Diesel prices an ominous sign for the economic outlook
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“The lifeblood of modern-day America” is oil, President Richard Nixon said in 1972. It might be more accurate to say it is diesel. More than 70% of US freight is moved by trucks, most of them diesel fueled, and more than 40% of the energy used in US agriculture is diesel.
Its essential role means that demand for diesel tends to be resilient. At the peak of the impact in the US of the Covid-19 pandemic, in April 2020, gasoline consumption was down 44% on the same period a year before. Demand for distillate fuel, including diesel, was down just 15%. When diesel prices rise, they put upward pressure on inflation for food and for any goods that are moved by road.
So the soaring price of diesel this year is an ominous sign for the US and the global economy. The average retail price of diesel in the US rose this week to a new record high of about $5.62 a gallon, up 76% over the past year, according to the Energy Information Administration. Prices are particularly high in the Northeast, averaging about $6.32 a gallon in the Central Atlantic region from Washington to New York, and about $6.34 a gallon in New England.
What is particularly noteworthy is that the prices of diesel and other products have become unmoored from the price of crude. Those record diesel prices came as Brent crude has been trading in a range of $102-$112 a barrel for most of the past month, well below its record high of $147 in the summer of 2008. Wide crack spreads have opened up between the cost of crude and the prices of oil products, creating historically strong profit margins for refiners.
One would-be reassuring argument about the current level of oil prices is that in real terms, adjusted for inflation, they are not particularly high by the standards of the past two decades. But that reassurance does not apply to diesel. Adjusted for inflation, Brent crude today is still about 17% below its average during 2010-13, which were years when both the US and the wider world economy grew steadily. Current retail diesel prices, however, are in real terms about 20% above their 2010-13 average.
Russia’s invasion of Ukraine in February is one factor behind these strong diesel prices, but not because its exports have been cut off. Russia’s diesel exports have so far remained “pretty healthy”, says Mark Williams, Wood Mackenzie’s research director for short-term refining and oil product markets. It has been the prospect of possible future disruption caused by an EU ban on oil imports from Russia, now being debated by European leaders, that has driven prices higher in recent weeks.
The impact has been intensified by the relatively low level of diesel stocks when the crisis hit. High natural gas prices in Europe were a constraint on refiners, and a market in backwardation created an incentive to allow inventories to run down.
Expectations about the transition to lower-carbon energy have also played a role. Since the pandemic hit at the start of 2020, about 3 million b/d of refining capacity has been shut down around the world. For companies with aging refineries that required significant investment to remain viable, it has been difficult to justify the spending in the face of a weak demand outlook, particularly for gasoline as a result of increased fuel efficiency and the rise of electric vehicles. Refining capacity in the PADD 1 region of the US, the East Coast, dropped from 1.22 million b/d at the start of 2020 to 818,000 b/d a year later.
Meanwhile, new refining capacity has been delayed, in part because of the pandemic and weak refining margins, and is only now becoming available. The Jazan refinery in Saudi Arabia started operations last year but only fully commissioned its diesel production units this month, and the Al-Zour refinery in Kuwait is scheduled to begin operating very soon, probably next month.
With demand growing, buyers have been forced to bid up prices to secure supplies. In the Northeast US, diesel markets have been particularly tight after jet fuel prices in New York Harbor last month hit record highs, encouraging refiners serving the region to maximise production of that. Stocks of distillate fuel oil on the US East Coast have fallen 49% since the end of 2021, dropping last week to about 21.3 million barrels, their lowest level since the series began in 1990.
For refiners, this has created market conditions of a kind that are rarely seen. Refiners that have are still choosing to process Urals crude, currently selling at a discount to Brent of $35 a barrel or more, have it particularly good. Wood Mackenzie’s calculated global composite gross refinery margin, which has rarely been above $5 a barrel in the past few years, has now risen above $30 a barrel.
As Russia loses its ability to export crude and products to Europe, it will have to find new markets elsewhere. Russian diesel will increasingly move instead to Africa and Latin America, with product from the Middle East filling the gap in Europe. “The whole global diesel market needs realignment,” Williams says. As that realignment takes shape, some of the risk premium in the diesel price may fade. The new refining capacity coming online in the Gulf region should also help ease the tightness in product markets.
