Understanding The Diesel Crisis
Distillates are one of the major categories of petroleum products made by oil refiners. The primary distillates are diesel, jet fuel, and heating oil.
The Energy Information Administration (EIA) shows that distillate inventories are at their lowest levels since 2008. However, distillate demand is seasonal. In 2008 distillate levels were low coming out of spring. Currently, they are low going into fall. That’s far worse than the situation in 2008.
Distillate demand generally spikes in spring — when farmers are planting crops — and in fall, when they are harvesting those crops and people start buying fuel oil for winter. Thus, a low distillate inventory in late April 2008 isn’t quite as serious as a low inventory in October 2022. In fact, distillate inventories haven’t been this low in October since the EIA began reporting this data in 1982.
These low distillate inventories are why diesel prices are above $5.00 a gallon nationwide, even though the nationwide average price for gasoline has dropped below $4.00 a gallon.
Factors Driving The Diesel Shortage
Why is there a diesel shortage this year? There are four factors, but two of those factors are in play every year.
As mentioned above, distillate demand spikes at this time of year. But, it does that every year.
This is also the time of year that refineries are doing maintenance. They tend to do that in the spring and fall, which is when demand is lower and the weather is decent. Refinery capacity drops at this time of year.
Third, U.S. refinery capacity has fallen in the past few years as several unprofitable refineries were closed. So, that’s a new factor that has appeared in the past couple of years.
But the primary reason is the cutoff of Russian imports. Prior to Russia’s invasion of Ukraine, the U.S. was importing nearly 700,000 barrels per day (BPD) of petroleum and petroleum products. Most of those imports were finished products and refinery inputs that boosted distillate supplies in the U.S.
The loss of those Russian imports have caused problems for refineries as they struggle to fill holes in their product slates. Refineries do have a small amount of flexibility in shifting gasoline production to diesel production. But it’s a relatively small amount (e.g., ~5% in a refinery I once worked in). That also means that if refiners do shift production, it potentially creates shortages in the gasoline market.
What About Distillate Exports?
One other factor that some have argued is that U.S. companies are exporting more than a million barrels of distillates a day.
That’s a fair point, but it isn’t a new development. U.S. companies have been exporting more than a million barrels a day of distillates for about a decade. The obvious question, then, is why this is being done.
The short and simple answer is that companies are doing it because they can, and because they are making more money doing this than selling it in the U.S. Consumers may complain, but ultimately these companies are trying to make as much money as they can, and that means selling products to the highest bidders.
A U.S. Gulf Coast refiner who wishes to ship distillates to the East Coast must abide by the Jones Act, which requires any cargo shipped between U.S. ports to be carried by U.S. ships, with American crews. This can drive up costs, and make it more economical for that Gulf Coast refiner to export to Europe or South America.
Another important point to note is that sometimes companies export distillates because the product doesn’t meet U.S. standards.
For example, in 2006 EPA began to phase-in more regulations to lower the amount of sulfur in diesel fuel to 15 parts per million (PPM). This required costly investments by refiners to comply. But, some refines chose to continue making high sulfur diesel, and to export that to countries with less stringent regulations. That practice continues today, and explains some of the exports.
That is ultimately a business decision for each company, although it’s understandable that consumers would be upset by such decisions.
The other obvious question — which I am often asked — is why we don’t ban companies from exporting fuel during a fuel crisis? That’s ultimately a political question. Would the crisis be eased if such a ban were in place? It’s hard to argue that it wouldn’t, but it would exacerbate the crisis elsewhere.
Europe is already grappling with a fuel crisis due to situation in Ukraine. They are relying on U.S. exports to help ease their fuel burdens headed into winter.
An American consumer may say that this isn’t our problem, but companies aren’t exporting for altruistic reasons. Some countries are in worse shape than the U.S. with respect to fuel supplies, and they are willing to pay more to obtain them. That, in a nutshell, is why companies are exporting diesel during a diesel shortage.
Winners and Losers
Who wins and loses in the current situation? Winners are the U.S. refiners. They may sell a bit less diesel due to higher prices, but the price more than offsets any loss of volume. The “Big Three” refiners in the U.S. are Phillips 66 (NYSE: PSX), Valero (NYSE: VLO), and Marathon Petroleum (NYSE: MPC). These companies have already seen their share price rise this year by 37%, 67%, and 79%, respectively. However, the good times for them do not yet appear to be over.
But the loser here is the consumer. Because distillates are used to move goods around the world — as well as to provide heating for consumes in the north — the next few months will continue to be expensive. It will be hard to keep inflation in check as long as distillate prices are high. Higher interest rates won’t be that effective at addressing this particular problem.
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