Growing demand for diesel fuel raises concerns about Europe's energy security

Nov 16, 2008 01:00 AM

by Guy Chazan

For years, Europe's automobile industry has been betting on diesel-engine cars. And drivers have lined up to buy them, attracted by their greater fuel economy and tax incentives that encouraged diesel use over gasoline.
But now, the rise in demand for diesel that resulted from that bet is contributing to a supply gap in Europe, highlighting a worrying imbalance in the region's refining industry.

The supply-demand mismatch is so serious -- diesel-engine cars now account for about half of new cars sold in Western Europe -- that it is raising concerns in the upper echelons of the European Union about what effect the block's reliance on diesel imports might have on prices and energy security over the long term.
"The growing dependence could become a problem," says Jan Panek, an official at the European Commission's Energy and Transport Directorate, "if the situation substantially changes in an unforeseen way."

A big concern is Russia, which supplies the majority of Europe's imported diesel. Russian oil companies refine much of their crude at home because of a tax system that levies higher export duties on oil than on petroleum products. If that were to change, however, Russia could decide to export more crude oil and fewer products, creating a big headache for the EU, which doesn't have the capacity to refine all that crude itself.
Europe currently relies on imports for about 15 % of its diesel needs, according to the European Petroleum Industry Association, a Brussels-based lobbying group that represents European refiners. That figure could grow significantly. A report from Houston-based consulting firm Purvin & Gertz, commissioned last year by the European Commission in partnership with OPEC, predicts that Europe's imports of diesel and gasoil -- a petroleum product used as a diesel fuel and heating oil -- will almost double by 2020, to 67 mm tpy, or 1.4 mm bpd, from 34 mm tpy, or 700,000 barrels, now.

Historical anomaly
A growing appetite for dieselexists not only in Europe, but in China, India and other countries in Asia where it is used widely in industry and for electricity generation, increased pressure on tight global-refining capacity, helping push up prices earlier this year.
From January to September, the average price of a litre of diesel in Europe's biggest economies -- France, Germany, Italy, Spain and the UK -- rose almost 14 % to about EUR 1.42, compared with a 7.7 % increase to about EUR 1.40 for a litre of unleaded gasoline, according to the Automobile Association, a British motoring group. (That is equivalent to approximately $ 6.94 a gallon for diesel versus about $ 6.84 a gallon for gasoline.) The average price of both fuels fell in October, with diesel retreating to about EUR 1.30 a litre and gasoline to about EUR 1.29.

Before this year, diesel had been cheaper than gasoline at pumps in Europe, largely because of tax rates: In many European countries, governments view gasoline as a consumer luxury and tax it heavily. Diesel, vital to the economy because of its use in transport, construction and industry, is taxed less.
That, in turn, encouraged car makers in Europe to start manufacturing diesel-engine cars. At first, engine quality was poor, but as technology improved, they became more popular. Governments helped by imposing vehicle and road taxes that favoured diesel's better fuel economy and lower carbon-dioxide emissions compared with gasoline-powered cars. The result is that in certain European countries, like France and Belgium, diesel-powered cars now account for more than 70 % of new cars sold.

But the switch to diesel in Europe wasn't matched by a corresponding increase in diesel production, in part because it is more costly for European refiners to install the equipment to make diesel compared with the equipment to produce gasoline. As a result, European refiners produce too much gasoline for the domestic market and not enough diesel. They compensate by exporting gasoline to the US -- 26 mm tons in 2006, accordingto the Purvin & Gertz report. But with a weakening US economy depressing demand for gasoline, fears are growing about a gasoline glut in Europe.
"People didn't see the coming diesel-demand boom and the diminishing demand for gasoline," says John Waterlow, an Edinburgh-based analyst for consulting firm Wood Mackenzie. "They assumed that gasoline demand would go on growing in Europe as more and more cars were bought. They underestimated the fact that a lot of the new cars were diesel."

Tougher fuel standards
The tightening market for diesel could get worse when new EU fuel specifications requiring an ultra-low sulphur content for the fuel come into force next year. Many Russian refineries won't be able to meet the new standards, industry observers say.
"There are real quality issues," says Neil Atkinson, an analyst at KBC Process Technology, a UK-based consulting firm. "The Russians aren't making the necessary investments and they're not keeping up with European standards."

In a recent report, KBC said that only about 30 % of Russia's gasoil production would meet the EU's higher emissions standards by 2015.
Some vital new refining capacity due to come on stream in Asia may provide short-term relief. Reliance Petroleum's new refinery in Jamnagar, India, due to begin operations in the next few months, will substantially boost supplies: Some 40 % of its output of 580,000 bpd will be diesel. But analysts warn that after Jamnagar, the next wave of big capacity additions world-wide won't come until 2012.

Brewing changes
The European refinery industry says that any effort on its part to make up the shortfall with more investment probably won't be enough to reduce Europe's reliance on imports.
"I don't see how we can add sufficient capacity over the next decade to handle the increasing demand for diesel in Europe," says Panos Cavoulacos, president of the European Petroleum Industry Association. He says that several European refineries have been upgraded over the last decade orso to produce more diesel, but that few available sites are left for more upgrades.
The Purvin & Gertz study drew a similar conclusion: "The long-term outlook is such that the European market will continue to rely heavily on trade to balance demand," the report says.

To be sure, the high pump price of diesel has started to put a dent in demand in the developed world, easing the gasoline-diesel imbalance, according to Wood Mackenzie's Mr Waterlow. And the EU says it is preparing to change the block's energy-taxation rules to remove the incentives that encourage diesel use over gasoline.
If diesel prices remain high over the long term, there will be other responses, says Olivier Abadie, a Paris-based refining expert at Cambridge Energy Research Associates. Car makers likely will try to make more energy-efficient gasoline-powered cars. There also will be more impetus to develop autos powered by alternative fuels like natural gas or liquefied petroleum gas.
"If people won't be able to afford diesel, they will go to other fuels," says Mr Abadie.

Mr Chazan is a staff reporter for The Wall Street Journal in London.
Write to Guy Chazan at

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