Despite a six-week rally that began on Feb. 22, average diesel prices nationwide are still at a seven-year low year-to-date as of April 4, according to AAA. With the fuel stock market as volatile as it is, what can we expect from the fuel pumps for the remainder of 2016 and beyond?
Diesel prices background information
According to Timothy Hess, diesel prices expert at the U.S. Energy Information Administration, there are three major components predicting retail diesel prices: refining margin (difference between refiners’ wholesale price and crude oil price), retail margin and taxes, and crude oil prices. The first two are mostly stable. Crude oil prices, on the other hand, are less predictable.
“There’s quite a bit of uncertainty where crude oil prices are heading,” Hess told Land Line. “Our baseline forecast calls for crude oil prices to be about $35 per barrel this year and about $40 per barrel next year.”
That gives you an average diesel retail price at about $2.12 a gallon in 2016 and $2.30-$2.40 in 2017. The days of $4 per gallon – as we saw in early 2014 – may not be in visible range in the current environment.
Here’s another way to look at it: Diesel prices are typically $1.50 more than a gallon crude oil. To determine how much crude needs to sell to reach $4 diesel, we subtract $1.50 from $4, which leaves us with $2.50. But that $2.50 is for a gallon of crude. Oil sells in barrels, which contains 42 gallons. Multiply $2.50 by 42 ($105) and you get the crude oil price needed to reach $4.
Reverse the equation to find out where diesel prices will be in the near future. For example, as of press time crude oil for June settlement is selling at approximately $38.70 per barrel. Divide by 42, then add $1.50, and we’re left with a projected diesel price of $2.42. Lately, diesel prices have fallen below the $1.50 baseline rate.
Crude oil supply glut
If diesel prices are dependent on the price of crude oil, where are crude oil prices headed? As Hess pointed out, that is the million-dollar question. Perhaps quite literally considering you could be a millionaire if you had the answers.
The main source of the current low prices is oversupply. Major oil-producing countries are pumping out barrels at record-high levels. Meanwhile, demand is relatively low. Due to global market competition, no one is willing to slow down production. That may change.
Currently, nations within the Organization of the Petroleum Exporting Countries as well as Russia are considering freezing production levels to what they were in January. Essentially, it is a production cap to ensure prices do not dip below what was experienced at the beginning of the year. Crude futures stocks have been all over the place because of conflicting news concerning this agreement. One day a production freeze is likely, the next day it’s not.
As of press time, the latest information about the production freeze negotiations is optimistic. Despite Iran’s unwillingness to oblige since it is capitalizing on recently lifted sanctions, major oil producers are expected to move forward. Pay attention to this situation as it is sure to directly affect crude prices, and consequently, diesel prices.
Other factors affecting oil prices
Oil supply may be the biggest factor that drives fuel prices, but external factors such as geopolitical disruption and natural disasters can affect fuel prices.
As Hess mentioned, the refining margin plays a role in determining diesel prices. How much the final product sells for relies on demand in the global market. From 2010 to 2012, that margin was relatively high as a result of strong growth in emerging markets like China, according to Hess. In the past year, reports have revealed that China’s economic growth has decreased substantially, putting stockholders on edge. In addition to oil supply negotiations, also pay attention to emerging markets’ economic status.
Perhaps the least predictable factor is weather and other events that can cause a refiner to undergo unexpected maintenance. With the Atlantic hurricane season beginning on June 1, severe weather can affect refineries. Very few refineries lie in the East Coast, but several are located in the Gulf area. Even if a refinery is temporarily shut down, it should only affect the local and regional economy. Furthermore, diesel stocks are high enough to cushion any supply disruptions, Hess said.
Additionally, hurricane landfall in the United States occurs only once or twice a year, according to the National Oceanic and Atmospheric Administration’s Hurricane Research Division. Every now and then, a major storm will disrupt infrastructure and refineries, but the effects are typically limited to local areas.
Another freak occurrence affecting fuel prices is unexpected maintenance on refineries. Last August, one of the largest refineries in the Midwest underwent unscheduled repair work. The BP Whiting Refinery malfunction in Indiana led to a 63-cent increase at the gas pumps within one week, according to the Chicago Sun-Times.
Expect prices below $3
Not accounting for unforeseen circumstances affecting oil prices, EIA is predicting diesel prices well below $3 for the rest of the year. Keep an eye on the supply freezes from OPEC and other major producers, including Russia and the United States. Also, watch the economic status of emerging markets. Those are two variables we have a crystal ball for, even if the glass is pretty hazy.
Beyond that, there’s no indication that diesel prices will reach levels we saw in 2014 anytime soon.
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