LONDON, June 7 (Reuters) - U.S. manufacturers are

gradually emerging from a prolonged but shallow slowdown over

the last two years, but progress has been fitful, and their

consumption of diesel remains tepid, which is weighing on oil

prices.

The Institute for Supply Management's manufacturing index

slipped to 48.7 (22nd percentile for all months since 1980) in

May from 49.2 (26th percentile) in April and a recent high of

50.3 (34th percentile) in March.

The March reading was the first time the index had climbed

above the 50-point threshold, signalling expansion, since

October 2022, but it has since slipped back into contraction

territory for the last two months.

The survey's production sub-index fell to 50.2 (21st

percentile) in May from a recent high of 54.6 (45th percentile)

in March, as activity rates faltered.

Indicating the expansion could remain desultory for a few

more months, the new orders component slumped to 45.4 (9th

percentile) in May from 51.4 (27th percentile) in March.

Chartbook: U.S. manufacturing and diesel use

Manufacturers reported weaker conditions than their

counterparts in services, real estate, construction, mining and

farming.

The ISM non-manufacturing index actually rose to 53.8 (33rd

percentile for all months since 1997) in May from 51.4 (14th

percentile) in March.

Manufacturing provides fewer jobs and accounts for a smaller

share of overall economic output but is much more

energy-intensive.

By contrast, services account for a far larger share of

value-added, employ more people but use relatively less fuel and

electricity.

The manufacturing sector's sluggish performance has

therefore dampened overall energy consumption - even as the

faster growth in services has boosted the overall economy and

employment.

Expectations at the beginning of the year that an

acceleration in manufacturing in the United States and the other

major economies would lift diesel consumption and prices have

not been realised.

DISTILLATE FUEL SLUMP

More than three-quarters of all diesel and other distillate

fuel oils are used in freight transport, manufacturing and

construction, so distillate consumption is normally correlated

closely with the manufacturing cycle.

But consumption of distillates has been even more lacklustre

than the slow and halting recovery in manufacturing activity

over the last six months.

The volume of distillate fuel oil supplied to the domestic

market, a proxy for consumption, was under 3.7 million barrels

per day (b/d) in March 2024.

Volumes supplied were the lowest for the time of year since

1998, according to estimates prepared by the U.S. Energy

Information Administration.

Volumes were down by 10% compared with the same month last

year and by the same percentage compared with the prior 10-year

seasonal average.

Supply can be volatile from one month to the next. March may

have been an outlier. But distillate consumption has been

lagging the upturn in manufacturing for several months.

Some petroleum-derived distillate fuel oils are being

replaced by biodiesel and renewable fuel oils, especially in

California.

Even if biodiesel and renewable fuel oils are included,

however, the volume of distillate supplied was down by 4-8% in

March compared with last year and the 10-year average.

Total petroleum and non-petroleum distillates supplied were

the lowest since the first wave of the pandemic in March 2020

and before that the mid-cycle slowdown in March 2016.

Total distillates supplied have been broadly flat over the

past 12 months despite the reported improvement in manufacturing

and freight activity.

DISTILLATE INVENTORIES

Reflecting tepid consumption and strong refinery crude

processing to make gasoline, distillate stocks have been

trending higher for the last three months.

Inventories were still 10 million barrels (-8% or -0.52

standard deviations) below the prior 10-year seasonal average on

May 31, according to data from the EIA.

But the seasonal deficit had narrowed from 18 million

barrels (-13% or -1.09 standard deviations) at the start of

March.

Stocks have been flat or increasing at a time of year when

they would normally be depleting and have climbed to a four-year

seasonal high.

In response, prices for diesel other distillates have been

falling faster than for crude, narrowing the gross refinery

margin or crack spread.

The crack spread for making diesel from Brent crude has

narrowed to an average of just $19 per barrel so far in June

2024.

The inflation-adjusted spread has narrowed from $46 per

barrel as recently as August 2023 and a record $63 in June 2022

after Russia's invasion of Ukraine.

In real terms, the spread has fallen back in line with the

average for the five years between 2015 and 2019 before the

pandemic and invasion.

Traders expect diesel supplies to remain plentiful for the

next few months, which should help contain inflationary

pressures within the supply chain and give the major central

banks more scope to trim interest rates.

Related columns:

- Renewable fuels take bite out of US diesel consumption

(May 10, 2024)

- U.S. manufacturers emerge from slump, set to boost fuel

use (April 4, 2024)

- Global freight acceleration will lift fuel prices (March

27, 2024)

- Diesel prices primed to rise sharply in 2024 (February 6,

2024)

John Kemp is a Reuters market analyst. The views expressed

are his own. Follow his commentary on X https://twitter.com/JKempEnergy

(Editing by David Evans)