Diesel spreads and refinery margins are no longer reliable on their own for gauging oil demand, as extreme weather and supply chain issues distort short-term signals.
Refinery closures in the West and lagging new capacity in Asia are creating regional imbalances, with physical tightness building despite weak headline indicators.
China’s slowing demand and India’s rise as a refining hub, combined with “missing barrels” and potential new US sanctions, could drive unexpected bullish shifts in oil markets.
The global oil market has entered a period of increasing volatility, with unpredictable supply, deceptive demand signals, and factors such as geopolitical uncertainty and souring economic sentiment all tugging at prices. Crude flat prices have been somewhat volatile but have on the whole suffered over the last month or two. Diesel timespreads (or “spreads”), which measure the physical need either to store barrels or release barrels from storage, have historically been a reliable indicator of broader market trends and of economic growth. Recent disruptions, however, suggest that traders must look beyond even this proxy to understand the evolving landscape fully. What’s more, the increasing complexity of supply chains, the rise of alternative energy sources, and shifting regulatory frameworks further complicate market assessments, making a more comprehensive approach to analysis essential.
Disruptions in short-term market indicators
Over the past few months, diesel spreads probably failed as a reliable indicator of medium-term oil demand. A major driver of this distortion was extreme weather conditions in Europe and North America. Cold spells, more frequent and severe than in previous years, led to increased heating fuel demand and logistical disruptions. This distorted pricing signals, creating regional shortages and surpluses that do not necessarily align with average conditions in the market expected through the year. Furthermore, ongoing supply chain constraints and transportation inefficiencies have exacerbated these distortions, making it increasingly difficult to predict market trends using conventional indicators alone.
Recent market indicators illustrate this complexity. The March ICE Gas oil contract expired at an exceptionally high level of “backwardation” at roughly +$20 per tonne, suggesting significant tightness in the physical market. This contradicts other market movements, such as the so-called “Trump Slump,” which drove crude flat prices down substantially over parts of Q1, alongside US equities (crude has since made some recovery on supply concerns brought about by US sanctions on Iran and Venezuela).
Diesel cracks, a measure of the economics of refining crude into diesel, weakened from $21 per barrel to below $17 since mid-February, leading some to conclude that the market is beginning to reflect an oversupply issue. However, a deeper analysis of current spreads, particularly post-winter, as well as refinery economics, suggests that fundamentals may not be as bearish as headline numbers imply.
The key indicators traders should watch
While diesel spreads this winter likely overestimated medium-term oil demand and the broader state of global economic growth, they still remain a more reliable indicator than the crude flat price, particularly with cold weather impacts fading. In fact crude oil, diesel, and other fuels markets are “backwardated”, which signals little incentive or need to store barrels. A contango structure, which incentivises storage, has not been observed for an extended period, reinforcing the view that immediate supply/demand conditions are not overly loose. This divergence between futures market pricing and physical market pricing highlights the importance of a multi-layered approach to analysis.
Refinery margins provide another critical signal. Despite broader economic concerns, margins remain historically healthy, even after a sentiment-driven sell-off in diesel cracks specifically (since diesel demand in theory suffers the most during a recession). High sulphur fuel oil and naphtha cracks are also strong, indicating a need for maintaining high refinery operating rates.
This comes at a time when the refining sector is already facing a significant reduction in capacity and with little evidence thus far of a demand collapse implied by markets. Approximately 400,000 barrels per day of refining capacity will be lost in Europe due to upcoming closures, including Grangemouth and several German refineries. In the US, LyondellBasell’s Houston refinery has already shut down, and further closures are possible later in the year on the US West Coast.
Refinery closures and their market impact
One of the critical unknowns in the months ahead is the extent to which refinery closures are already priced into the market. While traders actively factor in expected changes, the full impact of these closures may not be realised until inventories begin to decline. Much attention has been paid to the new Dangote refinery in Nigeria, which has almost fully ramped up already. This additional capacity should be offset by losses elsewhere in the Western Hemisphere.
