China (Platts) -- May 26-30, 2008

By reporters at Platts, the energy information division of the McGraw-Hill Companies. For more information about Platts' information products in China, contact Platts at china@platts.com, or call its representative office in Guangzhou at (+86) 20 2881 6588.

Oil futures ended May with a bump, dropping in general between 2% and 7% in value last week as this year's unstoppable rally in middle distillates finally started to unwind - just in time for gasoline futures to start moving into the spotlight.

Most losses in the energy complex were focused on gasoil and heating oil, classically "winter fuels" that have so far seen powerful demand coursing through the world throughout the spring and the earliest part of this summer of 2008.

Heating oil futures on the New York Mercantile Exchange dropped by more than 5% over the week to end last week at $3.6598 per gallon, while gasoil on London's ICE Futures swooned by almost 7.5% to close Friday at $1,187.75 per tonne.

In Asia, the premium for gasoil against Dubai crude oil fell by a massive $4.36 per barrel in the over-the-counter derivatives markets on Friday, the single largest one-day fall in value ever seen for the crack spread in Asia.

"With the seasonal shift to driving season in the US and several refiners like Valero radically changing their slates to maximize middle at the expense of light distillates, I think we are finally seeing an overdue flattening," one industry source said.

US refining giant Valero said last week that it planned to shift gasoline output to produce more higher-margin distillates like diesel, hiking its overall yield of middle distillates to over 40% in the long run. Plans call for an increase in distillate yield to 36% by 2012 from the 32% distillate yield Valero had in 2006.

The apparent end of the winter season's extended bull run for diesel and gasoil was punctuated by a weekly stock report from the US' Energy Information Agency that showed a larger than expected 1.6 million barrel distillate stock build for the week ending May 23, doubling analyst expectations for a 800,000 barrel build.

Farewell gasoil rally...hello gasoline?

But consumers around the world might be concerned to see that the momentum behind gasoline demand seems to be stirring and gathering pace, just as relief comes in the middle distillates markets.

"Even as refinery activity has improved amidst growing evidence of gasoline demand deterioration, the sizable gasoline supply surplus that has existed throughout this year is slowly being shaved to around 3-4 mb," said energy analyst Jim Ritterbusch in a report. "This reduction is supply cover has sensitized the gasoline market to any refinery problems and some recent downtime as a couple of east coast facilities appear to have tightened the gasoline market sufficiently to spark some independent price support into the RBOB futures."

In fact, gasoline futures rose quietly last week, adding half a percent in value to close Friday at $3.4089 per gallon on NYMEX. That strength was one reason why crude futures fell by a relatively modest 3.6% over the week as a whole, despite huge volatility from day to day.

Since the week ending March 7, reported US gasoline stocks have fallen by 29.845 million barrels. Over that same period, the surplus to the five-year average has fallen from 23.7 million barrels to a slight deficit.

The jury is out on whether this year's "Driving Season" in the US will be a strong one for gasoline demand. Meanwhile, most analysts seem to be looking for a test of support as the market looks likely to drift, for a short while at least.

"(P)rice volatility remains unusually high," independent energy consultant Ritterbusch said in a report on Friday. "Often, the type of wide swinging, two sided price volatility as seen during the past week in the energy complex will provide a strong indication of a potential market top," he added.

"Caught between tight credit and sky-high prices and concerned about consumer demand, refiners and others are in belt-tightening mode, trimming inventories of both crude and products," Antoine Halff, energy analyst at NewEdge, said in a report.

"Furthermore, a rebound in the dollar, speculation about US interest rate hikes and the announcement by the CFTC of measures to enhance the oversight of energy futures markets may be seen as potentially stemming future investment flows into energy and other commodities, and thus may heighten the market's sensitivity to fundamentally bearish news," he added.

Another analyst also pointed out the possibility of renewed move to the upside. "[It] is possible that the market will do what it has done after most of the big moves up over the past ten years," Barclays Capital analyst Paul Horsnell said in a report.

"That is to retrench a little, and to mark a bit of time to see how the global supply and demand data, as well as government policy, responds to the latest leg up. In other words, the case for a sustained move to $150 can not be made quite yet, as the waters have not up to now really been properly tested at $120."

Updated: June 2, 2008