Prices Moderate as Panic Buying Eases

For diesel buyers, price relief can’t come soon enough. Essential to truck fleet operations and a costly drain on business profitability, the distillate fuel oil was selling for a historic high of $5.75 a gallon this past summer, more than double the $2.40 level of two years earlier.

Prices have since moderated, declining to $5.21 by late 2022. And more relief is on the way. The U.S. Energy Information Administration projects a price dip to $4.41 by the Fall of 2023.

One reason for the price moderation is a decline in the panic-buying that occurred in the initial months of the Russia-Ukraine war. Another is a move by refineries to retool their operations for greater diesel capacity. Another a third is a general deceleration in the global economy which results in declining demand.

The costs of war

While diesel prices have moderated, they remain sky high by historic standards. Price estimates for the Fall of 2023 remain some 47% above typical pre-pandemic levels (see chart). And there’s no disagreement about the primary reason. “Diesel prices are elevated right now largely because of the Russia-Ukraine war,” said Clark Williams-Derry, an analyst at the Institute for Energy Economics and Financial Analysis. “What’s happening in Russia is affecting global energy markets in a very deep and profound way.”

Russia produces about 10% of the oil from which the world refines diesel. Europe is especially dependent on Russia for its supply, and its increasing demand for diesel affects prices everywhere, given the commodity status of oil and its distillates. “One nation’s demand affects everyone,” said Allen Schaeffer, Executive Director, Diesel Technology Forum. “We are seeing a whole trickle-down scenario as more people try to use a product that has become less available.”

The global nature of diesel is responsible for its elevated pricing in the U.S., despite the nation’s export of roughly one million barrels of the distillate every day. “The US is a net exporter of oil and petroleum products but is still as dependent and as vulnerable as ever to global market forces,” said Williams-Derry. “We don’t get a cheaper price just because we are producing more oil or because we have a lot of refinery capacity. We pay the same price as anyone else who is avoiding Russian oil.”

Upward pressures

While the Ukraine war is the major driver of higher diesel costs, it’s not the only one. “A number of factors have put upward pressure on retail prices,” said Andrew M. Lipow, President of Houston-based Lipow Oil Associates. “One is the post-pandemic reopening of economies around the world.” People are traveling more, and that means greater demand for the jet fuel which pulls from the same oil resources required for diesel. And more fuel is needed for the greater number of trucks delivering capital goods and consumer merchandise.

The rebound in global demand is happening at a time when many refineries have cut back production or closed. “We don’t have as much capacity to produce diesel fuel today as we did pre-pandemic,” said Schaeffer. “COVID caused a lot of layoffs at refineries around the world. It also caused a delay in the startup of new refining capacity which would have increased supply.”

The U.S. possesses some specific additional drivers of fuel prices. “For the last few years, even before the Russian crisis, diesel has sold at a premium to gasoline in the US,” said Williams-Derry. “One reason is higher federal and state taxation. Another is the shift to lower sulfur diesel. That’s been very good for clean air but has also slightly increased the price of diesel relative to gasoline.”

Low inventories

The fact that distillate inventory is running low around the world has only added to upward pricing pressure. “As economies have recovered, the supply of crude hasn’t kept up with demand,” said Lipow. “For all intents and purposes, diesel levels are the lowest they’d been since 1951. The world has been living on borrowed time if you will, by drawing down inventories.”

Diesel supplies are tight in most of the regions of the U.S., noted Lipow. Nationally, inventory supply has been running at 25 days, down from its normal 30 to 35 day level. Of particular concern is the East Coast, a region with high population centers, high heating oil demands, and a lack of refining capacity. In late 2022 the region had only 13 days’ supply of diesel, down from 26 a year earlier. One exception to the trend is the Gulf Coast with its robust refining capacity and limited requirement for home heating.

In a perfectly fluid market one would expect dwindling inventories and growing demand to stimulate higher production at the world’s refineries. Yet there are roadblocks, one of which is a carry-over from the worst days of the pandemic. “At the peak of the pandemic in 2020, diesel demand had gone down by 30%, and refineries were losing tons of money,” said Lipow. “At the same time, they were getting older. In the U.S. they were also facing more environmental restrictions, especially in California.”

Growing capacity

Not all is doom and gloom in the energy picture. Despite the cost and the delays required for creating new refineries or upgrading older ones, some new capacity is coming on stream in the first half of 2023. New facilities are slated for opening in Kuwait, Oman, Nigeria, Mexico and China. And we’ve got another large refinery coming on stream in Nigeria. Lipow figures these new refineries will produce some 2 million barrels a day, equivalent to about 1.5% to 2% increase in world refining capacity.

Another contributor to an increase in diesel supply is the green energy movement. Growth in biodiesel and renewable diesel production should help boost supply and put downward pressure on prices. Currently, renewable diesel and biodiesel account for about 5% of U.S. diesel demand, and account for a little over 3 cents a gallon of price suppression, according to The Clean Fuels Alliance America. Finally, the rapid growth of electric vehicles may lessen the demand for gasoline, freeing refineries to make more diesel.

Green energy initiatives aside, a deceleration in global economies may also help bolster diesel supply. “We have been seeing a little bit of a slow down on freight demand in the trucking sector,” said Schaeffer. “The economy and inflation seem to be taking a bit of a toll there, and that should allow some of the inventories to come back up a bit.”

Welcome relief

According to estimates from L.E.K. Consulting, fuel can account for up to 25% of a typical trucking operation’s operating costs. That can rise to 35% to 40% in a high fuel price environment. It follows that the price moderation forecast for the coming months will come as welcome relief. “We feel like we’ve hit the ceiling now and are just going to be settling down over the next six months,” said Schaeffer. “We’re going to be paying a higher rate for diesel than we’ve been accustomed to. But it won’t be as high as where we are now.”

Even so, uncertainties in the global operating environment mean that the future of diesel availability and pricing will depend largely on the answers to some open questions. How will the world deal with and recover from the Ukraine wear? How will Europe handle the shock of a drop in oil supply? Will sanctions and tensions escalate, or will the Russia experience an internal political shift and reach an accommodation?

“If you’re trying to predict what’s going to be happening in fuel markets, this is a particularly unusual time,” said Williams-Derry. “It’s not just about supply and demand. It’s also about politics.”

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