Record High Diesel Prices Will Ripple Across The Economy

Yves here. We’ve warned for some time that high energy prices will propagate through the prices of goods and services generally, just as they did in the 1970s oil shock. This is why what could have been transitory inflation (had the Administration also been competent in alleviating supply shortages, when we know that competence is seldom to be found inside the Beltway) is now looking very much baked in. We were also early to point out that was already under supply pressure even before Russian sanctions came into play.

So it’s useful to see someone take a stab at what the fallout might look like.

However, as we have stressed, interest rates are a poor tool for curbing commodities-driven inflation. Contrary to popular perception, energy prices had started falling in 1979, before Paul Volcker famously drove interest rates to the moon and backed off only because he was pushing banks like Citibank with a lot of Latin American debt to the brink. Warren Mosler argues that inflation would have substantially abated without Fed action, meaning the central bank could have made a later and less damaging intervention after the impact of cooling oil prices had cycled through the economy. But since Volcker was explicitly interested in breaking labor bargaining power, it’s highly unlikely the Volcker Fed would have acted on that opportunity even if they had seen it.

By Tsvetana Paraskova, a writer for Oilprice.com with over a decade of experience writing for news outlets such as iNVEZZ and SeeNews. Originally published at OilPrice

  • Diesel prices have hit record highs due to very tight domestic inventories and a global supply shortage.
  • A combination of spiking demand as the world recovers from Covid and falling supply due to Russia’s invasion of Ukraine has hit diesel markets hard.
  • Not only are diesel prices at record highs, but they are also at their largest differential to gasoline in history.

The highest inflation in the U.S. in four decades is set to persist and even increase in the coming months as the price of diesel is at record highs amid very tight domestic inventories and a global shortage of supply.   Diesel is used in every part of the industrial activity and supply chain, from goods transportation to manufacturing and agriculture; it fuels America’s economy. Diesel prices have soared to record highs in recent months, adding further upward pressure on U.S. inflation figures. The exceptionally tight diesel market at home and abroad is unlikely to ease any time soon, considering the post-COVID demand from industry and for leisure and travel, as well as the reduced supply of diesel, other fuels, and crude oil from Russia following the invasion of Ukraine and the bans on Russian imports or self-sanctioning of buyers in the West to buy Russian energy goods.

“Inflation Is Much Too High”

The national average U.S. diesel prices were at a record $5.540 per gallon on Monday, per AAA data, more than $1.20 a gallon over the average gasoline price, and up from $3.111 at this time of the year in 2021.

“Not only are diesel prices at a record high, they are at their largest differential to gasoline on record, surpassing the 98-cent difference in 2008 and currently standing at a $1.20 per gallon premium. While motorists filling with gasoline have seen a slight rise in prices, diesel’s surge will be a double whammy as diesel prices will soon be passed along to retail channels, further pushing up the cost of goods,” Patrick De Haan, head of petroleum analysis at GasBuddy, said in a weekly commentary on Monday.

A week earlier, De Haan commented that “For now, the rising cost of diesel will surely be felt in the grocery store, hardware store or on your next flight as jet fuel prices accelerate, leading to a continued rise in inflation likely to ripple across the economy.”

The Fed is seeking to curb the rampant inflation, announcing last week the single largest interest rate hike in more than two decades, when it raised the key rate by 0.50 percentage point.

“Inflation is much too high and we understand the hardship it is causing, and we’re moving expeditiously to bring it back down,” Fed Chair Jerome Powell said at the press conference following the monetary policy decision.

“It is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all,” Powell added.

In the Financial Stability Report published this week, the Fed noted that “inflation has been higher and more persistent than expected, even before the invasion of Ukraine, and uncertainty over the inflation outlook poses risks to financial conditions and economic activity.”

“Further adverse surprises in inflation and interest rates, particularly if accompanied by a decline in economic activity, could negatively affect the financial system,” the Fed warned, adding that this combination could weaken the finances of both households and businesses, “leading to an increase in delinquencies, bankruptcies, and other forms of financial distress.”

Diesel Price Surge “Maybe Out of the Solar System”  /strong>

As diesel prices impact every part of the economy, the fight against inflation becomes more complicated for monetary policymakers, as steeper interest rate hikes could lead to the deterioration of economic activity and household spending and, ultimately, recession.

However, there is no short-term cure to the record diesel prices in the United States. Demand is going up, while inventories are at multi-year lows and at a record low on the U.S. East Coast.

Distillate fuel inventories fell by 2.3 million barrels in the last week of April and are about 22% below the five-year average for this time of year, the EIA said in its latest weekly inventory report. At 105 million barrels, distillate inventories—which include diesel—are at their lowest since 2008. On the East Coast, there are at their lowest ever, as the refinery capacity in the region has halved over the past decade to just 818,000 barrels per day now.

So, instead of focusing on boosting the production of gasoline in the summer driving season, this year U.S. refiners could be looking to raise diesel and jet fuel runs, as the global market of distillates is very tight following the Russian war in Ukraine and supports high refinery margins for those products.

U.S. inventories are “very, very tight, especially tight for diesel,” Gary Simmons, Executive Vice President and Chief Commercial Officer at Valero Energy, said on the Q1 earnings call at the end of April.

Valero Energy saw its highest-ever March refining margins this year, led by diesel, Simmons added.

The global diesel crunch is expected to worsen if the EU reaches some kind of a compromise on banning Russian crude and oil product imports. This will keep diesel prices elevated, impacting every economic activity in the U.S. and elsewhere, and ultimately hitting consumers.

Currently, diesel at New York harbor is trading at around $5 per gallon, which is well above $200 per barrel, Tom Kloza, head of global energy research at OPIS, told CNBC’s Pippa Stevens.

“These are numbers that are not just off the charts. They’re off the walls, out of the building, and maybe out of the solar system,” Kloza told CNBC.