Diesel is pricing a scarcity with winter rush looming large

At any other time in history, the current state of the global diesel market would have sent some countries into a panic.

All over the world, prices for the fuel are sky-high relative to the crude oil from which it is made, pointing to a scarcity that should alarm inflation-obsessed governments everywhere. And within just a few months, the Northern Hemisphere will enter winter, pushing up demand for heating.

The good news is that the market looked even worse this time last year following Russia's invasion of Ukraine — and prices ultimately came down, helped by a relatively mild winter. However, today's shrivelled stockpiles mean the world can ill afford any bullish market surprises: supply curbs can arise at any time, or demand shocks can come from cold weather or surprisingly strong economies.

"We should be building stocks now as they usually begin drawing seasonally from September," said Eugene Lindell, head of refined products at industry consultant FGE. "There is a worry that stocks will not build sufficiently before October, and we will then start seeing draws from what threatens to be a low base."

The crux of the diesel supply concerns now lies in Europe and the US Atlantic Coast, he added.

Oil markets have been rocked by soaring fuel-making margins in recent weeks, with refinery curbs shrinking global supplies at a time when crude producers including Saudi Arabia are keeping barrels off the market.

Lean inventories

Stockpiles of diesel-type fuel in northwest Europe are set to fall in coming months, according to consultancy Wood Mackenzie Ltd. While that's typical for the time of year, inventories are currently lower than historical norms — though still up year-on-year.

"The outlook for Europe diesel/gasoil supply is tight in our current forecast, driven by the lower diesel/gasoil yields expected from lighter crude slates, the shift to jet yields, and unplanned refinery outages," said Emma Howsham, a research analyst for refining and oil product markets at Wood Mackenzie. "Demand is expected to increase month-on-month to November."

A switch to less dense crude — a function of cuts by Saudi Arabia, Russia and others — has led to OECD Europe's yields of diesel-type fuel being more than 1.6% lower in July compared with the historic average, she said.

In the midst of the existing supply crunch, markets are closely watching China as its refiners await a fresh round of fuel export quotas from the government, which will allow them to keep shipping fuels. While ample Chinese flows could help to ease the current tightness, there's a possibility they could offer thin relief this time.

It's unlikely there'll be a surge in Chinese diesel shipments, even after the quotas have been issued, said Jianan Sun, an oil analyst at Energy Aspects. China's domestic diesel demand has "surprised to the upside" with higher than expected infrastructure spending offsetting losses from the property market, he added. As a result, stockpiles failed to build even during seasons of weaker demand, said Sun.

In the US, retail diesel prices have risen consistently since late July, so much so that it contributed more to inflation than gasoline in August. American refiners haven't been able to build up inventories this summer, the typical period for supply growth in between crop seasons and ahead of winter heating. That's because market conditions have made stockpiling a losing venture, similar to last year.

New England's main supplier, East Canada's Irving refinery, will undergo major maintenance work lasting seven weeks starting September. This leaves the region out of reach for pipelines, at the mercy of seaborne shipments from further afield.

Bullish bets

The diesel market's performance is important beyond the universe of a few specialist traders.

In its broadest definition, this type of fuel — which has varying specifications and is used in everything from cars and ships to heating and heavy machinery — is the single biggest chunk of petroleum product demand.

Hedge funds are lifting their bullish bets, with net-long positions on Nymex diesel jumping to an 18-month high in August.

Beyond that, it's a vital fuel for the world's supply chains, and major shortages and price shocks can have implications for governments and industries.

Last year, high diesel prices spurred trucker strikes across Asia, pressuring governments trying to stave off inflation from rising energy costs. In the US, farmers and trucking companies that purchase in bulk stand to hurt even more from the rising costs.

The current crunch highlights a dilemma that nations have in phasing out oil refineries as they try to transition away from fossil fuels.

Recent heatwaves have capped refinery output and impacted a global system that's still coping with the halting of several plants in recent years, said FGE's Lindell.