London (Platts)--24Jan2013/747 am EST/1247 GMT

As Total's Gonfreville refinery in northwest France gears up for restart, with a much boosted diesel production capacity, last year's refinery upgrade program in Europe and the Mediterranean is nearing completion.

And with a large number of other refinery upgrades in Europe, Russia and the Middle East set to be completed in the coming years, the question is whether the market will be swamped with new diesel that it cannot consume.

Diesel consumption in Europe has been growing in recent years, but the rate has slowed and there are fears there could be oversupply in coming years, weighing on prices.

Among the more recent completed upgrades, Galp Energia said last week the new hydrocracker at its Sines plant in Portugal had started up and, in the first week of January, Israel's Paz Oil completed the planned upgrade at its Ashdod refinery.

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Some of the raised diesel production in these countries will cover domestic demand, but in the cases of Sines and Ashdod some will go to export.

Paz Oil said it plans to export between one and one a half cargoes a month to the Mediterranean, and traders suggested that Sines could benefit from its close proximity to normally diesel-hungry France.

But while France's diesel consumption grew by 1.5% in 2011, last year the growth slowed down to just 0.2% and even dropped by 5% in December, according to the country's oil industry association UFIP.

So far this year, diesel demand throughout Europe has been slow and diesel prices, which had been the king of the barrel throughout the third quarter of 2012, have been falling.

This week, diesel cargo prices in the Amsterdam-Rotterdam-Antwerp region fell to a 13-month low, reflecting low end-user demand and high supply from European and Russian refineries.

"Everybody filled up stocks after the year-end and there's simply low end-user demand," said one trader.

While the winter period traditionally sees lower demand from farmers and for driving, the diesel market has also been hit by ample production from European refiners, increased Russian exports and a lack of support from the German heating oil market.

Russia is expected to export around 1 million mt of 10 ppm diesel from its northern port of Primorsk in January, the highest volume in several months, as an increasing number of local refineries switch their output to Euro 5 (10 ppm) standard.

More are also expected to do so following major upgrades.

HICCUPS

And yet the diesel supply status could have been more acute if all the planned diesel upgrades had been completed on time or had avoided the usual start-up glitches.

Pernis' new hydrodesulfurization unit became fully operational in June last year, Shell said at the time, adding that it would help "to achieve a substantial production of low-sulfur diesel and heating oil."

But ever since, Europe's biggest refinery has been undergoing both scheduled and unscheduled shutdowns, denting its diesel output.

And after being in startup mode throughout the summer following a $1 billion upgrade, Hellenic Petroleum's Elefsis refinery in Greece reached full capacity only in November.

But traders have said the refinery has reduced its diesel production, which some linked to poor margins, but others suggested could be related to a unit malfunction.

Ashdod's upgrade was delayed several times during 2012, and was completed only at the end of the year.

Israel's second refinery Haifa was also set to start using its new hydrocracker in the second quarter of 2012. But it wasn't until January this year that ORL finally announced the start of commercial production. The new facility is set to produce primarily diesel and jet fuel.

Russian refineries have also been relatively slow in pursuing their upgrades, said Stephen George of consultancy KBC.

"You look at Russia, they are coming slowly, [but] there is no great incentive to start up before the shift in the heavy oil product export duty structure," he said.

This week, Rosneft said it had launched two new refinery units in 2012 and is currently working on 24 new units.

In 2012, according to Russia's energy ministry, the country's oil companies launched and upgraded 15 refinery units.

This is still a minor proportion of the 88 units set for launch or upgrade to 2015.

"67% of refining capacity has now committed to upgrade by 2016," George said, adding that that is when the majority of diesel upgrades will come online.

COMPLETED UPGRADES

Nonetheless, a number of very big refinery projects were completed in 2012.

Gazprom Neft launched the long awaited diesel hydrodesulfurization unit at its Omsk refinery in October, which will help in the product pipeline's switch to lower sulfur diesel.

In November, Gazprom Neft also completed upgrades at its Serbian refinery at Novi Sad, including the launch of a new hydrocracking complex, which will increase its gasoline and diesel supply.

But 2016 could see a flooding of the European diesel market as Russia's upgrade program comes to an end, coinciding with a large scale expansion in the Middle East.

"Russia, the US and Saudi Arabia will be the marginal suppliers. That is when the market will feel the pressure," said George.

Saudi Aramco Total Refining and Petrochemicals (SATORP) is expected to start commissioning the 400,000 b/d Jubail oil refinery by the end of 2013.

Yanbu Aramco Sinopec Refining Company's (YASREF) 400,000 b/d refinery at Yanbu is scheduled to be completed in 2015. Both are geared towards substantial diesel output.

And "by then the Russians will be converting as well," George said.

--Elza Turner, elza_turner@platts.com; Sophie Byron, sophie_byron@platts.com; Olivier Lejeune, olivier_lejeune@platts.com
--Edited by Stuart Elliott, stuart_elliott@platts.com

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