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Diesel
December 14, 2017
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Diesel

Stable outlook for pricing

Comment
With crude oil prices continuing to hold steady, diesel prices are expected to do the same. But the risk that an unforeseen event could spark volatility remains.

Diesel fuel markets today are very consistent with where they were last year—indeed, the average U.S. diesel price today is almost exactly what it was one year ago. That's no surprise, because crude oil markets also are relatively unchanged. Crude has been, and will continue to be, the dominant factor in determining diesel prices. With the outlook for crude oil prices flat, we can therefore expect diesel prices for the next few years to stay roughly where they have been over the past year.

Figure 1 shows a historical view of retail and wholesale diesel prices compared to the light sweet crude oil price. It demonstrates a market operating close to economists' ideal of "perfect competition": both peaks and valleys are quickly passed on to the pump. No single player has enough market power to alter the ongoing differential among these three lines. And because there has been no significant change in market dynamics over the past year, there's no reason to believe this trend won't continue.

Article Figures
[Figure 1] U.S. diesel price vs. underlying crude price (in US dollars) 1994-present
[Figure 1] U.S. diesel price vs. underlying crude price (in US dollars) 1994-present Enlarge this image
[Figure 2] Light sweet crude oil prices (historical and futures)
[Figure 2] Light sweet crude oil prices (historical and futures) Enlarge this image

As a result, diesel prices will continue to follow crude prices, which are not expected to fluctuate significantly. Figure 2 shows the value of futures contracts on crude remaining basically flat. Of course, the standard caveat that accompanies this chart is that the futures market may be caught by surprise. A major, unforeseen event (a war, a continued economic crisis, or a natural disaster) could dramatically raise or lower the price of crude, and therefore of diesel.

Be prepared
But let's also apply a caveat to that caveat: Such a huge event would have far more significant impacts on most companies than merely changing the prices they pay for diesel. For example, a price spike prompted by conflict in the Middle East could also cause widespread inflation and reduced consumer buying power that might, among other effects, significantly lower demand for many goods. The best way to prepare for such unpredictable events is not merely to hedge on the price of diesel, but to also have a companywide risk management strategy that considers these and other risk scenarios in a wider context.

Again, such risks represent wildcards. The futures traders, whose job is to predict trends, see any change as unlikely. That's what they said last year, and indeed there has been no significant change. And that's what they're still saying.

The futures traders' opinion may seem surprising in light of increasing domestic crude production. If the United States is producing more crude oil, why wouldn't prices come down? The answer is that current imports amount to almost 9 million barrels per day of crude, complementing 6 million barrels per day of domestic production. Even optimistic outlooks project that U.S. production growth will offset only about half of the current import volumes, so significant levels of imports will continue for the foreseeable future. And in the global crude market, the Organization of Petroleum Exporting Countries (OPEC) nations will continue to hold the balance of supply, so their actions will still exert a significant influence on pricing.

Another common question centers on liquefied natural gas (LNG). Given improvements in LNG engine technology, shouldn't conversions to that fuel reduce demand for diesel, thereby putting downward pressure on prices? The answer is, not enough—at least in the short term. For now, the time lag in rolling out national LNG distribution networks rules it out for passenger-car or cross-country travel; nobody wants to get stuck in the middle of the country hundreds of miles from a refueling station. LNG is likely to make early inroads in local-only fleets, such as taxis and local delivery trucks that regularly return to a central location to refuel. But these incremental increases will not dampen overall demand for diesel. That demand is still expected to grow, and thus prices are not expected to drop.

Throughout this analysis, we are looking at a "big picture," aggregate perspective. In any given local market, on any given day, prices may fluctuate. Developments such as significant weather events or unplanned refinery outages may cause temporary shortages, increasing prices until the system can adjust. But the outlook is that the system will indeed adjust, and that temporary, local fluctuations will even out in the longer term.

In summary, current trends pose no imminent threats or promises for the diesel market, and supply chain managers can expect few changes again this coming year.

Neal Walters is a partner in the Energy Practice of the global management consulting firm A.T. Kearney.

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