Authors: John Auers, Elizabeth Hilbourn and Ryan Couture
What do diesel fuel and the “Fast and Furious” movie franchise have in common? The easy answer is Vin Diesel, but there are other similarities as well. The fact is both are high energy, have had ups and downs over the past several years and like the F and F series (despite the impressive box office receipts of Furious 7), diesel may have seen its peak. For the past several years, diesel has commanded a large premium to gasoline, as demand growth has been strong during a long period of economic recovery and refiners have hit production limits; however, a variety of recent developments, on both the supply and demand side, provide indications that the party might be over (or at least quieting down). Sluggish global economic growth, a slowdown in oil drilling (which has been an important source of demand in the U.S.), and some headwinds for the future of diesel passenger cars are negatively impacting demand; while at the same time, significant new refinery production capacity is coming on line and increasing supply. What will this mean for the diesel markets? Will we be in for an action-packed next several years, or will diesel producers just have to take it a “quarter mile at a time”? Read further to find out, as in this first of a two-part series we will address the supply side of the equation and cover demand issues next week.
“Life’s Simple, You Make Choices and You Don’t Look Back.” – “The Fast and the Furious”
Life used to be simple for refiners, you did all you could to make as much gasoline as you could and diesel was generally an afterthought. That all changed over the last several years as strong demand growth for diesel has made it truly the premium product for refiners around the world. Where in the past diesel sold for a discount versus gasoline, a large premium has developed and incentivized refiners to find ways to maximize production. Their first efforts were to make modifications to existing equipment, operations and catalyst loadings to shift yields toward diesel and away from gasoline. As demand has continued to grow, refiners began investing in hydrocrackers, and new refineries and expansions have and are being built with a bias toward diesel, in many cases targeting diesel production levels as high as 50%. Table 1 and Table 2 below show some of the major world-wide refinery startups and upcoming projects to increase diesel production.
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As refiners have adapted and many new projects have come online, diesel supply has steadily increased. Since 2013, over 800 MBPD of incremental distillate capacity has been added. Refiners globally are planning to add an additional 1.5 MMBPD of production capacity through 2021, with 460 MBPD of that slated for 2015 alone. As fears of a slowdown in major growth markets such as China and Brazil solidify, worries are starting to develop that this furious surge of diesel will have nowhere to go. Keep in mind also that total world consumption of diesel is less than 30% of total petroleum demand, compared to the 40 to 50% being churned out by the new projects, and these fears of oversupply become particularly worrisome.
“I live my life a quarter mile at a time. Nothing else matters.” – “The Fast and the Furious”
There are indications that the world is already awash in diesel. Distillate inventories have continuously risen since the beginning of 2014 and are at the highest level since 2011. The chart below shows distillate inventories in Singapore, the U.S. and Europe as posted by Bloomberg. The shape of the chart below matches the U.S. East Coast distillate fuel inventory chart, but with an upper scale of 70 million barrels (versus 200 million barrels). Inventories of distillate fuel oil in the U.S. East Coast are higher now than they have been in the previous three years, reaching 59 million barrels on September 18, 2015. Heating oil, a type of distillate fuel oil, is used as a space-heating or water-heating fuel in about eight million U.S. households, almost all of which are in the Northeast. In the Northeast, 27% of households use heating oil for space-heating, while nationwide only 6% of households use heating oil, based on data from EIA’s latest Residential Energy Consumption Survey. The East Coast Region generally holds about 30% to 50% of the U.S.’s distillate fuel inventory. The distillate inventory typically draws down in winter months and builds up in summer months.
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Will inventories continue to build and are diesel markets headed for a serious fall? What happens to demand will certainly be the most important determinant of that answer. In the second part of this series, we will explore some of the major demand drivers, the main causes of the recent demand slowdown and what can be expected to happen in the future. This will include a look at how the supply situation has impacted diesel prices relative to gasoline. We will also look at the export markets, who are the major exporters of diesel, how much they are exporting and where those exports are going. Europe has been an important part of the picture and we will explore how diesel became the transportation fuel of choice in Europe and the outlook for its future, particularly in light of the Volkswagen scandal and other developments. Putting all this together might allow us to determine whether the world-wide expansion of diesel production has been “2 Fast and 2 Furious”?
Diesel is but one part of the overall energy picture, and as we enter into what could be an important “transition period,” Turner, Mason & Company continues to stay abreast of the overall market landscape. We are in the business of analyzing downstream markets and assisting all segments of the oil industry in responding to changing market dynamics. Turner, Mason & Company views the last several years as a transition period for the entire global market, one seeking a new equilibrium with regard to supply, demand and commodity prices. We have analyzed this developing equilibrium and the factors which will determine the outcome in a new study, The Evolving New World Order: Rebalancing Global Oil Supply in the Next Decade. In collaboration with Schlumberger Business Consulting (SBC), Turner, Mason & Company seeks to provide in this study an integrated perspective on petroleum markets, from upstream production to downstream demand with the aim to inform all players in the energy arena as they attempt to make important investment and operating decisions. The prospectus and a subscription form can be found by clicking here, and we are happy to answer any questions by phone or email.