Viewpoint: European diesel faces headwinds in 2021

A successful roll-out of Covid-19 vaccines in Europe is no guarantee of a rapid gasoil price recovery in 2021, mostly because of the vast supply overhang that has built up over 2020.

Although European refineries ran at record low rates for much of the year, middle distillate inventories in the EU-15 and Norway reached more than 472mn t in October 2020, the highest since Argus records began in 1990, and around 10pc above the five-year average.

Ample supply will hold back margins as it has over much of 2020. Diesel margins in May-December 2020 reached less than a third of the $16/bl on average in 2019, as travel restrictions slashed demand and inventories swelled. Rebalancing the market will require both limited refinery utilisation and a sustained increase in demand.

On the refining side, utilisation is likely to remain at low levels in the early part of 2021, as a result of a weak margins, and it is unclear if this will be enough to ensure robust stock draws. Latest Euroilstock inventory data show November inventories drew down by just 0.6pc on the month, a result of higher refinery utilisation as facilities returned from autumn maintenance work.

Inventories will have to fall furtherand fasterto see a sustainable margin recovery in the first half of 2021. Any recovery in margins for other refined products, such as gasoline, could complicate the picture for refiners by encouraging higher utilisation rates, although at present gasoline market fundamentals also appear unsupportive.

Regardless of the margin landscape, refiners in Europe will be keen to ramp up rates where possible following what has been an extremely difficult year. But production increases will have to be carefully managed.

A process of refinery rationalisation in Europe could support a rebalancing. This process is underway and has intensified in response to the pandemic, with firms such as Total, Finland's Neste and Sweden's Preem planning the conversion of refining capacity to renewables processing. Other European refiners, including trading firm Gunvor, UK-Chinese joint venture Petroineos and Spain's Cepsa, have mothballed capacity that is ostensibly capable of returning to operation in a higher margin environment, although some could close permanently.

Looking to demand, the speed of the uptake of Covid-19 vaccines will determine the rate of the gasoil recovery in 2021. But even under an optimistic scenario — in which the vaccine is rapidly rolled out and restrictions come to an end in the first part of the year — demand is unlikely to recover quickly to pre-pandemic levels. Higher levels of homeworking could become a permanent fixture of the post-pandemic economy, which could see some diesel demand from the passenger fleet permanently shifted to a lower footing.

Demand from the industrial sector is also likely to remain subdued following a year of economic devastation. And jet fuel markets too are unlikely to post a sharp recovery, with the International Air Transport Association (IATA) assuming passenger demand in 2021 to remain 38pc below 2019 levels. As a result large amounts of jet fuel — a middle distillate — are likely to continue being blended into the diesel pool. This was an important factor in bolstering gasoil stocks in 2020.

Looking beyond the immediate effects of Covid-19, diesel demand faces several long-term headwinds that are unlikely to abate in the early parts of 2021. The share of diesel engines in the passenger car fleet is shrinking in the face of competition from gasoline and EVs. Data from the European Automobile Manufacturers' Association show that diesel's share of new EU car sales in the third quarter down to around 28pc in 2020, from 30pc a year earlier and nearly 35pc in 2018. But diesel will continue to be the dominant fuel for the road freight sector, which will ensure a higher floor for diesel demand compared with gasoline in the long-term.

Globally, middle-distillate production capacity is climbing quickly and outpacing demand growth. Emerging market and developing economies in Asia-Pacific and the Middle East will add capacity in the medium-term — projects in those regions account for 80pc of capacity under construction, according to the IEA. Surplus gasoil from these new refining centres will likely find a home in Europe, adding to supply availability in the latter region and adding to the pressure on the continent's already-embattled refining sector.

By Harry Riley-Gould