Asia's diesel supplies are set to rise in early 2023 after a year of tight inventories as refiners ramp up output to capture higher margins and China maintains export volumes with new quotas, according to industry sources and analysts.

The increasing supply will help Asian refiners capture some European demand expected after sanctions on Russian oil products start on Feb. 5. More regional diesel output should also be enough to meet the forecast rise in fuel demand in India and Southeast Asia.

Asian diesel margins and cash premiums are expected to soften late in the first quarter as supply is forecast to exceed demand, while

European tanks have been filled to the brim ahead of the sanctions, limiting the pull from there for now.

In a sign of this softening, January and February cargoes loading from Asia sold through tenders have been trading at discounts of 50 cents to $4 a barrel to Singapore quotes.

Asia's 2023 diesel supply could rise by almost 3% over the previous year while demand growth will lag behind at around 1%, according to consultancy Wood Mackenzie.

Crude processing at Asian refineries in the first quarter is expected to rise 2.8% from the final quarter of 2022 to 31.1 million barrels per day (bpd), Wood Mackenzie said. For the full year, this could rise to 4.7% higher 2022, it said.

"The increase will mainly come from India, Japan and Korea, with major refineries to raise runs after Q4 2022 maintenance on the back of healthy margins," said Wood Mackenzie senior analyst Daphne Ho.

Operating rates at Japanese refiners rose last week, according to official data, while Taiwanese refiner Formosa Petrochemical Corp has also raised their average crude runs for January-February to 480,000 bpd from 420,000 bpd in Q4 2022, said company spokesperson K.Y. Lin.

"Every refiner will maximise their runs as much as possible until middle of 2023 since major oil products in the chain are profitable now," Lin said.

Buyers could also look to Asia for supplies as two Saudi Arabian refineries are shut for maintenance in January and February, he added.

CHINA

Diesel exports from China will stay elevated after Beijing granted fresh quotas and refiners capitalize on robust overseas margins.

For January, exports are expected to ease to about 2 million tonnes, or 497,000 bpd, according to an average of forecasts from Wood Mackenzie and Chinese consultancies Longzhong and JLC. That is down from 2.79 million tonnes in December but higher than the average of 1.63 million tonnes per month between September and November.

Rising Chinese exports will partly offset falling supplies from Russia, where Western sanctions are expected to have a significant impact on its oil product exports.

Up to 670,000 bpd per month of Russian diesel imported by Europe will have to find alternative markets in Latin America, Africa and the Middle East after February, said Serena Huang of analytics firm Vortexa. That will likely displace the Asian cargoes that regularly flow to Latin America and Africa.

Traders are also eyeing opportunities to send Asian diesel to Europe to fill the Russian shortfall. For example, Latvia imported its first diesel cargo from China earlier this month.

Europe's imports from northeast and southeast Asia rose by more than fourfold in the second half of 2022 to around 103,000 bpd, compared with the first half of 2022, Refinitiv data showed.

"Some potential gaps could be filled by Japan and South Korea running hard to capture more European market share,", said Janiv Shah, a senior analyst at Rystad Energy, although Middle East supplies are closer to Europe.

Robust diesel demand growth in India, Indonesia and Vietnam will also encourage refiners to boost output, analysts said.

Diesel demand in India - the second-largest consumer of the fuel in Asia after China - is expected to grow by 5% to 6% this year from 2022 while consumption in Indonesia and Vietnam could rise by between 6% and 7%, said Wood Mackenzie analyst Lee Kuan Hui.

(Reporting by Trixie Yap; Editing by Florence Tan, Tom Hogue and Christian Schmollinger)