Oil Market Report May, 2017

Back in the early 1990’s, it would have been interesting to be a fly on the wall during a (hypothetical) conversation between the CEO of one of the big European Car Manufacturers and the CEO of an Oil Major. The head of the auto firm would be waxing lyrical about all their investment in diesel engine technology and telling the oil man how diesel engines would soon match their petrol counter-parts in terms of performance, speed and power.

The Oil Major CEO would by now be looking uncomfortable, having realised that this improvement in engine technology would result in a huge increase in diesel car sales and a massive rise in the amount of diesel required to power them. The oil man would then rather sheepishly describe how his company had just completed a massive refinery upgrade programme designed to meet the projected increases in petrol demand that the oil company had been working on. The car man would leave the room shaking his head in disbelief, whilst the oil man would frantically try to work out how a set of refineries configured to produce twice as much petrol as diesel, could actually make any money in this new diesel-centric world…

As things turned out, the concerns of the oil man were well founded. Diesel consumption did indeed rocket and refineries lost millions of $, as they desperately tried to increase diesel production, whilst off-loading boatloads of gasoline at bargain prices. By 2010, almost 60% of road fuel consumed in Europe was diesel. In China, thanks largely to the success of European car manufacturers – but also coupled with the explosion of commercial road freight – the figure was more like 70%. Global diesel consumption went up from 15m barrels per day (bpd) in 1990 to 25m bpd by 2010 and of course prices soared. For the first time in history, diesel prices leap-frogged petrol and by the mid 2000’s, diesel was regularly trading 5-6 pence per litre higher than petrol. In Europe, aged refineries were unable to cope and along with prices, imports of diesel also surged. Even today – after 25 years of refinery upgrades – a full 60% of diesel is still imported into Europe and of course, the extended supply-chain associated with these imports has kept both prices and volatility at high levels.

But then the tide against diesel started to turn. Firstly, VW Gate proved that at least one major car manufacturer had been lying on an industrial scale about the level of emissions given off by diesel engines. Then about the same time, long-published studies on the high incidences of respiratory illness associated with diesel clogged city environments, started to be picked up by the press. And now, everywhere you look, there is an avalanche of anti-diesel sentiment. Several cities across Europe – including Paris and Madrid – have vowed to ban diesel cars from city centres by 2025. In London, there are proposals for increased congestion charges on diesel vehicles, whilst even the British Prime Minister has made no secret of her disdain for the diesel car – much to the annoyance of the UK Car Industry. In China, the Beijing 6 air pollution rules are squarely aimed at the diesel engine and in particular light commercial goods vehicles, which in effect are going to be banned from city limits unless they are powered by Gasoline, Electric or Dual Fuel Hybrids.

Sceptics may pour scorn on these proposals and will bring up numerous examples of “nice to have” environmental policies that have never seen the light of day. They may also focus on the scientific facts behind modern diesel engines, pointing out that new Euro VI diesel engines (manufactured from 2015 onwards) produce 20 times less Nitrous Oxide (the main cause of the documented respiratory illnesses) than equivalent engines in the 1990’s and have a quarter of the CO2 emissions of equivalent engines in 2000. But such black and white analysis misses the point, as it is the surrounding “mood music” – not technical specifications – that drives markets forwards. Where are the entrepreneurs (and consumers) who will stake their hard-earned money on diesels when the public mood is so against them? Look at the car manufacturers themselves – diesel is no longer cool and all the investment money is now going on “hot” new products such as hybrids, dual fuels, LNG and electric.

Ironically, all of this suits the traditional oil companies rather well. If diesel demand starts tailing off, then this will remove a massive operational headache that has plagued them since the 1990’s. Try as they might, the likes of Exxon, BP and Shell were never able to meet diesel demand through their own refining facilities and this opened up market share to new, state supported “Super Refineries” in the Middle-East, India and China. The raison d’etre of these new market entrants was to produce enough diesel to meet exploding global demand and to do this, they literally spent billions of $ building diesel refineries on an unprecedented scale. But if the boom days are over, then the owners of these diesel producing leviathans will find themselves in exactly the same position as the European Refiners over the last 20 years. It’s just the product that no-one wants will be diesel rather than petrol…