Oil Market Report July, 2013

It’s fair to say that as summer holiday flights hit their peak, only a few (rather tiresome) air passengers will be stopping to think where their jet fuel comes from and they are almost certainly not the type of person you want to be sitting next to on a flight. If you do engage in conversation (mistake on a long-haul flight / just about OK on short-haul), your neighbour may well tell you that Europe still produces most of its own jet fuel, but that up to 2.5 billion litres are imported per month from North Africa and the Persian Gulf. However, even this most irksome of know-alls will surely be unaware of the increasing confusion and concern around the EU’s Generalised Scheme of Preferences (GSP) and the impact it may have on jet fuel prices.

The GSP is a pretty technical piece of economic legislation, which allows import tariff exemptions on goods from developing countries, thereby encouraging trade with poorer countries. The first surprise is that countries eligible to benefit from the scheme include Russia (!!) and most of the Persian Gulf (including Saudi Arabia), so it was not unexpected when earlier in the year, the World Bank re-classified a number of nations as Upper-Middle Income Economies. The impact of this change on the GSP is that as of January 2014, all standard import tariffs will apply to products brought into Europe from most of the Middle East and Russia. The GSP is not specific to oil of course, but initially it was suggested that all oil coming from re-classified countries would be liable to the 4.7% tariff. This was soon changed to jet fuel only and the rationale behind this latter decision remains slightly cloudy. The suspicion is that the EU concluded that whilst tariffs had to be applied somewhere, an umbrella tariff was out of the question, with crude prices remaining so high. In addition, Petrol is rarely imported and Diesel / Gasoil both have low sulphur (ie, good green credentials) and have a higher emotional impact on the consumer when it comes to price increases (Diesel for mobility and Gasoil because it is Europe’s heating oil grade). So this leaves Jet Fuel as the only major grade on which to apply the tariff.

If this change does go ahead, the impacts on jet fuel supply start to look significant. At present, the EU as a whole imports roughly one million tonnes of jet fuel per month from the proposed declassified countries, with this figure doubling in peak (holiday) periods and these figures equate to between 30% – 35% of total consumption.  With jet fuel trading at about $1,000 per tonne, a 4.7% tariff is a price increase of circa $50 and whilst this may not initially seem too drastic, the fear is that jet fuel in Europe could end up being sold at a premium to the rest of the world. For an industry already deeply concerned about the recent EU carbon tariffs on air transport, any price increases are bad news and may lead airlines to start looking to re-fuel outside of Europe. And it is not only the aviation industry affected by this; for the 1.5m UK homes that take oil (kerosene) for home heating, this increase in price (circa 2.5 pence per litre) on imported fuel will be most unwelcome, coming as it does (January 2014) in the middle of the heating oil season.

The other aggrieved parties in this whole process are the Middle-Eastern refiners themselves. Their jet fuel production and margins will be reduced at a time when they are considerably expanding capacity, largely to meet European requests for greater supply! However, refinery investment programmes tend to have a habit of demanding payback, so we could well end-up with a situation where the Middle-Eastern refineries continue to produce high amounts of jet fuel, only to ship them to a non-classified intermediary country – thus still qualifying for GSP import tariff relief – before finally sending the cargoes to Europe. This would hardly be the intended effect of the scheme and even then, whilst this course of action may avoid the 4.7% tariff, the extended supply-chain would certainly not bring prices down.

Don’t expect anything to happen on all of this (changes or otherwise) until the Autumn – holidays and post-holiday “hangovers” will take precedence until then. In fact, the Middle-Eastern import tariff could be avoided all together if the Gulf Cooperation Council States reconsider engaging in bilateral trade negotiations with the EU, which have been on hold since 2007. It’s even possible that the EU have got their act together on this one and have used the threat to jet fuel as a strong-arm tactic to boost trade with the Middle East (“come back to the table on the trade bilaterals or we will block your fuel imports”). Then again, it could just as easily be a failure to consider the practical implications of the GSP…