By Ryan M. Couture and John Auers
While Jerry Reed certainly wasn’t thinking about diesel in this classic 1970’s trucker ballad about hauling beer across the U.S., the trucks he was singing about (big rigs hauling goods to market) are critical drivers of diesel demand across the globe. They’re certainly not the only consumers of diesel, as passenger vehicles (primarily in Europe), power generation, marine transport, agriculture, industrial use, oil field requirements and a variety of other markets are also important demand sources. Over the past year there have been many important developments in several of these markets, and we have written a number of blogs looking at what this might mean for diesel demand in the future. Given the importance of the fuel (second in volume only to gasoline among petroleum products) and continued developments impacting key markets, we felt it worth revisiting the issue. As the first part of a blog series addressing refined products, we will look at what has taken place in recent months, how this has impacted diesel demand so far, and what they portend for longer-term diesel demand dynamics both internationally and domestically.
It is important to note that diesel demand, because of the nature of many of the key markets noted above, is generally closely tied to general economic trends, which is not necessarily the case for gasoline. While gasoline demand, driven more directly by consumers, has responded strongly to lower pump prices resulting from the collapse in crude prices, diesel has not enjoyed the same boost in many of its key markets. Much of this is due to the economic woes in Latin America and China, as well as in oil producing regions throughout the world, all of which has negatively impacted commercial demand for diesel in those markets. However, low prices have helped to boost economic growth in other regions, and consumer demand in diesel-centric Europe has incentivized drivers of diesel vehicles to put more miles on their cars just as it has for gasoline car owners. Overall, low prices have been good for refined products as a whole, with total product demand in 2015 increasing by 2% year-on-year, the highest level since the post-recession recovery in 2010. The IEA has recently revised the global demand growth number up to a 1.6 MMBPD rise in the 1st quarter of 2016 versus the same period in 2015, and forecast a rise of 1.2 MMBPD for the year. For the reasons noted above, these increases in demand have not been distributed equally though, either geographically or by fuel type. As it has over the last couple of decades, demand certainly was “East Bound” with Asia continuing to be the growth engine for the world in 2015 (see Figure 1 below). The “big dogs” were China, which despite slowing growth, still saw the largest demand increase of any single country at 765 MBPD, and India, where growth is accelerating and increased by about 300 MBPD. Another boost to global demand was the positive performance from the U.S. and Europe, where low prices caused a reversal from previous years which saw slumping demand.
Since the focus of this week’s blog is diesel, let’s take a look at what has taken place in the key markets. BP recently released their 2016 Statistical Review of World Energy, which gives us a view on global and regional diesel demand for 2015. Globally, the world saw a modest 1.2% demand increase in diesel from 2014 to 2015. With 2015 the first year of “low” prices (Brent averaged $52.39 in 2015, a sharp drop from $98.95 the year before), it is expected there would be a rise in overall demand. But diesel demand growth fell short, below that of gasoline (which grew by 3.3%) and of petroleum as a whole (2.0% growth).
As was for total demand growth, diesel growth was far from uniform globally. North America saw diesel demand decline in 2015 by 1.8%, while Latin America, hit hard economically in the last year, shrank by 1.6%. For the first quarter of 2016, initial indicators do not look promising, either. Latin America is still grappling with recession, with 2015 the worst year since 2009. The U.S., the largest component of North American distillate demand, is down by a whopping 8.6% versus the first quarter of 2015 (in large part due to the mild winter), while Canadian demand, hit by low prices and the same mild weather, has slowed as well.
The EU was the shining star of diesel growth in 2015. The region was edged out only by Africa in diesel demand growth at 4.1% to Africa’s 4.4%, although African absolute consumption is less than a third of the EU’s. EU growth in 2015 was driven in large part by consumer demand. Unlike the U.S., nearly 50% of EU passenger cars run on diesel, and demand is impacted by low prices much like gasoline in the U.S. as consumers take to the road. The IEA predicts that this trend will not continue, though, with demand in early 2016 holding flat from 2015.
Asia is a mixed story. As a whole, the region saw a 2.0% rise in diesel demand in 2015, in line with total global petroleum demand growth. Chinese demand saw only a 1.1% gain, lower than in many previous years which saw mid-to-high single-digit growth. Given that Chinese demand comprises 40% of total Asian diesel demand, this has a significant impact. Japanese demand fell 2.0%, despite the low prices. This marks a long trend in declining demand that has continued since the mid-1990s and is expected to continue. Of the remaining countries in Asia/Pacific, India is the next major center for growth. According to Indian government data, total absolute diesel demand grew an impressive 5.3%, or 75 MBPD in 2015. The figure below shows a map of percent and absolute diesel demand growth for various regions in 2015.