In the short term, however, the only way that the diesel market may really be able to come back into balance may be through a downturn in the economy. That could result from the programme of interest rate rises that the US Federal Reserve has embarked on, with the goal of curbing inflation, which is being stoked by rising diesel prices. “The demand destruction that could come from these prices is substantial. And the GDP loss could be substantial too,” Williams says. “When we look at the tight market, the natural conclusion is to say that a recession sorts this.”
US members of Congress aim to stop fuel price gouging
Proposed legislation intended to prevent “price gouging” for fuel in the US will be brought to a vote in the House of Representatives. The law would make it illegal for anyone to sell fuel during a designated “energy emergency” at prices that are “unconscionably excessive” and indicate “the seller is exploiting the circumstances related to an energy emergency to increase prices unreasonably.” Companies found to have breached the law could be made to pay penalties and compensation.
Katie Porter, chair of the House Natural Resources Subcommittee on Oversight and one of the sponsors of the bill, said: "Big Oil is price gouging families because they can. Enough is enough. I'm proud to help introduce this bill that will hold these corporations accountable, stop their abuse, and give families relief.”
The legislation is unlikely to win sufficient support in Congress to become law. There is a broad consensus among economists that the price controls introduced by President Richard Nixon in the early 1970s, were ineffective and caused long lines at filling stations. As the US Federal Reserve put it, the controls “only temporarily slowed the rise in prices while exacerbating shortages, particularly for food and energy.”
BlackRock, the world’s largest asset manager, has said it expects to support a smaller proportion of climate-related shareholder proposals at this year’s round of company annual meetings than the 47% it backed last year. In a statement on its approach to shareholder votes this year, BlackRock said it was seeing more proposals this year that “implicitly are intended to micromanage companies”, which it was unlikely to support. Those attempts at micromanagement include constraints on board decision-making and demands to address issues not material to long-term shareholder value.
BlackRock noted that other investors were also less inclined to back detailed prescriptive proposals such as those demanding an end to providing finance to fossil fuel companies, alignment to a specific 1.5⁰C climate scenario, or absolute targets for cutting Scope 3 greenhouse gas emissions.
Hundreds of upstream oil and gas assets sold over the past five years by large international companies have ended up in the hands of smaller operators with lower profiles and fewer commitments to cut emissions, according to the Environmental Defense Fund, a campaign group. “These transactions can make it look as though sellers have cut emissions, when in fact pollution is simply being shifted to companies with lower standards,” Andrew Baxter of the EDF said.
Midland, the oil capital of west Texas, is experiencing the fastest price inflation in the US.
Electricity grid operators across the US, from California to Texas to Indiana, are warning that supply capacity is struggling to keep up with demand, the Wall Street Journal reported.
Boris Johnson, the UK prime minister, has refused to rule out the possibility of a windfall tax on oil and gas companies.
In September 2020, it was seen by some as significant that the market capitalisation of Zoom, the video conferencing company, was greater than that of ExxonMobil. This week, ExxonMobil’s market capitalisation was more than 14 times that of Zoom.
Quote of the week
“The key thing is not to give into this notion that, ‘Oh, Ukraine has changed everything, and so we will be building out infrastructure that we decided a little while ago that we can’t do now’… Some people are trying to interpret it as, ‘This means we gotta build coal’… But that’s not our reality.” — John Kerry, the US climate envoy, used an interview with the Financial Times to urge governments to continue their progress towards goals for cutting greenhouse gas emissions, despite the strains on energy security and affordability caused by Russia’s invasion of Ukraine.
Chart of the week
For a long time, there has been a broad consensus in the transport industry that while electric vehicles might be highly competitive for passenger cars and light commercial vehicles, heavy road transport would be difficult to electrify, not least because of power-to-weight issues for trucks needed to carry heavy loads long distances. However, a fascinating new opinion column from Prachi Mehta, a Wood Mackenzie principal analyst who follows EVs, suggests that there is “a promising move towards heavy duty electrification,” thanks to strong support from manufacturers and governments. This chart shows the gross vehicle weight ratings (GVWRs) and ranges for a selection of existing and proposed electric heavy trucks. Based on truck usage data, Mehta has estimated that “about 42% of heavy-duty single and combination vehicle sales and 21% of vehicle miles travelled (VMT) can be hypothetically electrified, based on the 250-300 mile range available on the models to be released this year.” The full details of her analysis are available in this report.