Prices will likely be on their way back up relatively soon.
As of this week, diesel prices have declined to their lowest level since April 18. That includes a 67.2-cent-per-gallon decline in the past six weeks.
That’s good news for truck drivers, farmers, and others dependent on diesel for their livelihoods. But does this price drop represent a return to more normal price levels, or only a momentary reprieve from this year’s soaring costs?
John Kingston of FreightWaves believes the data suggest that prices will rise again soon. In an interview with Rachel Premack, he outlines the reasons why.
Refineries are still “running just full blast,” he says. He points to the Q2 earnings call from Phillips 66, one of America’s major refiners, where executives noted that inventories are still tight, and summer is not peak diesel season. In the fall, harvesting crops increases diesel demand from the agricultural sector, which will squeeze inventories further.
Unlike gasoline, diesel is a distillate. One of the other major distillates is heating oil. That means winter will see greater demand for distillates, which will increase price pressures. That’s normal seasonal behavior, but this year will present further challenges due to Europe’s dependence on Russian natural gas that may not be forthcoming. “When you don’t have enough natural gas, you inevitably turn to diesel or some kind of distillate as a substitute, whether it is for an industrial process [or] whether it’s to generate electricity, diesel can be a substitute for natural gas,” Kingston told Premack.
Kingston explains the present “backwardation” of the diesel market. He says that ordinarily, the price of a commodity on the futures market should be greater in the next period than in the previous period. That’s because of the time value of money and the cost of storing the commodity until it is used. But, he explains:
When markets get very, very tight, like they are now, the market shifts into a structure known as ‘backwardation.’ In backwardation, it’s X for the first month, X minus something for the next month, X minus something even more for the next month after that. The reason is because with supply short, you absolutely want the front-month barrel. You want the most immediate supply right now.
The diesel market is in eye-popping backwardation right now. It’s not quite as crazy as it was. The highest number I’ve got here was $1.19 for the 12-month backwardation, meaning the front month versus 12 months out. I’ve got one number that got out to $2.14. I mean, it’s just nuts. Right now, it’s about 50 cents. A year ago on Aug. 3, the 12-month curve was 7 cents.
That backwardation has continued, even through the price decline, which indicates that traders still believe supply is very tight and will remain so in the near future.
The longer-term regulatory constraints on the diesel market, as I wrote about in April, have not changed. Neither has the fundamental chemistry problem: One barrel of crude oil yields about 20 gallons of gasoline, but only 12.5 gallons of distillate. “As the world looks to consume more diesel, relative to gasoline, if that is in fact the way we’re going, that’s a problem. You cannot stand in front of a refinery and demand that it produce nothing but diesel because we don’t want gasoline right now,” Kingston says.
That trend is caused both by an increased appetite for diesel and a decreased appetite for gasoline. The International Maritime Organization, a U.N. body that regulates global shipping, wants all ships to use a diesel-like product as fuel rather than bunker oil, the current industry standard, because it would reduce sulfur emissions. (The IMO also wants all ships to go slower to reduce emissions.) At the same time, demand for gasoline is expected to decline in the long run as more people buy electric cars. The increased reliance on electricity will, in turn, increase demand for distillates used in electricity generation.
That means the “energy transition” celebrated by the Left will, in the short-to-medium run, be one that moves away from gasoline and towards distillates, the refined product that is less plentiful from one barrel of crude. Refiners have to keep those trends in mind when making investment decisions, since refinery investments are very expensive and only pay off over a decades-long time horizon. Layer in the regulatory hurdles on top of that economic trend, and it’s no wonder that nobody wants to invest in refinery expansion.
Both for short-run reasons in commodity markets and long-run trends in energy usage and regulation, diesel prices will likely be on their way back up relatively soon.