“Roll with the Changes” – Europe’s changing views on Diesel

By Robert Auers

Europe originally began promoting diesel over gasoline in the 1990s primarily as a way of decreasing carbon dioxide emissions.  This is a result of the higher efficiency achieved in diesel engines due to their lack of spark plugs, higher compression ratios and leaner air/fuel ratios; however, as discussed in the August 22 Blog, this relationship may no longer exist (or exist to a lesser extent) in a few years as the traditional gasoline-fueled internal combustion engine continues to improve.  Still, today’s diesel engines emit approximately 15% less carbon than today’s gasoline engines per mile traveled.  Furthermore, diesels emit less carbon monoxide and unburned hydrocarbons; however, diesel engines emit more NOx and significantly more PM 2.5 (particulate matter less than 2.5 microns in diameter), which are especially harmful to human health and the environment.  Now, as sung by REO Speedwagon, we’ll have to “Roll with the changes” as Europe begins to turn its back on diesel in its search to improve air quality in its cities.

“So, If You’re Tired of the Same Old Story” – The rise of diesel’s popularity in Europe

Western European countries have a long history of taxing fuels at a higher rate than the U.S. and most other countries, leading fuel efficiency to be a higher priority for European consumers.  Furthermore, diesel taxes in Europe have historically been about $0.25/liter (~$1.00/gallon) lower than taxes on gasoline.  This, combined with the fact that diesel engines are inherently about 20%-30% more fuel efficient (on a distance per volume of fuel basis) and continued improvements to diesel engines over the years, has led to a tremendous growth in diesel cars on the road in Europe since the early 1990s.   The graph below shows diesel’s share of new car registrations in Western Europe, defined as the EU 15 plus Iceland, Norway and Switzerland.

This trend toward “dieselization” in Europe has led to a 10% increase in diesel demand in Europe since 1990; while gasoline demand has fallen by 34% during the same time period.  Furthermore, this demand shift has contributed to diesel margins widening significantly compared to gasoline margins from 2010 to 2015 across the globe.  As a result, we’ve seen a wave of diesel focused refinery projects that have increased diesel supply.  The table below highlights some of the recently completed refinery projects with an emphasis on increasing diesel production.

As Europe begins to rethink its reliance on diesel, this trend toward “dieselization” is likely to at least partially reverse over the next 25 years as the decline in European diesel demand will likely outpace the declines gasoline demand over this same period.  We’ll take a look at what Europe is currently doing to curb diesel demand and some catalysts for future diesel demand that may have the potential to prevent demand from falling too far.

“I … Felt the Tables Turnin’” – Europe’s views begin to shift

While European views on diesel were already beginning to shift before the VW “Dieselgate” scandal, which became public on September 19, 2015, this event brought the issue of diesel emissions to the forefront and likely significantly sped up Europe’s trend toward “de-dieselization.”  As a direct result of this scandal, the EU has agreed to fine any car manufacturer caught cheating on future emissions scandals up to 30,000 euros per noncompliant vehicle.  Still, major federal governments across Europe have thus far been somewhat slow to react.  As a result, many local governments have decided to take matters into their own hands.  Athens, Madrid, and Paris have committed to banning diesels from their cities by 2025, while Munich is considering a similar proposal.  Meanwhile, in response to a lawsuit by environmental group DUH, a lower court judge in Stuttgart (the home of VW) ruled that banning diesels from the city would be the only way to sufficiently improve the city’s air quality.  The state government of Baden-Württemberg (where Stuttgart is located) had previously endorsed more conservative measures for improving air quality, such as bringing older diesels into compliance with current Euro VI standards and improving public transit.  The state has the ability to appeal the decision to a higher court, but if the ruling holds up, it could force Baden-Württemberg to ban diesel completely from Stuttgart and may ultimately require other German cities to follow suit.

Some in Germany have begun to interpret these increasingly negative views toward diesel as a sort of national crisis, given that Automobiles are Germany’s leading export and the most recognizable symbol of German engineering throughout the world.  Furthermore, the country is home to Volkswagen, BMW, Audi, Daimler and Opel, many of which have spent a great deal of money investing in and developing high-quality diesel engines.  Lastly, many fear that a shift towards gasoline could make it more difficult for Germany to reach its ambitious targets for CO2 reduction.  As a result, major German automakers met with top politicians on August 2 at a major “diesel summit.”   At the summit, German automakers committed to spend more than $500 million to provide free software upgrades in more than 5 million vehicles that they believe will decrease NOx emissions by as much as 30%; however, many opponents feel this deal is insufficient and wish to see more radical changes in the industry, such as a complete ban of diesel vehicles.

Finally, this negative sentiment toward diesel has caused a continued shift away from diesel in new cars across Western Europe.  The figure near the beginning of the blog shows diesels decreasing from a peak of over 55% of new car sales in 2011 to just under 50% of new car sales in 2016.  These trends appear to be continuing in 2017, as the UK saw 2Q sales on new diesels fall by 14.7% YoY, while those for gasoline-powered vehicles grew by 2.5% over the same period.  European consumers in many places seem to fear that if they buy a diesel-powered vehicle, they may eventually no longer be able to drive to the places that they need to get to and that, at that point, resale value of their car will be significantly impacted for those same reasons.

“Keep on Rollin’” – Why it might be as bad as it seems

While we are likely to see lower diesel demand growth (relative to gasoline) in the passenger car market going forward, there is another market for distillate fuel which will likely grow significantly in the coming years – the bunker fuel market.  As discussed in previous blogs, the IMO (International Maritime Organization) has set a 2020 date for the mandatory introduction of low sulfur bunker fuels.  On this date, the bunker fuel sulfur specification will drop from its current value of 3.5% down to 0.5%.  Meanwhile, refiners have made little, if any, progress toward meeting this goal by desulfurizing existing high sulfur resid.  As a result, it appears the only feasible way to meet these new specifications, at least initially, will be to blend low sulfur distillates and gasoils into bunker fuels.  This has the potential to create as much as 2 million BPD of incremental distillate demand growth (equal to approximately four years of distillate demand growth at current growth rates), if large scale compliance is achieved.  The actual rate of compliance, however, is another issue and is discussed in more detail in the May, 16, 2017 blog “Your Cheatin’ Heart” – Compliance Issues Cause Uncertainty About Low Sulfur Bunker Impacts. 

TM&C constantly monitors changes and projected changes in pricing and supply and demand across the globe for diesel and other petroleum products.  Our projections take into account changing rules and regulations, technological advancements, production and transportation costs, demographics, changes in consumer behavior, and other factors impacting supply and demand.  We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook and our various other studies. More information on these publications and our other work involving oil industry developments and dynamics can be obtained by contacting us, visiting our website at turnermason.com or calling Shanda Thomas at 214-754-0898.