Will We Run Out Of Fuel?
Diesel fuels the global economy, and the outlook going into next year looks grim. With inventories at the lowest level in decades and prices continuing to rise, could this spark the next global crisis?
Diesel prices have surged 50% since last year, fueling headlines like these:
It's hard to think of a fuel more important than diesel. It powers trucks, buses, and almost everything else that moves goods across the globe. It fuels construction and farming equipment, and it heats homes through cold winters in the Northeast and Europe. But “rising prices” and “crisis” are not the same, so let’s explain how we got here and how bad it could get.
There are three main forces that are currently impacting diesel supply. The first is constraints on refining capacity. Diesel is created by taking crude oil out of the ground and refining it. Supplies of crude oil have been tight for some time.
The refining process is also complicated and expensive, so few refineries produce diesel. Making matters worse, the lockdowns destroyed demand and forced refiners to close some of their least profitable plants. The political push to move away from fossil fuels to cleaner forms of energy has also taken capacity offline. Over in Europe, shipping disruptions and worker strikes have also hurt production.
The second force is a pivot away from Russia. Europe relies more heavily on diesel than anywhere else. Roughly 500 million barrels a year get delivered by ship, with around half of that coming from Russia2. Europe is planning on banning Russian seaborne deliveries starting in February. The U.S. has also halted Russian supply, which historically has been a big supplier to the East Coast in the winter.
The third force is human behavior. Supply crunches tend to feed off themselves (lumber prices quadrupled in months last year, and toilet paper sold for a premium on Craigslist in 2020). The futures market for diesel is showing similar signs of hoarding. Part of this is Europe buying as much diesel as possible before the winter months, but it could also be speculators looking to make a quick buck and distorting the market.
How bad could it get?
Diesel inventories in the U.S. are the lowest in over 40 years. Despite the stockpiling, Europe is also facing a low buffer. Global export markets have gotten so tight that poorer countries are not getting enough fuel to meet demand.
In the U.S. alone, the rising diesel cost could mean a $100 billion hit to the economy1. It’s hard to say if this is accurate, but the intuition makes sense. If Americans in the Northeast spend 50% more on heat this year, that’s less discretionary income to put into the economy.
Supply crunches can also lead to price spikes and localized outages. Thanks to pipeline bottlenecks in the Northeast and a century-old law that makes shipping diesel across the U.S. very difficult and costly (the Jones Act3), there is a possibility that both could happen more than once next year.
But while $100 billion is a big number on its own, it’s a rounding error compared to the $23 trillion total economy. There’s also an old saying amongst commodities traders that “the cure for high prices is high prices.”
Furthermore, despite low inventories and sanctions, the U.S. remains a net exporter of diesel. The shipping constraints and massive premium European countries are paying for diesel right now have pushed U.S. refiners to sell more diesel overseas because they make more money doing so.
Said another way, the U.S. has plenty of diesel fuel. It’s just a matter of incentivizing refiners here to sell it here. Free markets and governments have a way of creating those incentives when needed most.
Additionally, exporters like China and India face fewer regulatory hurdles to boost refining capacity than the U.S. In fact, overall fuel exports from China are expected to rise by 500,000 barrels a day to near 1.2 million barrels by year-end1. That’s a big move in a short amount of time.
Simply put, prices could remain high for a while, but that in no way implies a crisis.
The Bottom Line
Rewind the clock to March, and it felt like a foregone conclusion that crude oil was headed to $200/barrel. It was hard to find anyone who thought otherwise, fueling headlines like these4:
These calls seemed justified at the time because the global economy was opening, inflation was surging higher, and the war in Ukraine was front-page news. Fast forward to today, and the chart below shows that crude oil in the U.S. is effectively flat year-to-date. It’s almost as if that price spike never happened.
It's not just oil. Lumber prices are down to pre-lockdown levels. Chicken prices spiked earlier in the year only to have fallen 70% since June5. The story is the same for copper, wheat, cotton, shipping container rates, and so many other input costs.
To be clear, I’m not predicting the same for diesel. I have no idea where prices are going, but neither does anyone else. Just be careful of jumping to conclusions the next time one of these headlines comes across the screen.
What I’m more certain about is that the eternal battle between supply and demand has a way of fixing market anomalies. I see no reason why the diesel fuel market would act differently.
The bottom line is that the diesel market should be watched closely, but it will likely take much more than price spikes and temporary outages to fuel a true crisis.
Sincerely,
Brian Malizia, President
Mike Sorrentino, CFA
Sources
1 https://www.bloomberg.com/news/articles/2022-11-22/shortage-looms-for-diesel-world-s-most-crucial-fuel
2 https://markets.businessinsider.com/news/commodities/russia-oil-europe-energy-crisis-diesel-sanctions-price-cap-2022-11
3 https://www.investopedia.com/terms/j/jonesact.asp
4 https://awealthofcommonsense.com/2022/11/the-thing-thats-hard-about-markets/
5 https://www.wsj.com/articles/popeyes-wingstop-others-step-up-chicken-offerings-as-poultry-prices-drop-11669501569
Disclosures
This newsletter/commentary should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.