2022 Theme: Energy Crisis: It’s Diesel, Not Oil!
One of the more puzzling aspects of modern commodity markets is that no one actually buys the commodities that are most frequently quoted and discussed.
This is pretty weird!
Rather than buy oil, consumers instead buy refined oil products. Yes, there is a close connection of course but, as we will dive into below, not always and this distinction is pretty important.
To abuse an old adage, the market could stay exceptional longer than you could stay in business.
Your average US consumer is directly exposed to some of these products like gasoline or diesel and indirectly exposed to others (like jet fuel or diesel or fertilizer).
And the strange thing is, the difference between raw crude and a refined product actually matters quite a bit financially. Especially at present.
Here is why:
Because the prices refined products can be, in some cases, very disconnected from the price of the underlying commodity.
In other words, the normal correlation between wheat and bread or iron ore and stainless steel or, especially, oil and refined products like gasoline or jet fuel or diesel can break down.
This can happen for any number of reasons - weather or a war or refinery maintenance or an unplanned disaster like a fire. In this case, a war in Europe has led to artificially scarce supply and the requisite high prices to go along with it and new markets for certain types of oil which has led to shortages in regions and areas that normally don't struggle to maintain supply.
And when happens, this breakdown usually creates a simple unbalance that can then feed on itself and achieve two things:
A severe and exaggerated dislocation compared to what standard models suggest.
And a self fulfilling prophecy that feeds into many other choices made in the modern economy.
This happens most often because of structural constraints. There is often just not enough capacity or supply of oil to refine enough of some critical product or even a byproduct. Veteran readers may remember that we broke this down with rising prices ammonia and sudden and unexpected shortages of carbon dioxide in Europe and the United Kingdom last summer.
Uncomfortably and yet helpfully, this is happening at present in the US diesel market.
This past Friday we saw the 9th straight record all time high for U.S. average diesel retail prices, climbing to $5.539 per gallon, according to the AAA.
As you can also see at the link, gasoline prices are also very high ($4.317 per gallon, the record is $4.331) but far, far cheaper than diesel.
This means that U.S. retail diesel prices are up over 80% year-on-year, 30 cents per gallon in the last few weeks and over $2.25 per gallon in the last year.
Another way to put it is: oil is up 40% this year, diesel is up 125%.
And here is what the chart looks like:
Does this matter?
Quite a bit. You might not drive a diesel vehicle (or even a fossil fuel vehicle) but the price of diesel will nonetheless have an major impact on your life in the coming months.
Two reasons for this:
We are simply just not yet very far down the carbon transition.
Diesel is the secret workhorse of the modern economy.
It goes unacknowledged in this era of high signaling over climate change but the global economy literally runs on diesel. The fuel is more important than gasoline for supply chains, since it powers the trucks and freight trains that deliver our goods.
As the price of diesel rises, life gets harder for trucking companies and railroads, transportation costs increase, and those costs can get passed on to consumers as higher prices for a variety of goods. For instance, according to the CEO of Freightwaves, an owner-operator truck driver doing 7000 miles per month in her truck and getting 6.5 MPG would be watching their fuel bill jump $1800 per month since the start of the year.
The fuel is also a critical input for farming as well as any industry like manufacturing that relies on a lot of heavy machinery.
Two follow on impacts here:
Sky high diesel has an inflationary pulse throughout the economy.
But that price level will also drive a lot of behavior within the energy industry itself.
For instance, the current price of diesel, especially in certain regions like the Northeast will make it very attractive for local refiners to refine diesel.
This won't be happening in a vacuum though.
It will displace other fuel distillates and refined product. So, today's high dieself will start to become tomorrow's high gasoline (or what have you). A record all time high for gasoline is, for instance, extremely likely this summer.
And so what began as a structural imbalance due to too little of one type of oil in one part of the country thanks to a far off war that had the side effect of destabilizing global energy supply will eventually ripple out to determine that nearly everyone is paying higher diesel (or higher gasoline or both!) prices.
The heavy US driving season begins in just over 3 weeks after Memorial Day and nearly all Americans are going to get a rude surprise to go with their higher interest rates.
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