By: Ryan M. Couture
As oil prices fell from what seems like stratospheric levels to below $30 over the past 18 months, the implications for the industry have been many-fold. Producers have felt shockwaves as crude prices have touched 2003-era levels. Prices at the pump have returned to similar levels, spurring demand for gasoline as more drivers hit the road, a boon for refiners. Yet despite the low prices, diesel has not seen the same surge in demand. This is in large part due to diesel’s place as a fuel for industry, with demand driven by the economy. Diesel is less “discretionary” than gasoline, and slowdowns in demand do generally correlate with economic slowdowns. In addition to the economy, there are other factors that are impacting diesel demand today. Industry buildout in response to high diesel margins over the past several years is beginning to take hold, with significant impacts on supply. At the same time, demographic shifts threaten to undermine future demand that was presumed to be there. Read today’s blog to find out what is bringing diesel down, and what might be able to turn it around.
Global diesel demand surpassed motor gasoline in the early/mid 1990s. Driven by surging demand in emerging markets, primarily in Asia, the global price of diesel fuel rose, surpassing that of gasoline. Refiners increasingly shifted to maximize diesel production as the spread widened. This demand spurred investment to maximize the production of clean diesel fuel over the past several years. A short list of these projects can be seen here:
As shown in Table 1, the buildout of the diesel infrastructure is global, and includes over 1100 MBPD of diesel capacity since 2013. With the list of upcoming projects in the coming years, an additional 1200 MBPD of incremental distillate capacity could come online. These future projects are in varying degrees of planning/construction, and it is possible some may see changes, especially in the lower price environment. A complete list of construction projects is discussed in the Refinery Construction Outlook section of our Crude and Refined Products Outlook.
This industry buildout has helped to increasingly tip the tables towards increasing diesel production. With surging demand, it seemed like the obvious choice. Shifts in several areas bring the future of demand into question. With the most recent rumblings from emerging markets in Asia and South America signaling a decline, the demand for diesel as a fuel for the engine of economic growth is faltering. Additionally, the trend of dieselization of passenger vehicles is showing chinks, as demand increases for inexpensive gasoline vehicles in emerging markets, and the fallout of the Volkswagen scandal expedites the trend away from diesel vehicles in Europe. Globally, a drive toward increased efficiency is beginning to focus on diesel vehicles as well, after years of focus on gasoline-powered ones. Finally, the impact of increased biofuels usage has helped to pare demand for the petroleum portion of the fuel.
The most recent indications are of an economic slowdown in what were the fastest growing economies. Brazil is forecast to have its second year of negative GDP growth in 2016, as the burdens of high inflation and cost of borrowing, coupled with lower real wages and the corruption scandal at Petrobras, Brazil’s biggest investor, has crippled investment. Russia, owing to sanctions and the fall in global oil prices, has seen a drop in GDP, and the IMF forecasts that 2016 will see a further contraction of 1%. Demand for petroleum-based diesel and gasoline have both slumped.
While Brazil is an important story, China is even more so. Chinese petroleum demand has been rising faster than any other country. As the Chinese economy grew, fueled by strong infrastructure buildout, commodity prices surged. Now that the investment is moderating, and an oversupply situation exists, markets are reacting. The latest numbers show that Chinese manufacturing may be on the cusp of contraction, with the latest Caixin/Markit Purchasing Managers’ Indices (PMI) and official government manufacturing PMI showing declines. Numbers below 50 indicate contraction of the sector, and has shown contractions since March. While China’s non-manufacturing PMI, which tracks the services sector, is showing growth, this will continue to impact diesel demand which drives industry. Despite overall oil demand growth in China of 7.9% in October 2015, versus the prior year, demand of diesel fell 3.4% and is only up 2% from January-October 2015 versus 2014. Comparing this to gasoline demand, which is up 14.6% year-on-year in October and up 11.2% January-October, the contrast is significant. Diesel stocks in China and exports of diesel have been rising as refiners process additional crude to supply gasoline demand, while diesel piles up.
The reverse dieselization of the consumer market, primarily in Europe, is another factor threatening to tip the balance. For decades, many EU countries have implemented tax regimes to promote diesel car adoption as a way to curb CO2 emissions. Over the past several years, EU countries, struggling with poor air quality have pushed to move away from diesel vehicles, which produce higher amounts of NOx and particulates than their gasoline counterparts. The Volkswagen scandal that came to light in late 2015 prompted EU lawmakers to expedite this transition. In addition to Volkswagen (as well as Audi and Porsche, under the same umbrella), Renault, Nissan, Hyundai, Citroen, Fiat, Volvo, Mercedes-Benz, Honda, Mazda and Mitsubishi have all shown to emit more NOx than permitted under realistic driving conditions. The problem, which now appears to be systemic to many diesel vehicles, turns the focus away from diesel and toward alternative methods to reduce CO2 emissions while keeping other emissions down. The industry, which had been working to implement the Real Driving Emissions (RDE) testing as part of the Euro 6 standards, and which would effectively allow higher NOx emissions through exemptions and loopholes, is now getting strong pushback by the EU parliament.
While European fuel demand has been slowly falling over the past several years, a majority of new passenger vehicles sold in Western Europe remain diesel-powered. As the number of passenger vehicles move from diesel to gasoline powered in the future, a shift away from diesel will occur. The average age of vehicles in the EU was 9.65 years in 2014. Looking at historic registration data, 42% of passenger cars (over the past 20 years) were diesel. Given current rates of diesel and gasoline consumption, that represents 1- 2 MMBPD of diesel demand which could be shifted to gasoline should the demographics of the passenger car market shift away from diesel. While such a shift would still keep diesel as the dominant transportation fuel overall, it would help bring a balance between gasoline and diesel.
It is worth mentioning, not all news is bad for diesel demand. As regulations around low sulfur bunker fuels take effect, the demand for diesel will increase. Historically, bunker fuel needed to be 4.5%, unless burned in an Emission Control Area (ECA) where the regulations were 1.5%. The levels were ratcheted down slowly over the past several years. On January 1, 2015, the sulfur specification was 0.1% for fuel burned while in an ECA. This primarily affects ships near coasts around the U.S. and parts of Western Europe. The 0.1% sulfur fuel cannot be made from conventional crudes in a cracking refinery, and is comprised in large part from distillate-range material toady. While this is a relatively small amount of total fuel burned today, the regulations are slated to shift all bunker fuel not consumed in an ECA from 3.5% today to 0.5% by January 1, 2025 (it may be as soon as January 1, 2020, depending on a review to be conducted by 2018 on fuel availability). Ultimately there are few types of crude that can meet the 0.5% bunker fuel specification without additional treatment, meaning a majority of that fuel will be comprised at least in part of lower sulfur distillate-range material. This is a silver lining for refiners who have built out additional capacity, and see global demand growth for diesel less robust than they thought.
Turner, Mason and Company analyzes this and more as part of our Crude and Refined Products Outlook which we will be releasing next month. The Outlook contains our regional outlooks for petroleum demand globally, coupled with in-depth analyses on regulatory developments and various breakout topics, including a more detailed evaluation on global dieselization. For more information on The Outlook or any of our other publications or TM&C services, please visit our website, send us an email or give us a call.