John Mayes and Robert Auers
We chose Fleetwood Mac’s 1975 hit “World Turning” as the title song for this week’s blog. Much as the name suggests, the song describes the constantly changing and moving world around us. Similarly, just as few suspected it only a few years ago, petroleum demand is growing once again in Europe. Furthermore, this represents a trend not seen since the first half of the previous decade. After peaking in 2006 at 16.6 million BPD (Figure 1), demand declined for eight consecutive years to less than 14.0 million BPD in 2014. In the last three years however, consumption has increased by nearly a million BPD, reversing over a third of the previous demand decline. While the dominant factor in the turnaround is the crude price collapse (which began in late 2014), accelerating economic growth in the region since 2014 has also provided a major tailwind for petroleum demand.
Since 2014, only a handful of countries have not participated in the demand surge; notably Sweden (-4.9%), Belgium (-3.1%) and Finland (-2.8%). The strongest growth occurred in countries which are also experiencing solid economic gains, Turkey (33%), Poland (24%), and Slovakia (17%). The larger economies have seen smaller but still significant petroleum demand increases, Germany (4.3%), France (4.5%), and U.K. (2.5%).
The majority of European demand growth over the past three years has been distillate related, however, over the same time period the bloc (and most its members) have continually soured on diesel in order to curb particulate pollution. This de-emphasis of diesel resulted from the combination of the VW emissions cheating scandal and the related recognition of the understated environmental impacts of burning diesel versus gasoline as a transportation fuel. It is now becoming widely recognized that much of the haze seen in European cities is the result of particulate emissions from diesel. Previously, however, several countries had enacted tax policies which encouraged the use of diesel over gasoline, due to diesel engines’ better efficiencies, in an effort to curb CO2 emissions. Many of the incentives can still be seen at fuel stations across the continent, where diesel is typically €0.10-€0.20/liter less than gasoline, despite diesel’s strong premium vs. gasoline in the wholesale market. Nonetheless, as diesel moves out of favor with European governments, these tax incentives are also being removed, both at the pump and by other means, such as increased vehicle registration taxes, parking fees, and tolls for diesel vehicles. As a result, sales of new diesel vehicles (as a percentage of total new vehicle sales) in Europe have fallen every year since 2011, but still made up more than 50% new vehicle sales until 2016. Therefore, the percentage of total diesel vehicles on the road in Europe has not changed much (and likely risen) over the past few years, as diesel sales were still high relative to historical (pre-2005) levels. Still, this trend likely reversed in 2017, as the drop in the demand for new diesel vehicles appears to have accelerated in 2017 and likely will continue to do so in the New Year.
“Everybody’s got me down” – Declining European Demand
As consumer demand for petroleum products began to decline in 2007, European refinery utilization rates also plunged, falling from 84.7% in 2006 to under 77% in 2011 (Figure 2). Refinery closures (mostly during the period from 2011-2015) helped to stabilize utilization rates through 2014. As product demand began to surge in 2015, however, utilization rates quickly followed. More than 20 European refineries have closed in recent years on the assumption that demand would continue to decline, and the resulting smaller refining base contributed to the sharp increase in utilization rates. The additional demand increases in 2016 and 2017 have pushed utilization rates back above 85%.
One of the usual benefits of higher refinery utilization rates is higher refining margins. In Europe, this relationship is more clouded than other regions due to the higher import levels from Russia, the Middle East and the U.S. Furthermore, since the most unproductive plants, in general, are the first to close, the current European refining base should be more efficient than that of years past and be able to cover operating expenses with thinner margins. Figure 3, displays a computed product margin comprised of 40% 95 RON gasoline, 45% ULSD and 15% high sulfur fuel oil versus Brent and Euro 95 Gasoline vs Brent. This margin was reasonably constant from 2013 through 2015 at around $9 per barrel but fell sharply in 2016. The Saudi Yanbu refinery (400 MBPD) started in 2014 and the UAE Ruwais refinery (417 MBPD) began in 2015. Still, with no new Middle East construction completions in 2016 and continual rising product demand, European refining margins rebounded in 2017. Margin prospects look good for 2018 due to the continued demand increases in 2017 and no major Middle East projects coming on-stream last year. The next significant completion in the Middle East is the Saudi Jazan (400 MBPD) refinery in 2018. This will likely negatively impact European margins in 2019 unless demand continues to increase.
“I need somebody to help me through the night” – The IMO Effect
Probably the greatest uncertainty facing the European refining sector is the IMO mandated shift to low sulfur bunker fuel. The transition date of January 2020 is now less than two years away with the global maritime and refining industries making few substantive preparations. As a result, the 0.5 % sulfur bunker fuel in 2020 will be produced from the modest volume of crudes which can yield a fuel oil of less than about 1.0 % sulfur with large volumes of low sulfur gas oils and distillates. It is estimated that over two million BPD of distillates will be blended into the bunker pool in 2020. This dynamic will create two significant pricing responses; a spike in distillate prices resulting from the sudden increase in demand and a sharper decline in the price of the now surplus high sulfur fuel oil.
The shifts in product prices in 2020 will create specific refining winners and losers. Refining winners will be those with coking units, as they generally do not produce fuel oil. Refineries which do produce fuel oil are the most at risk because of the uncertainties in maintaining sales. Asphalt refineries are also likely to be winners if they are not impacted by fuel oil refiners attempting to enter the asphalt market due to the lack of fuel oil sales. On a geographic basis, fuel oil refineries operated by national oil companies will be less impacted than commercially owned facilities because of political issues. The largest concentrations of commercially owned fuel oil refineries are in Singapore and Europe. The biggest challenge for these refiners will not be the price of their high sulfur fuel oil, but whether they can find a buyer at any price.
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, with the next update due be released in February. In addition, our Worldwide Refinery Construction Outlook, also to be released in early February, provides a detailed list of global proposed refinery construction projects and an estimated likelihood for the eventual completion of each. 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 Cindy Parker at 214-754-0898.