Global oil markets are adjusting to relatively strong demand for diesel and jet fuel compared to gasoline, coupled with the introduction of new bunker fuel regulations at the start of 2020.
Rising diesel and jet fuel prices, at least relative to crude and gasoline, are forcing adjustments that should lessen the chance of a severe shortage at the end of next year.
Futures prices for ultra-low-sulphur diesel delivered at New York Harbor have moved to a premium of more than $21 per barrel over futures prices for gasoline delivered at the same location.
The diesel premium has doubled since the end of September. It is trading at the highest level since 2011 and before that 2008, both of which were years when diesel consumption was growing much faster than gasoline.
Refiners have a strong incentive to maximise the production of diesel and jet fuel while minimising output of gasoline, and many are adjusting production plans in response.
In the United States, for example, refiners cut gasoline yields by 1 percentage point while boosting yields of jet fuel by 0.7 point and distillate fuel oil by 0.5 point in August compared with a year earlier.
U.S. refiners produced a near-record 40 barrels of middle distillates (mostly diesel and jet fuel) from every 100 barrels of crude in August, the most recent month for which data is available.
U.S. refiners have rarely squeezed more middle distillate from each barrel of crude they process, according to data from the U.S. Energy Information Administration (EIA).
At the same time, refiners produced fewer than 45 barrels of gasoline per 100 barrels of crude, close to multi-year lows (“Petroleum Supply Monthly”, EIA, October 2018).
As a result, the ratio of distillate to gasoline production is at the highest level since the summer of 2008, when oil prices were spiking before the global financial crisis.
Global diesel consumption has generally been rising faster than gasoline for the last quarter of a century.
Diesel consumption increased by 10.5 million barrels per day (bpd) between 1992 and 2017 while gasoline was up by just 8.4 million bpd (“Statistical Review of World Energy”, BP, 2018).
Refiners have responded by squeezing more diesel and jet fuel from every barrel, mostly at the expense of lower-value products such as heavy fuel oil, bitumen and asphalt.
U.S. refiners made almost 39 barrels of diesel and jet fuel from every 100 barrels of crude in 2017, up from 31 barrels in 1993, according to the EIA.
Over the same period, production of residual fuel oil and asphalt declined from nine barrels to fewer than five barrels per 100 (“Petroleum Supply Annual”, EIA, August 2018).
The International Maritime Organization’s new regulations on bunker fuels are likely to accelerate the transition to distillate fuel oil and away from heavy fuel oil.
From the start of 2020, the regulations will require ship owners to start using lower-sulphur distillate fuel oil unless they start buying lower-sulphur heavy fuel oil or install exhaust gas cleaning systems (“scrubbers”).
Some analysts have expressed concern that the regulations will create an acute shortage of middle distillates resulting in a surge in diesel and jet fuel prices and pulling up crude oil prices with them.
But with prices already starting to adjust, there is probably enough flexibility in the system to enable it to meet the rise in middle distillate demand over the next 12-15 months.
Experience shows U.S. refiners have flexibility to adjust the gasoline/distillate mix by two to four barrels per 100 barrels of crude, and in some cases more, in the short term by making straightforward operational changes.
For example, fluid catalytic cracking units can be operated at reduced severity to cut the production of light hydrocarbons in the gasoline range and increase the number of heavier hydrocarbons in the diesel and jet range.
FCC units play a critical role in giving refiners the flexibility to adjust their output mix in response to short-term changes in gasoline/diesel demand over a matter of months.
Over longer time horizons, refiners have multiple routes to increase the output of diesel by investing in new processing units (“Refinery configurations for maximum conversion to middle distillates”, Chevron, 2011).
Most refiners have been planning to increase their yield of middle distillates for nearly a decade in response to projections of increased diesel demand.
The new mega-refineries in the Middle East and Asia have all been planned to maximise the production of middle distillates for the transport market in anticipation of new IMO rules and projected increases in freight demand.
On the consumption side, price changes will help smooth the adjustment to IMO rules, with higher diesel prices forcing more fuel efficiency in the freight transportation sector.
And the sharp rise in diesel prices relative to gasoline is likely to accelerate the shift away from diesel among European motorists, making more fuel available to the shipping sector.
By encouraging maximum refinery production and restraining consumption over the next six to nine months, the rise in diesel prices should help build stocks and reduce the risk of a price spike in late 2019 and 2020.