Europe Diesel Crisis Incoming?

Days are numbered on Russian diesel. In the coming weeks the EU will face a significant shortage of diesel supply as seaborne deliveries from Russia, its primary supplier, will be greatly restricted. This raises questions about who will fill the supply gap and if there will be enough diesel to meet the demand, which is essential for the EU's economy as it powers a variety of vehicles, ships, and industrial machinery. Is the EU facing a potential fuel crisis? 

Starting February 5, most diesel imports from Russia will be prohibited as a form of punishment for Moscow's involvement in the war in Ukraine. This presents a significant challenge as it requires finding a replacement for the large amount of diesel imported from Russia, equivalent to about 14,000 Olympic-sized swimming pools. However, some progress has already been made in reducing dependence on Russian imports. In 2021, over half of all diesel shipped to the EU and UK, which already has a ban in place, came from Russia. But by December of that year, that percentage had dropped to around 40% due to increased imports from Saudi Arabia and India. There is reason to believe that the remaining Russian supplies can be replaced by imports from other countries. According to Eugene Lindell, head of refined products at consulting firm Facts Global Energy, the decrease in Russian diesel imports will be compensated by imports from other sources. However, this outcome is not certain. 

New Suppliers for Diesel? 

One potential source for increased diesel imports to Europe is the Middle East, as it is relatively close to European countries bordering the Mediterranean Sea and has new oil refineries that will produce large amounts of fuel. Abu Dhabi National Oil Co. has also already made a deal to supply Germany. India and the US, both long-time suppliers to the EU, have also increased their shipments in recent weeks. American refineries are projected to produce a record volume of distillates, a category of fuel that includes diesel used in trucks and automobiles.Another important potential supplier, although indirectly, may be China. According to Mark Williams, a research director at Wood Mackenzie Ltd, "China holds the key to all of the surplus refining capacity globally." 

China has significantly increased its exports of diesel in recent months. While only a small portion of these shipments are sent directly to Europe, they increase the overall regional supply, which in turn can free up more diesel from other producers that can be shipped to Europe. China's fuel export quota for 2023 has risen by almost 50% from the previous year, making it unlikely that diesel exports from China will decrease to the levels seen in early 2022. Exports of diesel-type fuel from China could reach 400,000 to 600,000 barrels a day during the first half of this year, according to Williams. This is a similar volume to what the EU and UK are set to lose in terms of seaborne deliveries from Russia. However, it is important to note that in the past, China has prioritized its environment over profit from exporting fuels and may do so again in the future. 

Regardless, Problems Likely to Arise 

While there are multiple potential options for the EU and UK to replace diesel imports from Russia, there is a concern that the EU's sanctions may lead to Russian diesel disappearing from the global market. If Russia is unable to find new, non-EU buyers for its fuels, it may cut production at its refineries, which could lead to a decrease in global diesel supplies and an increase in prices. FGE estimates that crude processing at Russian oil refineries will fall by 510,000 barrels a day year-on-year in February and March, due to deferred maintenance and trade friction surrounding the implementation of the embargo. Lindell added that the consultancy expects these processing rates to recover by summer. 

Even if there are buyers for Russian diesel, transporting it may be difficult as many shippers may be hesitant to violate Western sanctions, which may require that the price of these cargoes does not exceed a certain level that is currently being discussed by the G-7. The mechanism for this and the price cap, which is currently set at $60 a barrel for crude oil, has yet to be established for Russian fuels. At the end of last year, Argus Media Ltd. assessed Russian diesel at $926 per ton, which is about $124 per barrel and $30 per ton more expensive than non-Russian diesel, which is about $4 per barrel. If the price cap is set significantly lower than the market level, much of the global tanker fleet would be unable to continue transporting Russian cargoes if they want to access G-7 services such as insurance. 

What About Demand? 

The other side of the question of whether the EU will have enough diesel supply in the future is: how strong will the demand be? Recent warm weather in Europe has likely reduced the consumption of heating oil, which is a diesel-type fuel, and helped lower the price of natural gas, which makes it cheaper for oil refineries to produce high-quality diesel and reduces the incentive for companies to use gas instead of oil for power generation. "A macroeconomic slowdown has been gradually reducing European diesel demand," said Benedict George, market reporter at Argus. "Country-by-country data suggests that European diesel demand is already at least 5% down year-on-year. During the 2008 recession, diesel demand fell by around 10% year-on-year at its lowest point." However, Goldman Sachs no longer predicts a euro-zone recession after the economy proved more resilient at the end of last year. 

The role of intermediate countries should not be overlooked in helping to mitigate the impact of the EU's ban and accompanying price cap either. For example, Turkey, which is not a member of the EU, could potentially import large volumes of Russian diesel, as it already does to a significant extent, and then use it to supply its domestic market. The non-Russian diesel produced in its own refineries could then be sold to the EU at a higher price. "A prolonged economic slowdown, warm weather, continued increases in Chinese exports, and a well-oiled price cap would help global diesel balances remain feasible and provide Europe with enough options to obtain replacement barrels," said Hedi Grati, head of Europe/CIS refining & marketing at S&P Global Commodity Insights. "The higher the demand and the steeper the Russian diesel production decline, the more complex and potentially fragmented the situation could become."