The world’s most crucial fuel is running out of everything

(Bloomberg) — No fuel is as essential to the global economy as diesel. It powers trucks, buses, ships and trains. It powers machines for construction, manufacturing and agriculture. It is burned to heat homes. And with the high price of natural gas, it is also used to generate power in some places.

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In the next few months, nearly every region on the planet will be at risk of a diesel fuel shortage at a time when supply tightness in nearly all the world’s energy markets has exacerbated inflation and stifled growth.

The toll could be huge, spilling over into everything from the price of a Thanksgiving turkey to consumer bills for heating homes this winter. In the U.S. alone, rising diesel costs will hit the economy with a $100 billion blow, according to Mark Finley, an energy fellow at Rice University’s Baker Institute of Public Policy.

“Anything that moves in our economy, diesel is there,” Finley said. “Moving stuff is one thing. People potentially freezing to death is another.”

In the US, diesel and heating oil inventories are at all-time lows for this time of year, according to data going back four decades. Northwestern Europe is also experiencing a low buffer – stocks are expected to bottom out this month and fall further in March shortly after sanctions take effect that will cut the region off from Russian overseas supplies. Global export markets have become so tight that poorer countries like Pakistan are left out, with suppliers unable to book enough shipments to meet the country’s domestic needs.

“It’s certainly the biggest diesel crisis I’ve ever seen,” said Dario Scaffardi, the former CEO of Italian oil refinery Saras SpA, who has worked in the industry for nearly 40 years.

Diesel in the Port of New York spot market, a key benchmark, is up about 50% this year. The price hit $4.90 a gallon in early November, about double what it was a year ago.

Even more telling is the premium that diesel commands. Spreads for the fuel are widening, both against crude oil, a sign of how tight refining capacity is, and over supplies due to be delivered later, underlining that traders are desperate to get their hands on the stuff now. In Northwestern Europe, diesel futures cost about $40 a barrel more than Brent, versus a five-year seasonal norm of just $12. New York diesel futures for December delivery are trading about 12 cents higher than those for January. That compared to a premium of less than a cent at this time last year.

What causes the deficiency?

There are major restrictions on refining capacity worldwide. Crude oil inventories are already quite tight. But the bottleneck is much more acute when it comes to converting that raw material into fuels such as diesel and gasoline. That’s partly a function of the pandemic, after lockdowns destroyed demand and forced refiners to close some of their least profitable plants. But the impending transition from fossil fuels has also affected investment in the sector. Since 2020, US refining capacity has shrunk by more than 1 million barrels per day. Meanwhile, in Europe, shipping disruptions and workers’ strikes have also affected refinery production.

Things could get much more dramatic with the European Union’s looming pivot away from Russian supplies. Europe is more dependent on diesel than any other in the world. According to data from Vortexa Ltd. about 500 million barrels per year are delivered by ship, about half of which are typically loaded in Russian ports. The US has also halted imports from Russia, which was a major supplier to the East Coast last winter.

Also playing in the background is a market structure known as backwardation, where premiums are higher for fast delivery than for longer term deliveries. Not only has that spread been unusually wide, but the backwardation has been unusually long. This outdated market structure incentivizes suppliers to sell now instead of holding the product to build up stocks.

Emergency protocols

In the US, shortages along the East Coast have already caused suppliers to ration and put emergency protocols into effect, and winter hasn’t even started yet.

The Northeast, the most populous corner of the US where temperatures often dip below freezing during a bitter winter, also relies the most on heating oil to keep homes warm. (Diesel and heating oil are the same product in the US, but are taxed differently.) Even in the best-case scenario, consumers there will be saddled with the highest energy bills in decades this winter. The government has already nearly doubled its estimate for the increase, predicting that households dependent on heating oil will be able to pay 45% more than last winter, up from an October estimate of 27%.

Certainly, long-term diesel shortages in the US are unlikely as the country is a net exporter of the fuel. But local outages and price spikes are likely to become more common, especially on the East Coast, where a lack of pipelines creates huge bottlenecks. The region is heavily dependent on the colonial pipeline which is often full. A centuries-old shipping law known as the Jones Act further complicates the transportation of domestic fuel and encourages Gulf Coast producers to favor export over supply to the domestic market.

‘Big dent’

From early February, EU sanctions will ban Russian deliveries by sea. Those Russian barrels need to be replaced somehow if the region’s economy is to continue to run as it is today. How and if that will happen is still unclear.

Winter cold will also exacerbate the problems in Europe. In the Northwest, inventories are expected to fall to 211.9 million barrels in March, the month after EU sanctions take effect, according to consultancy Wood Mackenzie Ltd. That would be the lowest level on records dating back to 2011.

With the sanctions deadline fast approaching, Europe is still importing a huge amount of diesel from Russia. It also brings in massive amounts from Saudi Arabia, India and other countries. As a result, waterborne imports in October hit their highest level since at least early 2016, according to data from Vortexa, compiled by Bloomberg.

Germany has already experienced tightness as low Rhine stocks hampered supplies and curbed production, while refineries in neighboring Hungary and Austria also suffered significant disruptions. French production was stifled by a wave of workers’ strikes over wages.

“If Russia is no longer a supplier, it will put a big, big dent in the system, which will be very difficult to repair,” said Scaffardi, Saras’ former CEO.

Poorer countries suffer

The global fuel scarcity has made it more profitable for exporters such as China and India to send shipments to countries in Europe that can pay high premiums. According to industry consultant FGE, total fuel exports from China are expected to rise by 500,000 barrels per day to nearly 1.2 million barrels by the end of the year.

It remains to be seen whether that will be enough to close the global supply gap, meanwhile poorer countries that cannot afford sky-high prices are suffering.

Poor Sri Lanka is struggling to pay international fuel prices and is unable to secure adequate supplies, the country’s energy minister said. Thailand has extended a diesel tax cut to protect consumers from rising prices, with the government predicting the move will cost about $551 million in lost revenue. Vietnam is seeking emergency measures, including using its central bank to extend more loans to domestic fuel producers to boost supply.

The diesel crisis is “damaging the global economy,” said Amrita Sen, head of research at Energy Aspects Ltd. “Solving diesel density will ultimately require new refining capacity.”

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