Vol. 27, No.21 Week of May 22, 2022
Providing coverage of Alaska and northern Canada's oil and gas industry

Diesel crunch not a passing fad

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Curtailed supply from Russia squeezes tight market further, kicking prices up

Allen Baker

for Petroleum News

Diesel fuel prices across the United States - and around the world - have taken off in recent months. Reduced supply of Russian diesel and crude oil are part of the problem, but not all of it by any means. And it isn’t likely to ease any time soon.

A recent report of the International Energy Agency outlines the dilemma:

“Limited spare capacity in the global refining system, together with reduced exports of Russian fuel oil, diesel and naphtha have aggravated the tightness in product markets, which have now seen seven consecutive quarters of stock draws,” the IEA says in its Oil Market Report for May 2022.

That means that even with the economic contraction of the pandemic, refineries couldn’t keep up with the demand. With those relentless draws, middle distillate stocks in the developed countries are the lowest they’ve been since 2008, IEA says.

In the United States, diesel prices reached $5.61 a gallon on May 16. That’s up 73% - or $2.36 a gallon - from just one year earlier, according to the U.S. Energy Information Administration. European diesel prices rose 88% in the same period.

Since diesel fuel powers the trucks and trains that deliver most goods, price increases on fuel ripple through the economy swiftly and seriously.

Russian supplies of diesel fuel to the U.S. market have been significant, but not huge, in recent years. In 2021, Russia shipped 23,000 barrels a day of diesel to the U.S., about 8% of imports. Only Canada supplied more. As a part of total distillate product supplied to the U.S. market, however, it’s a tiny sliver of the 3.9 million barrels a day total.

Refiners cutting back

But refineries haven’t been standing still. Instead, they’ve been cutting back on production. Some of that goes along with the theme of reducing greenhouse gas emissions.

The biggest U.S. refiner, Marathon Petroleum Corp., has cut its refining capacity by 188,000 barrels a day, or 6%. Marathon still has the capacity to process 2.9 million barrels of crude a day.

The company, which operates the Alaska refinery in Nikiski, recently chose to “indefinitely idle” refineries in Gallup, New Mexico, and Martinez, California. The company plans to switch the Martinez operation to produce a tiny stream of renewable fuels. The company’s refinery in Dickinson, North Dakota, was also switched over to renewables.

Marathon logically wants to keep its options open, and its permits in force, in case it wants to restart the plants or sell them. In the meantime, producing renewables is a green thing to do.

“By indefinitely idling two of our highest cost, least efficient facilities, we are becoming more cost efficient and lowering the carbon intensity of our operations,” the company says.

Marathon also plans to devote 20% of growth capital over the next three years to “projects that progress our sustainable energy vision while producing good returns on invested capital.” That capital won’t be plowed into more refinery capacity, however.

Europe’s dilemma

Europe’s energy mix has been shaped by a political push for renewables and more renewables, often supported by generous government subsidies. In that environment, oil companies have been loath to invest in new refinery capacity, so the plants in Europe are among the oldest and least sophisticated in the world. New refineries being built from scratch in the Middle East and Asia are far more efficient and flexible.

Indeed, Middle East producers are now making up some of the deficit in Europe as Russian supplies are cut. Diesel shipments from the Middle East to Europe are expected to double, to close to 400,000 barrels a day, in the wake of the Ukrainian conflict. At higher prices, of course.

Just as in the U.S., distillate supplies in Europe were tight well before all the sanctions and counter sanctions started ramping up.

At this point, it’s not clear if Russian supplies will actually be substantially reduced, or the supply chains will simply be rearranged so that countries willing to deal with Russian products at a substantial discount take up much of the supply that Europe rejects.

Russian producers can offer those discounts and still pocket more money than they were getting at the lower prices of a few months ago. Russia shut in about a million barrels a day of production in April, according to the IEA report. Further Russian cutbacks, if they occur, will strain the system further and likely push prices even higher.

Record crack spreads

For refiners, profits have reached levels not seen for years or decades.

“During April,” the IEA says, “crude and product markets saw diverging trends. While crude prices trended lower overall, diesel and gasoline cracks surged to record levels, pulling up refinery margins and end-user prices.”

Even with the profitable environment, world refinery throughputs in April fell by 1.4 million barrels a day to 78 million barrels daily, the lowest since May of last year, the agency reported.

“Between now and August, runs are forecast to ramp up by 4.7 mb/d, but the tightness in product markets is expected to continue based on our current oil demand outlook,” the report concludes.

So absent a major economic downturn, diesel and other fuel prices are likely to remain elevated for quite some time.

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