Diesel remains a strong source of oil demand growth
Overall, 2017 was a strong year for global oil demand growth, with diesel continuing to play a substantial role. Global oil demand in 2017 rose by 1.6 MMb/d (or 1.7%). Demand for diesel accounted for 430 Kb/d of the growth, with gasoline accounting for a significantly smaller 270 Kb/d.
Unexpectedly, Europe was one of the strongest sources of demand growth. This occurred despite the strong political and social reactions to Dieselgate—the 2015 scandal that found that automakers were manipulating test data to hide the fact that diesel produces more emissions than is allowed by current standards. For the first 10 months of 2017, European demand for diesel in all uses actually grew by 2.4% over 2016. This was similar to the growth rate seen following the drop in global crude prices in 2014 when lower fuel retail prices and rising diesel car sales stimulated demand.
Growth in economic activity seems to explain most of this increased demand. Preliminary data shows average growth for the first three quarters of 2017 was the most productive for the Euro area since 2007 (before the global financial crisis). A combination of improving labor markets, diminished political uncertainty, and favorable borrowing conditions have supported domestic consumption in the region.
And the positive impact of economic recovery on demand was not limited to Europe. US diesel and gasoil demand also grew by 2% in the first 10 months of 2017, mostly driven by increasing industrial and freight activity. Similarly, Chinese demand grew by 1.5% in 2017 compared to a decline of -3.0% in 2016.
Dieselgate impact limited so far
Overall growth in European diesel demand has continued despite clear anti-diesel sentiment fueled by Dieselgate. After the scandal broke, the public outcry was swift and strong. Multiple cities have announced intentions to ban diesel use altogether, both in response to Dieselgate and out of a more general desire to follow a less energy-intensive path. Last October, Paris announced plans to ban diesel engine cars from the city streets by 2025 in a bid to tackle air pollution. In February 2018, German federal courts gave cities the right to impose bans on diesel cars which do not meet the latest Euro-6 standards. Thus far, these announcements have not materialized into any immediate measures, though they have impacted consumer confidence in diesel.
After years as the preferred engine type for new light-duty vehicles, diesel has seen some erosion in the new vehicle market relative to gasoline. In 2016, new diesel passenger car registrations in EU-15 fell by 2% over 2015, the biggest drop seen in the last decade except for in 2009. By the first half of 2017, gasoline has overtaken diesel cars in percentage of new vehicle sales in the EU, making up 49% of new cars registered in the first half of 2017 versus 46% in 2016. Diesel, on the other hand, fell from 50% to 46%.
So why is this downward trend not reflected more clearly in the demand data? First, although the decline in share of new vehicle sales is significant, its overall impact on the total fleet is quite small. New vehicles represent less than 7.0% of the operating fleet and tend to be more fuel-efficient, therefore generating less of an impact on overall fuel demand.
Second, on-road diesel demand from the passenger car segment only represents approximately half of total diesel demand in Europe, with the commercial sector accounting for the other half. Due to an increased need for large trucks and vans to deliver products, growth in this sector was more evident in 2017, which helped to offset the decline for diesel passenger vehicles.
Gasoline demand, on the other hand, is predominantly in the passenger car segment and is showing some impact, though the total volume is relatively small. OECD Europe demand for gasoline grew by an average 13 Kb/d per year since 2016 whereas it was in decline up until 2015.
Medium term outlook still favors middle distillates
Looking forward, there will almost certainly be continued pressure to move away from diesel drive trains in light-duty vehicles. However, the switch away from diesel will take time to materialize. We believe the overall outlook for total middle distillates (diesel, heating oil and jet/kero) demand in the medium term will continue to be favorable.
This growth will be driven in part by a strong economic outlook globally. Demand in the shipping sector is also expected to boost overall gasoil demand when the International Maritime Organization’s MARPOL Annex VI regulations on sulfur content in bunker fuel is introduced in 2020. This will significantly reduce bunker demand for high sulfur fuel and raise demand for low sulfur marine gasoil either as a direct product or blended into 0.5% sulfur fuel oil.
Adding to this, demand for jet fuel will continue to see the strongest growth of any type of oil product, owing to both the strong linkage between air travel demand and economic growth, and the lack of any realistic fuel substitutes.
This contrasts with our outlook for gasoline demand, which we expect to see peaking in the medium term and then experiencing a long-term decline. Gasoline will suffer from being most exposed to changes in light-duty vehicle technology and shifting consumer preferences for transportation. Gasoline demand is disproportionately focused in the light duty passenger vehicle sector which is most at threat from the growing penetration of electric vehicles. This sector is also likely to see more impact from shifts in consumer preferences towards less use of personal transportation and a shift toward public transport and delivery services. Even in Europe where gasoline is expected to benefit from the switch back seen in new car sales, the combination of the above will result in a market moving back into decline in the long term.
Implications for refiners
These trends provide a positive outlook for refiners who are able to focus on middle distillates production. In particular, this trend should favor:
- Distillate hydrotreating investment – The shift in bunker fuel demand to low sulfur marine gasoil and 0.5% sulfur fuel oil requiring low sulfur blendstocks should provide a strong incentive to continue expanding distillate hydrotreating capacity to satisfy demand
- Hydrocracker upgrading investment – The combination of a lower demand for heavy fuel oil and relatively strong demand for middle distillates over gasoline should favor incremental investment in hydrocracking, which produces both more and higher quality distillate than FCC upgrading
In general terms, the likely losers in this outlook are refiners that are heavily invested in more gasoline-oriented capacity (ie FCC/RCC) and located in mature markets that are most susceptible to changes in technology and consumer preferences (eg Europe).
Tim Fitzgibbon is a senior industry expert with McKinsey’s Oil and Gas Practice in Houston, where Cherry Ding is a senior analyst with McKinsey Energy Insights. Piotr Szabat is an analyst with McKinsey Energy Insights in the Warsaw office.