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India is set to experience a significant drop in diesel exports to Europe in January, reaching a two-year low due to elevated security risks in the Red Sea. The ongoing threat of hijacking incidents in the region has led to a drastic decline in export volumes, down by approximately 80% month-on-month to a range of 33,400-58,000 barrels per day. The heightened freight costs, triggered by the Red Sea security concerns, are likely to prompt Indian sellers to shift their focus to Asian markets, further tightening diesel supplies to Europe.

Freight costs impacting supply chain

Persistently high freight costs, which surged more than 30% on the Asia-Europe route in the past week, have added a war risk premium. This situation is expected to compel sellers to explore Asian markets, contributing to a supply shortage in Europe, especially ahead of the refinery maintenance season. Major refineries, including Shell's Pernis plant in the Netherlands and ExxonMobil's Rotterdam refinery, are undergoing maintenance, impacting overall diesel production.

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The arbitrage from the U.S. Gulf Coast to Europe has been hindered by the high freight rates, impacting the opening of this crucial supply route. The spread between European low-sulphur gasoil futures contracts has surged, indicating market expectations of supply tightness. The increase in the east-west arbitrage differential aligns closely with the rise in freight costs, rendering the arbitrage effectively closed since early January.

Jet fuel exports remain steady

Despite challenges in diesel exports, India-origin exports of aviation fuel to Europe have remained steady. The arbitrage window for jet fuel remains open, with stable demand and prompt jet fuel swap prices trading at least $3 a barrel above diesel. Approximately 88,000 barrels per day of jet fuel for January are expected to be bound for Europe.

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In summary, India's diesel exports to Europe are at a historic low in January, influenced by security risks in the Red Sea, leading to increased freight costs and impacting the overall supply chain dynamics.