of Suez, with Europe competing with Latin America and the US Atlantic Coast via the Colonial pipeline.

US Gulf Coast exports of ULSD to Europe surged 117% on the month to 484,200 mt in September, before crashing to 284,000 mt in October and rising to about 418,800 mt in November, shipping fixtures and Kpler data showed.

The impact of the EU ban on refined products will depend on how quickly trade flows can adjust and whether there are willing buyers of Russian diesel and gasoil further afield, which would free up alternative supplies for the EU. "However, the quality of product and logistics could certainly complicate the necessary shift in trade flows," Patterson said, as potentially longer distances and quality requirements affect buying behavior.

One thing looks clear, the European diesel market could still take some time adjusting to life without direct and immediate access to Russian barrels.