The recent publication of two significantly different outlooks for diesel markets in 2023 shows how the International Maritime Organization’s environmental rules will remain an enormous factor.
Just one slight issue: Will the impact on diesel be bullish or bearish?
The direction of diesel, as always, will still overwhelmingly be determined by the price of crude. A slide in crude prices created by a possible ’23 recession, or the opposite of recession if an increase if China’s demand surges as it comes out of COVID lockdowns, will be the major determinant in whether diesel is rising or falling this year.
But in 2022, the diesel market was hit with its own unique surge, which actually began the year before: the spread between the price of crude and gasoline on the one hand, and the price of diesel on the other. There are numerous ways of measuring it, but one of the most basic is to compare the front month price of ultra low sulfur diesel (ULSD) on the CME commodity exchange to the price of Brent crude on CME. Brent is the world’s crude benchmark.
For all of 2021, the spread averaged about 38 cents per gallon. For all of 2022, it was slightly more than $1.18 a gallon.
That spread eventually makes its way down to the pump. And since there isn’t such a thing as a retail price of crude, the best comparison in the pump impact comes from looking at retail gasoline — which saw no impact from new environmental rules — versus diesel.
In 2021, the weekly average retail gasoline price published by the Energy Information Administration was about 38 cents a gallon less than the EIA price of diesel, the one that is used as the basis for most fuel surcharges. In 2022, that spread had blown out to just under $1.19 a gallon and got up to more than $1.70 a gallon for a few weeks in the fall.
One of the recent reports on where diesel might be headed comes from the analytics firm Energy Aspects. In a report released in December, the well-respected forecaster provided both a review and a look forward on the crack spread between spot diesel prices and various grades of crudes. It is that crack spread that serves as the basic building block on the multistep road to the difference between crude and retail diesel price as well as retail gasoline.
According to the Energy Aspects report, the average crack spread between U.S. Gulf Coast ULSD and Light Louisiana Sweet (LLS), a benchmark grade of crude, averaged $16.2 a barrel in 2021. But the average masks the yearlong rise, coming in at $11.80 a barrel in the first quarter and climbing to $22 a barrel in 2021’s fourth quarter.
In 2022, the full-year average of $49.50 per barrel featured a moderate first-quarter average of $29.40 a barrel. That was followed by a low of $53.30 in the third quarter, sandwiched between $58.10 in the second and $57 in the fourth. Data provided by Energy Aspects for other grades of crude in other markets showed a similar pattern.
And moving into 2023, Energy Aspects doesn’t see a lot of change. Its first-quarter Gulf Coast LLS crack spread is projected to be $55.20 a barrel. And while the next three quarters are all less than $50 per barrel, they aren’t below it by much: The low forecast is $48.40 in the fourth quarter.
The report is a summary of Energy Aspects’ larger analytical forecast. But there are snippets in it of some of the reasons it expects continued strong diesel markets: a likely slowing of Chinese exports of diesel and other products; European inability to replace lost Russian supplies; and slower Indian exports due to that country’s own strong demand.
Refiners have been stepping up to meet that strong market. For example, at the recent Goldman Sachs Global Energy and Clean Technology conference, Phillips 66 vice president of investor relations Jeff Dietert said, “We’re expecting to [maximize] diesel throughout the year,” according to a transcript of the Phillips 66 (NYSE: PSX) presentation at the event.
Similarly, on the third-quarter earnings call of Valero Energy (NYSE: VLO), Chief Commercial Office Gary Simmons, in discussing movements of diesel and other prices, said, “What we expected in IMO2020, we’re finally starting to see in the market.”
IMO2020, implemented by the International Maritime Organization that governs much of worldwide shipping, sharply restricted the amount of sulfur that can be in marine fuel, down to a level of 50 parts per million. The previous limit was 3,500. Not that long ago, there was no limit.
How this was expected to impact diesel is that a pathway to meeting this requirement was to use a relatively new blend called very low sulfur fuel oil, whose chemical composition required a significant amount of distillate molecules that might otherwise go into the production of diesel. It would substitute for high sulfur fuel oil, a dirtier product that is not a distillate like diesel.
Soon after IMO2020 went into effect at the start of that year, the pandemic hit and suddenly oil markets had too much of pretty much everything. The thesis that IMO2020 would tighten diesel markets therefore didn’t get its test in 2020. But as the comments from Valero’s Simmons suggest, it got its test in 2022 and the thesis held. It is evident most clearly in that diesel-to-crude spread which as Energy Aspects forecasts is expected to stay well above historic norms in 2023.
But a contrary view comes from longtime energy economist Philip Verleger, who warned of the impact on diesel markets from IMO2020 for several years leading up to its implementation.
And now Verleger is becoming more bearish on the price of diesel relative to crude, and the reason for it is a familiar institution: the IMO.
The latest IMO rule that went into effect this year is the launch of the Carbon Intensity Indicator (CII), an initial step on the road to greater decarbonization in the maritime sector. It is complex but at its most basic it will grade ships for their carbon intensity on the basis of several factors, including the fuel powering the ship.
Verleger sees that as a problem for diesel. In a recent weekly report, Verleger cites other reports about new shipbuilding planned by companies such as Maersk in which energy will come from such fuels as biomethanol, liquefied natural gas and hydrogen, primarily in pursuit of positive CII scores and whatever other decarbonization issues the industry will face.
Of the various projects to produce green marine fuels, Verleger says, “While many will fail, it appears that adequate supplies will be available by 2030, although at significantly higher costs than conventional oil.”
Getting data on marine fuel usage has always been a challenge in oil statistics. Verleger quotes an EIA report from 2019 that assumed global demand was 4 million barrels a day. He adds that it is probably higher now.
But given the new IMO rules on decarbonization, with more to come, “consumption [of petroleum-based marine fuel] will decrease in 2023 as the new rules take effect, perhaps by as much as 200,000 to 300,000 b/d.” Given that IMO2020 shifted marine fuel toward distillate molecules and away from the heavy oil molecules that had been the primary fuel source prior to IMO2020, the potential impact on diesel demand is clear.
“The impacts by 2030 and 2050 could be much greater,” Verleger writes. That 4 million-barrel-per-day figure from 2019 could be down to 3 million in 2030 and less than 2 million by 2040, according to Verleger, with distillate demand taking the brunt of the decline.
As Verleger titled his weekly report: “What The IMO Giveth, The IMO Taketh.”
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