The return on diesel production has declined sharply over the past few months, as the supply of this industrial and transportation fuel has exceeded demand, which has prompted refineries to reduce crude oil processing and focus instead on producing gasoline and aviation fuel.

Winters in the northern hemisphere were warmer than expected, meaning stocks remained relatively high while industrial demand was tepid. In China, liquefied natural gas-powered trucks are becoming more popular, and diesel consumption is declining as a result, which may be the beginning of a long-term structural transformation.

The profit of diesel produced by Asian refineries has dropped from nearly $29 per barrel in early February to around $15, which is close to the lowest level in a year. During the same period, refining profits in the US and Europe also fell sharply, but there was a slight recovery this month.

In response to questions about diesel during a recent earnings call, Brian Mandell (Brian Mandell), executive vice president of marketing and commerce at Phillips 66 (Phillips 66), said, “We are beginning to see cuts in processing volumes in Europe and Asia.” However, as demand for gasoline will increase during the summer driving season and aviation fuel consumption is also improving, refineries are still “constructive” about the outlook.

This is quite different from the situation where diesel prices soared due to supply concerns after the Russian-Ukrainian conflict broke out a few years ago. Russia is a major producer of diesel. In recent months, refineries in Russia have been attacked by drones. If the attacks accelerate, it will pose a potential threat to diesel production, but the current supply and demand situation has offset this threat.

According to Eugene Lindell, head of refined oil products at FGE, the reason for the weakness in the European diesel market is also an increase in the flow of US diesel to the region and a drop in freight costs as it becomes cheaper to import diesel from Asia. He said, “We are on the verge of a larger round of production cuts, but the rebound in fuel oil and naphtha cracking spreads and the stabilization of diesel cracking spreads have improved overall profit margins.”

In China, sales of trucks powered by liquefied natural gas have soared, which is not good for the future of diesel in the long run. According to Mysteel OilChem, in March, in the world's largest oil importer, these heavy vehicles accounted for nearly 30% of sales, and their rapid growth trajectory is similar to that of electric vehicles a few years ago.

Goldman Sachs Group analysts Callum Bruce (Callum Bruce) and Daan Struyven (Daan Struyven) and others said in a report this month that China's liquefied natural gas-powered truck fleet currently replaces 800,000 barrels of distillate oil every day. They said the global gas bear market has made Asian gas prices “consistently” lower than diesel prices in the region.

LNG is cheaper than diesel

Struyven said in an interview that the weakness in diesel is mainly due to reduced demand in China. Diesel production was particularly high last year, he said, and additional supply also put pressure on the market. Increased diesel production capacity at refineries in Asia and the Middle East has caused losses in the short term and may have long-term effects.

Goldman Sachs said in the report that the refining and processing volume of the Organization for Economic Cooperation and Development (OECD) member countries increased 400,000 b/d in the first quarter compared to the same period last year. Alan Gelder, Wood Mackenzie's vice president for refining, chemicals and petroleum markets, said: “Given weak distillate prices, the refineries with the highest distillate production have been hit the hardest, in Europe and Asia.” He said the decline in profit margins for diesel vehicles was “surprising recently.”