In this paper, we propose an IC engine fuel system diagnostic algorithm based on a discrete-event nonlinear observer using the production oxygen sensor. A mean value engine model is used to describe the engine dynamics. A procedure for designing the discrete event based observer is presented and applied to estimate important engine variables using the measured binary oxygen sensor output. The estimated variables are then used to perform diagnostics of the fuel system of the IC engine. Experimental results on a multi-cylinder production engine are presented to demonstrate the effectiveness of the proposed method.