Headwinds – “We’ve got a long way to go and a short time to get there”
In September of last year, the infamous Volkswagen scandal broke. While in some ways it was the straw that broke the camel’s back, it gave credence to the arguments that experts had made for years about the impacts diesel exhaust has on air quality.
Internationally, diesel cars make up a large part of the passenger vehicles, with nearly 50% market penetration in Europe and growing numbers in India and elsewhere. The level of particulates and NOx emissions in diesel exhaust are much higher than with gasoline vehicles. While there are emissions requirements for diesel vehicles, the scandal unearthed the truth about diesel emissions under real-world driving conditions. A recent study done by Emissions Analytics in Europe showed that 97% of diesel passenger vehicles tested emitted more than the legal limits, with a quarter producing more than six times the legal emissions limit. The study found that just one of 201 Euro 5 diesels, the EU emissions standard from 2009, did not exceed the limits, while only seven of 62 Euro 6 diesels, the stricter standard since 2014, did so.
Increasing pressure from both the public and legislators has prompted a wave of new legislation that promises to reverse the dieselization trend that passenger vehicles were taking. The UK is considering reversing diesel tax cuts at the pump, while in France they have already begun to do so. Germany is evaluating scrapping diesel vehicle tax breaks. In Paris, legislation was recently passed which outlawed any vehicles registered prior to 1997, and any motorcycles prior to 1999. By 2020, the cutoff will shift to vehicles registered prior to 2010. This is in response to poor air quality, and is said to impact about 10% of vehicles there. The hope is it will help remove the worst polluters from the road, in a desperate bid to combat smog.
The trends in legislation are not restricted to just Europe. India, which suffers from traffic congestion and heavy pollution in its major cities, has begun to take steps to limit diesel vehicle adoption. In order to combat the pollution, taxes have been imposed on passenger vehicles, with diesel vehicles seeing the highest taxes at 2.5%-4.0%, versus as little as 1% for gasoline vehicles. In Dehli, where some of the worst pollution exists, a ban on diesel vehicles over 10 years old has been implemented. This has prompted vehicle buyers to move away from diesel and toward gasoline vehicles not only in Dehli, but nationwide, fearing the legislation may spread. Vehicle manufacturers have responded, shifting production to increasing gasoline vehicles to meet demand.
Tailwinds – “Keep your foot hard on the pedal, son never mind them brakes”
Despite the headwinds, diesel demand long term has some steady tailwinds. As mentioned before, diesel growth in both India and Africa were much higher than in developed regions. While their absolute demand now is low, the growth potential is very large. The IEA has forecast that demand growth will be dominant in the non-OECD regions.
As the economies of these developing countries grow, the demand for diesel fuel is almost guaranteed. While diesel and gasoline can be exchanged in light duty trucks and passenger vehicles, in heavy duty equipment, diesel will remain the fuel of choice. Given the level of development yet to take place in these places, there remains growth potential despite efficiencies in modern engines that have countered some of this growth.
The other major contributor to demand will be from the upcoming bunker fuel regulations. As we discussed in a previous blog series (found here and here), the International Maritime Organization (IMO), who is in charge of regulating marine fuels in international waters, plans to reduce allowable sulfur levels in the coming years. While certain Emission Control Areas (ECAs) had been implemented in previous years (primarily around heavily trafficked coastal regions in Europe and North America, which reduced sulfur to 0.1% in bunker fuel) the pending regulations in January 2020 will be global. Current regulations restrict fuel sulfur to 3.5% in areas not covered as part of an ECA. In 2020, that level will be reduced to 0.5%. A majority of today’s fuel oils are well above this 0.5% sulfur limit. The dominant method by which low sulfur bunker fuels will be produced is by blending very low sulfur distillates with the heavy oils to produce a 0.5% sulfur material. This will require increasing volumes of diesel, and give a significant boost to demand after this legislation takes effect.
Conclusion – “We gonna do what they say can’t be done”
Diesel has recently relinquished its leadership role in global refined products demand growth. Much of this is due the dynamics of a low price market environment, which has favored consumer products such as gasoline. Diesel, which is tied much more closely to industrial and commercial uses and therefore the overall performance of the economy, has not fared as well, particularly in regions where low oil prices actually have negative impacts. Other factors have also provided “headwinds” for diesel demand. However all is not doom and gloom; as the global economy recovers and developing countries grow, diesel demand should get a boost and certainly the potential of a vast new market for demand in the bunker market could be a real “game changer.” As the ole “Guitar Man” put it in the title tune of this blog – “You gotta keep that diesel truckin.”
We will be releasing the Mid-Year update to our 2016 Crude and Refined Products Outlook in mid-July. The Outlook will provide a detailed look on future supply, demand and prices for refined products, and distillate markets will be an important part of this analysis. Please feel free to contact us with questions about this study, as well as any of the other work we do in assessing petroleum markets.