Oil Traders Set Sights on High Seas as Diesel Renaissance Is Born

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By Heesu Lee and Debjit Chakraborty (Bloomberg) — It was only two years ago that the world’s biggest oil market was awash with diesel and profits from making the fuel cratered. Now the refined product is getting a new lease of life, and more demand is poised to emerge from the sea.

With crude’s bull market being underpinned by diesel consumption, Asian refiners could soon be scrambling to meet further appetite as a maritime rule in 2020 seeks to replace dirtier fuel that runs tankers. While shippers could add technology that’ll clean up their traditional power source, it’ll mean investing millions of dollars in each vessel — an expense they may not be prepared to bear. Their other option is to use diesel.

“By 2020 is too short a time to find an alternative other than to shift to marine gasoil,” said Rakesh Mehra, Dubai-based strategic advisor at Gulf Petrochem Group, a company that runs a refinery in the Middle East as well as trades fuels and operates storage terminals. “This will drive diesel demand and that’s going to stay.”

The renaissance in diesel, also known as gasoil, has contributed to the surge in global benchmark Brent crude to the highest level in more than two years. It’s a far cry from 2015 when a flood of exports from China swamped the Asian market, dragging profits from making the fuel in the region to below $8 a barrel and the lowest level in at least five years.

After the average annual diesel margin in Asia declined for the past three years, it has rebounded in 2017 to more than $12 a barrel as industrial activity picks up in the region. Unexpected refinery outages at plants from Europe to the U.S. due to fires and hurricanes have also contributed to a slump in stockpiles of the fuel. China’s exports, meanwhile, dropped in September to the lowest since January as domestic demand increased.

More good news is coming in the form of the fight against pollution. The International Maritime Organization, a global shipping regulator, will cap the limit on sulfur content in fuel oil — a residue from the refining process that’s used to power ships — to 0.5 percent in 2020 from 3.5 percent now. One way of meeting the new emissions standards is to use an exhaust gas cleaning system, or scrubbers, that removes pollutants before they’re released into the atmosphere.

Shipping Uncertainty

Vessel owners may be skeptical about whether this technology, still in its infancy, will be economical in the long term. The uncertainty over how the rules will be implemented, as well as concerns the IMO could one day impose stricter regulations that render newly installed scrubbers obsolete, is keeping shippers on the sidelines, said Rahul Kapoor, an analyst at Bloomberg Intelligence.

“The easiest option, therefore, is to switch over to gasoil,” Gulf Petrochem’s Mehra said. “Gasoil with 0.1 percent sulfur is easily available.”

Most shippers will use less sulfurous diesel than spend $4 million to $10 million per ship to add scrubbers, Kapoor estimates. Just one out of every five ships that have come to the market in the last five years will install the cleaning system by 2020, said Suresh Sivanandam, a senior research manager for Asia refining at Wood Mackenzie Ltd.

Diesel consumption in Asia, home to nine of the 10 largest container ports in the world, will rise by an annual average rate of 5 percent from 2020 through 2026, according to BMI Research. That compares with growth of 1.6 percent a year from 2017 to 2019.

Profits in Asia from turning benchmark Dubai crude into diesel, known as the crack spread, more than doubled to $15.37 a barrel in September versus a record low in April 2016, according to data compiled by Bloomberg going back to 2010. It was at $12.35 as of 3:26 p.m. Seoul time on Thursday. Inventories in Asia are also tightening, with onshore middle distillate stockpiles in Singapore shrinking to 11.5 million barrels, down 22 percent from their peak in 2015, the year China began significantly increasing its overseas diesel shipments.

“These regulations are definitely good for refiners, especially in Asia,” said Arun Kumar Sharma, finance director of Indian Oil Corp., the nation’s biggest refiner. “Opening up of a new market for gasoil will further improve diesel cracks.”

Demand is likely to gain by as much as 300,000 barrels a day for gasoil in 2020, while fuel oil consumption may drop by 350,000 barrels daily, according to Ehsan Ul-Haq, a London-based director of crude oil and refined products at Resource Economist.

“By around 2020, the diesel market even looks tight unless refiners do something about it,” said Ul-Haq. “And there’s not much time left.”

© 2017 Bloomberg L.P