LONDON - The worldwide shortage of diesel and other distillate fuel oils has started to ease as stocks accumulate in response to exceptionally high refining margins and the slowdown in manufacturing and construction activity:

* EU inventories of diesel oil and gas oil increased to 49.5 million tonnes at the end of August 2023 from 44.9 million a year earlier and were +1.8 million tonnes above the prior ten-year seasonal average.

* U.S. stocks rose to 119 million barrels by the end of September from 111 million a year earlier and the deficit to the ten-year average had narrowed to 20 million barrels (-14%) from 30 million (-22%).

* Singapore distillate stocks increase to an average of 9 million barrels in September from 8 million a year earlier narrowing the deficit to the ten-year average to 2.8 million barrels (23%) from 3.8 million (32%).

More recent weekly data for the U.S. and Singapore, and partial monthly data for the EU, shows inventories tracked the seasonal average or rising between September and November.

Diesel and distillate stocks accumulated in response to the increase in both crude prices and refining margins over the third quarter, which encouraged maximum refinery processing and enforced a reduction in fuel use.

Benchmark crude prices increased by $124 per tonne (+22%) between May and September while the gross refining margin or crack spread more than doubled by $145 per tonne (+124%) over the same period.

Chartbook: Global distillate inventories and prices

Diesel and gas oil consumption are the most sensitive to the state of the business cycle, particularly the condition of the manufacturing, freight transport and construction sectors.

The surge in fuel costs coupled with rising interest rates and tightening credit conditions contributed to a slowdown in manufacturing and construction at the end of the third quarter and into the start of the fourth.

Diesel and gas oil account for almost 30% of global petroleum consumption so softening distillate demand also filtered back into the crude market.

Since September, partly in response to softening industrial activity, benchmark crude prices have retreated by $119 per tonne (18%) while the crack spread has fallen by around $68 (26%).

Lower fuel costs have offered some relief to manufacturers, freight hauliers and construction firms, as well as taking some heat out of inflation for central banks and investors.

At the same time, strong El Nino conditions over the Pacific are expected to produce a relatively mild winter across the northern United States, cutting total heating demand by around 7%.

Europe too is forecast to have a warmer-than-average winter, which is expected to diminish distillate use for household and commercial heating.

The impact of sluggish manufacturing, construction activity hit by rising interest rates and a mild winter have taken much of the tension out of the distillate market.

But inventories are still low by historic standards, especially in the United States, which explains why crack spreads are still relatively high.

If manufacturing and construction activity were to accelerate, perhaps in response to a reduction in interest rates, tension in the distillate market is likely to re-emerge very quickly.

John Kemp is a Reuters market analyst. The views expressed are his own. Follow his commentary on X

(Editing by Josie Kao)