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(John Kemp is a Reuters market analyst. The views expressed are his own)
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By John Kemp
LONDON, Dec 16 (Reuters) - U.S. refiners are likely to see stronger demand for middle distillates such as heating oil and diesel in 2017 after two years of declining domestic consumption.
Distillate consumption is forecast to increase by 60,000 barrels per day in 2017, after falling by 120,000 bpd in 2016 and 40,000 bpd in 2015, according to the U.S. Energy Information Administration.
Hedge funds have taken notice and bet on higher prices by building a net long position of 24 million barrels in heating oil futures and options on the New York Mercantile Exchange.
Hedge fund managers have accumulated the largest net long position for almost 30 months, according to an analysis of data published by the U.S. Commodity Futures Trading Commission (tmsnrt.rs/2h85LZL).
Distillate consumption is driven by a combination of heating demand (the smaller but more variable share) and freight demand (far larger and more steady) and both look positive, or at least not negative, in 2017.
Heating demand has been unusually low during 2016 because of the exceptionally warm winter of 2015/16 and the warm start to the heating season of 2016/17.
The first three months of 2016 were the second-warmest since 1973. Only the start of 2012 was warmer, according to data from the U.S. Energy Information Administration.
The outlook for the first three months of 2017 remains subject to considerable uncertainty but it is unlikely to be warmer than 2016 which should put a floor below heating oil consumption.
On the freight side, the outlook is more clearly positive as the sector emerges from a two-year long downturn linked to the decline in oil and gas drilling, high coal stocks, and the build up of business inventories.
Freight movements have steadied this year after declining during 2015, according to the U.S. Bureau of Transportation Statistics (tmsnrt.rs/2h82B8s).
There are reasons to expect freight movements will start to grow again during 2017. Oil and gas drilling and related freight movements have started to increase in response to rising oil and gas prices.
Drilling will itself provide an increase in demand since diesel-electric generators are used to provide power for rigs as well as the pressure pumping equipment used for fracking and all the auxiliary onsite power.
Coal shipments are also expected to rise next year as higher natural gas prices cause power producers to run coal-fired power plants for more hours.
More generally U.S. manufacturers, distributors and retailers are finally getting to grips with the problem of excess inventories at all stages along the supply chain.
The ratio of business inventories to monthly sales has declined steadily since March 2016, after rising since March 2011 and strongly since August 2014 (tmsnrt.rs/2h7XYv8).
Inventory levels remain elevated which will ensure that businesses remain cautious about placing new orders in the near term.
But if firms continue their recent progress on inventory control there is the potential for stronger ordering in the second half of 2017.
U.S. refiners strained to maximise output of gasoline during 2015 and 2016 to meet rapidly-growing demand from private motorists.
But domestic gasoline demand growth is likely to moderate next year ("U.S. gasoline consumption may slow in 2017", Reuters, Dec. 7).
Refining margins for distillate have been gradually rising since the second quarter of 2016, starting to reverse the previous downtrend since 2013 (tmsnrt.rs/2hF3xBR).
Refiners are getting a signal to shift the balance slightly towards distillates in 2017. (Editing by Susan Thomas)