Diesel settles: 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 $5.81 a gallon in the summer of 2022, more than double the $2.39 level of two years earlier.

Prices have since moderated, falling to $3.89 by late May 2023. That’s due largely to lower demand caused by a decline in the panic buying that occurred in the initial months of the Russia-Ukraine war and a general softening of the global economy. And more relief is on the way. The U.S. Energy Information Administration projects a price dip to $3.79 by the start of 2024.

Even so, diesel prices remain high by historic standards. Price estimates for the fall of 2023 are nearly double what was typical before the pandemic, when the cost per gallon hovered around $3 (see chart below). There’s no disagreement about the main reason: the Russia-Ukraine war.

“What’s happening in Russia is affecting global energy markets in a very deep and profound way,” says Clark Williams-Derry, an analyst at the Institute for Energy Economics and Financial Analysis.

Russia produces about 10 percent of the oil from which the world refines diesel. Europe is especially dependent on Russia for its supply.

“The war has disrupted the European market, either completely eliminating it or dramatically reducing it,” says Allen Schaeffer, executive director of the Diesel Technology Forum. “That means that folks in Europe and other countries that might have done business with Russia in the past now are scrambling to find fuel in other places.”

Europe’s increasing demand for diesel affects prices everywhere, given the commodity status of oil and its distillates.

“One nation’s demand affects everyone,” says Schaeffer. “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 1 million barrels of the distillate every day.

“The U.S. is a net exporter of oil and petroleum products but is still as dependent and as vulnerable as ever to global market forces,” says 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 war is the major driver of diesel’s price tag, it’s not the only one.

“A number of factors have put upward pressure on retail prices,” says Andrew 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 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,” says 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 U.S.,” says 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,” says 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., notes 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 carryover from the worst days of the COVID-19 pandemic.

“At the peak of the pandemic in 2020, diesel demand had gone down by 30 percent, and refineries were losing tons of money,” says Lipow. “At the same time, they were getting older. In the U.S., they were also facing more environmental restrictions, especially in California.”

Refinery operators were put on the spot as the pandemic softened demand for their products and the Biden administration moved away from fossil fuels.

“Suppose you’re looking at spending several hundreds of millions of dollars, perhaps even a billion dollars, to comply with new environmental regulations,” notes Lipow. “In an environment where the demand for your product is going down, you may well decide to simply shut down.”

The slim levels of diesel inventory leave the market vulnerable to unexpected shocks.

“All you need is one little hiccup in the supply chain or a problem with a pipeline or a big cold snap in the Northeast,” says Schaeffer. “The next thing you know higher prices and shortages are back in the news.”

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.

“Kuwait and Oman are building brand new large refineries,” says Lipow. “Two new refineries have just come on stream in China. And we’ve got another large refinery coming on stream in Nigeria. Closer to home, Mexico is building a new refinery, known as Dos Bocas, coming online in the next couple of years.”

Lipow figures these new refineries will produce some 2 million barrels a day, equivalent to about a 1.5 percent to 2 percent increase in world refining capacity.

Another contributor to an increase in diesel supply is the expanding green energy movement.

“We are seeing a tremendous growth in investments to produce biodiesel and renewable diesel,” says Schaeffer. “Having more renewable biofuels helps not just keep the price down a little bit, but also it helps with more supply being available.”

Major oil refiners jumping onto the green bandwagon include Phillips 66, Marathon Petroleum and Chevron. All are investing in new refining capacity or transitioning older petroleum operations to make more renewable diesel. Other companies such as Marathon and Diamond Green Diesel are joining the effort. All told, the past year has seen the production of 3.2 billion gallons of green diesel, about two-thirds of which was biodiesel. Schaeffer figures that by 2030 production should top 15 billion gallons.

Currently, renewable diesel and biodiesel account for about 5 percent of U.S. diesel demand, and there has already been some favorable effects. The Clean Fuels Alliance America, an organization of biodiesel producers, estimates that renewable fuels account for a little over 3 cents a gallon of price suppression.

The larger benefits of green energy, however, are expected to be more medium than short term in nature. Industry watchers feel that it will take three to five years before a significant growth in green diesel production will assist the broader diesel market.

A larger concern is the effect the green energy production may have on food availability – particularly soybeans.

“Currently, renewable diesel and biodiesel production consume roughly 35 percent of soybean oil production,” says Lipow. “And there is enough renewable diesel capacity coming online this year and next to increase demand for soybean oil by another 10 percent. We can certainly divert crops to fuel, but that gets us back into the debate about food for fuel.”

Another technology, electric vehicles, may also help loosen the diesel market.

“The growth of EVs may lessen the demand for gasoline,” says Schaeffer. “And that might lead refineries to adjust their output of finished products.”

Green energy initiatives aside, a deceleration in global economies may also help bolster diesel supply.

“We have been seeing a little bit of a slowdown on freight demand in the trucking sector,” says 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.”

Slowing economies

According to estimates from L.E.K. Consulting, fuel can account for up to 25 percent of a typical trucking operation’s operating costs. That can rise to 35 percent to 40 percent 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,” says 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 war? How will Europe handle the shock of a drop in oil supply? Will sanctions and tensions escalate, or will 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,” says Williams-Derry. “It’s not just about supply and demand. It’s also about politics.”