US diesel fuel supplies are at record lows. The problem is acute throughout the entire country, though the East Coast is feeling the most severe impacts. Prices are said to be running +30-80 cents more per gallon in pockets of the East where inventories are tightest, with some fuel suppliers already rationing supplies. Across the US as a whole, diesel prices at the pump are double what they were at this time last year. Below is a little more information about how we got into this situation and where industry insiders expect things will go from here.
It’s All About Distillates: Technically, diesel is classified as a “distillate” which is a product obtained from the condensation of vapors during a distillation process. Beyond diesel, distillates include kerosene, heating oil, jet fuel, and gasoils, among others. US petroleum refineries can produce an average of 11 to 12 gallons of diesel fuel from each 42-gallon barrel of crude oil. Most refineries generally produce 50% unleaded gasoline, 30% diesel, 10% jet fuel, and 10% other fuels, including propane and general aviation gasoline. Refiners are cautious about changing up their refining ratios to produce more of just one type of fuel as the consequence is typically an oversupply of other fuel types.
Record Low Supplies: One key way the industry gauges the US diesel supply is a measurement known as “Days Cover” which is literally the number of days the current supply is estimated to last. Non-jet distillates inventories, which are typically around 90% diesel, came in below 30 days for four consecutive weeks through October 21. In the most recent week, Days Cover dropped down to 25, the lowest level for this time of year in records going back to 1993.
Extreme Backwardation: With high demand for diesel fuel, traders are paying more for prompt deliveries than longer-term ones as they expect prices to drop in the future. This is a market structure known as “backwardation.” This creates a situation where suppliers have little incentive to build inventories as it is more profitable to sell now.
Lack of Refining Capacity: The entire global petroleum and refining system has been unable to keep up with the rapid growth in fuel consumption. Unlike gas and jet fuel, demand for diesel recovered at a much faster pace from the pandemic. Since the beginning of the COVID-19 pandemic, at least 13 US refineries shut down, significantly cut operations, or switched to other petroleum products, including renewable diesel. The loss of the 13 refineries accounted for more than 1.4 million barrels of oil per day, or more than 7% of the country’s entire capacity of gasoline, diesel and jet fuel. Worldwide, refining production is down by an additional -2.13 million barrels.
Factors Exacerbating East Coast Supply Troubles: According to the EIA’s most recent Winter Fuels Outlook, distillate fuel inventories on the East Coast at the end of September were -45% below the five-year average. Contributing factors include limited refining capacity, increased domestic demand in the first half of the year, and low imports due to generally tight global distillate supplies. The EIA notes that although refineries on the East Coast are running at close to their capacity, regional refining capacity has fallen in recent years. In 2019, the Philadelphia Energy Solutions refinery, the region’s largest, was shut down permanently following a fire. From January through September 2022, East Coast refinery utilization averaged 91%, and gross refinery inputs averaged -15% less than the five-year average.
US Competing with Europe: Relatively low global natural gas and coal supplies can affect US distillate markets because certain international markets use distillate fuel for power generation if prices of natural gas or coal become uneconomical or supplies are unavailable. Many EU refiners, for instance, use natural gas to power their facilities. This is usually economical because certain processes in a refinery also use natural gas. However, most EU refiners are facing extremely high natural gas prices so have switched to diesel instead, further straining global supplies. Additionally, experts say a French refinery workers’ strike made the shortage much worse than it would have been otherwise. Shutdowns for seasonal maintenance in October also knocked some -1.5 million barrels per day of refining capacity offline.
Outlook for the US: If manufacturing and freight activity peaked in the third quarter of 2022 like many economists believe, that will provide some demand relief. However, industry experts say it would take a significant slowdown to reduce consumption enough to begin building inventories by any meaningful levels. Some warn that rebalancing diesel supplies will require further tightening by the Federal Reserve and other global central banks, and possibly even global recession.
EU Unknowns Complicate Outlook: The diesel crisis in Europe is expected to intensify with the EU set to ban the import of Russian refined petroleum products by sea starting in February 2023. When the ban comes into force, Europe will have to replace Russian diesel either by ramping up its own production or importing from countries. An EU embargo on Russian crude is also expected to go into effect in February 2023, though it’s unclear what impact that may have as EU diesel demand is far greater than what it has the capacity to produce even with Russian oil supplies.
US Government Options: The White House is said to be considering a release of diesel supplies from the Northeast Home Heating Oil Reserve. According to experts, it houses around 1 million barrels of diesel fuel. Unfortunately, experts say that at current demand levels, that 1 million barrels would be depleted in less than 6 hours. The Biden administration is also still considering export restrictions, though the industry has pushed back hard against the idea, saying it will end up backfiring because refiners would further reduce capacity. (Sources: US Energy Information Administration, Bloomberg, The Economist)