A key signal to watch will be the arbitrage movement of Middle Eastern & Indian barrels to Europe. Over the past few months, Europe has not had to rely heavily on Middle Eastern imports. However, if these arbitrage routes reopen consistently (via prices), that will be indication of tightening conditions and an increasing need for external supply. Refinery closures often have a lagging impact, as inventories act as a buffer in the initial stages. However, supply constraints will likely become more apparent as stocks deplete, particularly in distillate markets.
Supply chains may also be whip-sawed by renewed tensions in the Red Sea. The trade route through the Suez Canal, closed off due to Houthi attacks for some time now, had looked likely to reopen more completely in recent weeks, drastically cutting diesel transit times to Europe. But recent renewed tensions look likely to cut the nascent recovery short.
With steady demand at least for now, the Western Hemisphere’s refining sector is positioned for a period of moderate bullishness. Strong margins should incentivise refiners to maximise throughput where possible, but this will not be enough to fully offset the lost capacity. As a result, regional imbalances are likely to persist, contributing to localised price volatility and disruptions in supply chains. All this is also ultimately bullish for the outright price of oil.
What is more, new refining capacity in China is unlikely to alleviate global supply constraints significantly. Many of the country’s additions are focused on petrochemical feedstock production rather than diesel and gasoline output. Furthermore, China’s long-term strategy involves rationalising its refining sector, particularly in Shandong, by phasing out older units. Consequently, while new capacity is coming online, its net contribution to the global supply of road fuels will be less than expected.
India is another country to watch here and it continues to expand its refining footprint, positioning itself as a growing force in the global downstream market. However, the extent to which Indian refining capacity can offset declines in other regions remains uncertain, and some domestic supply will go to servicing domestic growth in oil demand – India is one of the primary sources of global growth here.
China’s slowing growth and India’s rise
The shifting dynamics of Chinese oil demand growth remain a significant uncertainty for global markets. While official statistics are often unreliable, crude import data provides a clearer picture of underlying trends. In 2024, China experienced a notable slowdown in oil imports, exerting downward pressure on the crude market. Given China’s dominant position in global seaborne crude imports, a decline of 500,000 to one million barrels per day has significant market implications, however the market managed to absorb these losses reasonably well.
At the end of 2024, Chinese agencies forecasted another substantial decline in domestic gasoil demand for 2025. This raises two possible scenarios: China will reduce crude imports again, creating a bearish environment for crude prices, or it will increase refined product exports, weighing on refining margins elsewhere. While neither scenario has fully materialised yet, this remains a key factor to watch for global markets, and also with respect to ongoing stimulus efforts from the Chinese government.
The ‘missing barrel’ phenomenon
One persistent challenge in oil market analysis is the so-called ‘missing barrel’ phenomenon, the discrepancy between reported supply figures and observable market conditions. Year to date, the inventory picture looks substantially tighter than official supply vs demand statistics and forecasts suggest.
This discrepancy complicates market outlooks, as some traders base decisions on official data while others rely on observed physical conditions. The timespread structure is the most reliable way to cut through this noise. A highly backwardated market reflects more genuine tightness in physical supply, regardless of what balance sheets suggest. With this in mind, any successful ratcheting up of efforts to cut down on oil exports from Venezuela and Iran as part of US foreign policy would be a bullish black swan scenario for the market this year.
Macroeconomic developments, particularly trade policies and potential tariff escalations, which could alter global end-user demand patterns, will eventually shape the market, but over the course of the next few quarters. While economic concerns continue to dominate sentiment, supply-side factors, especially refining capacity reductions, will likely support product prices in the near term.
In this environment, traders must go beyond traditional indicators and focus on real-time physical market conditions. With structural tightness persisting in multiple product markets, the broader narrative of weakening oil demand may not hold up for long under closer scrutiny.
By Neil Crosby for Oilprice.com – Jul 07, 2025,
