The growing strength of diesel fuel relative to crude is beginning to draw significant attention in oil markets, even as there is evidence the past few days that the widening spread between the two may be taking a breather.
The benchmark Department of Energy/Energy Information Administration average retail diesel price fell 0.7 cents/gallon Monday, posted Tuesday, to $3.805/g. It’s the first decline after three weeks of increases, and only the second decline in the last eight weeks.
Ultra low sulfur diesel (ULSD) on the CME commodity exchange settled Monday at $2.4266/g, down from a week-earlier settlement of $2.5092/g.
Measuring the diesel futures market on a straight comparison of the front month price (some comparisons make other adjustments) shows just how strong diesel has been compared to crude.
On June 11, crude made a significant upward move, with the West Texas Intermediate price on the CME commodity exchange rising 3.17% to settle at $68.15/barrel, and worldwide benchmark Brent rising 2.9% to settle at $69.77. Ultra low sulfur diesel (ULSD) on that day settled at $2.2053/gallon.
Since then, based on Monday’s CME settlements, WTI is down 2.11%, settling Monday at $66.71. But ULSD is up just over 10%, settling Monday at $2.4266/g.
Diesel isn’t just strong against crude. RBOB gasoline, an intermediate gasoline blendstock that is the proxy for gasoline prices on CME, is now about 30 cts/g less than ULSD. The spread got as wide as 37 cts/g last week. But RBOB was at a small premium to ULSD as recently as late May.
John Kemp, a long-time journalist who writes about energy and is now independent, described diesel recently as “the lone bright spot in an otherwise despondent oil market.”
In a distributed email, Kemp said data on investment in oil futures showed that investors have “continued to boost their bullish position in middle distillates while selling the rest of the petroleum complex” in the week ended July 25.
“Investors expect low diesel inventories to support prices and crack spreads even if the rest of the complex comes under pressure from rapid production increases by Saudi Arabia and its OPEC⁺ partners,” he wrote.
Open interest in ULSD on both the CME and the Intercontinental Exchange (ICE), which reflects investor activity, were high enough on a combined basis to be in the 85th percentile all-time, Kemp wrote.
In an article late last week, Bloomberg said a report published by Goldman Sachs said that while the recent margins of diesel against Brent may slow, the investment bank said they “are still likely to end up above long-run averages given a crunch in global processing capacity.”
Energy economist Philip Verleger, who has long focused on the diesel market as a driver of overall oil market movements, headlined his weekly report published over the weekend as “A third distillate disruption.”
The reference to “third” is his view that oil topped out over $100/barrel twice in recent history because of environmental regulations regarding diesel: the introduction of ULSD around 2008, leading to the $100 crude spike that spring and summer, and the conversion of bunker fuel that powers ships to a tighter sulfur specification in 2020 but which didn’t really kick in to markets until 2022, given the impact on demand from the pandemic. That regulation, known as IMO2020, pulled distillate molecules out of the diesel market and into the bunker fuel supply.
Verleger’s report had several key points about why diesel markets may be on the verge of yet another instance of pulling oil prices higher.
His analysis gets into politics, noting that the Trump administration’s emphasis on rising U.S. production, even if it is successful, is likely to bring about an increase in the types of crudes that produce only a small amount of diesel when refined given the dominance of light crudes coming out of U.S. wells. Those crudes traditionally have a low diesel yield when refined.
On top of that, restrictions on production by non-OPEC countries in order to support higher prices are taking supply out of the market in those grades of crude that do produce healthy levels of diesel when refined.
“The US does not produce the crude oil types that are most useful for world energy users,” Verleger wrote. “Further, to sustain oil prices, other nations shut in production of the more desirable crudes to maintain price levels. Their actions and others have now limited the global diesel fuel supply, pushing diesel and crude prices higher.”
He ticked off several current conditions in the market that are contributing to the diesel squeeze, and noted they are likely to continue.
Restrictions on importing Venezuelan crude into the United States
The decline of Mexican Mayan crude exports to the United States
The efforts of Asian nations to import more US crude to avoid high tariffs
The EU’s adoption of regulations that prohibit imports of petroleum products made from Russian crude
China’s limits on diesel exports
Expanding on those points, Verleger notes that several U.S. refineries were specifically built to process heavier Venezuelan crudes that have a strong distillate yield. But there are restrictions now on U.S. companies’ ability to bring in that crude.
U.S. tariffs are sending Mexican Maya crude elsewhere, and that heavier crude has a stronger distillate yield.
Meanwhile, heavy demand for U.S. crudes solely to placate U.S. demands for more exports mean that more of those diesel-poor crudes will be refined elsewhere.
The end result is that those Brent to diesel spreads that recently went above 80 cts/g are some of the highest on record, Verleger said. They have softened recently as reports on U.S. inventories show stocks in this country rising, he added.
But that may not last, Verleger said. “Margins may return to that high in the coming months if global demand remains strong and the (listed) disruptions worsen,” he said. “A major hurricane hitting refineries on the US Gulf Coast could turn things catastrophic.”
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