The Global Diesel Problem

SPEAKER_1 (0:00)

Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.

SPEAKER_2 (0:06)

And I'm Martijn Rats, Head of Commodity Research at Morgan Stanley.

SPEAKER_1 (0:10)

Today, the secret life of diesel and why there's so much attention on it. It's Thursday, September 24th at 2 p.m. in London.

Diesel is a fuel that I think a lot of investors may be aware of but not familiar with, so to speak. It's often the other price that you see when you're driving down the road. But Martijn, it's incredibly important for the industrial side of the economy and unusually disrupted by current geopolitical events. And so I'd like to really start at the top or technically the middle of the barrel, so to speak. What is diesel and what makes it so special?

SPEAKER_2 (0:50)

Yeah, when people talk about diesel at the moment, they really talk about three things combined. They talk about outright diesel as well as jet fuel and also heating oil. These are effectively part of the same pool of molecules coming out of the refinery. And so when you look at that sort of pool of molecules, you talk about the things that fuel trucks, trains, ships, tractors and agriculture, excavators, generators, home heating. It is a molecule that has a tremendously broad range of applications.

It is really the fuel of the industrial economy. One of the characteristics of diesel is that it has very high energy density. In contrast to say gasoline, electrifying the uses of diesel is harder because it carries so much punch.

SPEAKER_1 (1:35)

And why has there been so much on diesel recently given the current energy disruption in these geopolitical events?

SPEAKER_2 (1:42)

Yeah, so the global refining system normally processes about 85 million barrels a day of crude oil, and from that it makes a range of products. Diesel is at the heart of it, but it's only one of many. At the moment, we are short in terms of refinery runs, i.e. the amount of crude that refineries process, to the extent of about somewhere between 4 to 5 million barrels a day. So 4 or 5 million barrels a day on the base of 85, you're talking about 5 to 6 percent. That may not sound like a lot, but in the world of commodities where prices really depend on relatively small changes, that is actually a very large amount.

That 4 or 5 million barrels a day of refineries that are currently not running, they are 50-50 either in the Middle East or in Russia. In the Middle East, it is a story of the Strait of Hormuz and refineries locked behind the Strait and they can't export their products. Some of them are also damaged, although information on that is hard to find. And then the other half that is out is in Russia, where they are effectively taken out by Ukrainian drone attacks.

In total, that's 4 to 5 million barrels a day of refining capacity that is not running.

40% of their output would typically be diesel. So we are missing something like 1.5 million barrels a day of global diesel supply, all into the seaborne market. Now, I mentioned the seaborne market because the seaborne market is the sort of the traded market, where traders buy and sell cargoes to each other. And that is where, from a physical market perspective, price formation takes place. The global seaborne diesel market is an 8 million barrel a day market. And so, given that all of the supply we're missing is also into the seaborne market, the comparison to make is to say that we're missing about sort of close to one and a half million barrels out of an 8 million barrel a day traded market.

SPEAKER_1 (3:29)

It's a pretty large percentage, yeah.

SPEAKER_2 (3:31)

Absolutely. That is very, very large. And that is hard to offset. Every other refinery around the world that can run is running flat out. The margins are all time highs.

So there's a lot of incentive to run very hard, but nevertheless, it's left the market very, very tight.

SPEAKER_1 (3:48)

So that tightness in the market shows up via price. And just talk us through a little bit about what has happened to the price of diesel and its related fuels. You know, I think a lot of listeners are probably more familiar with the price of gasoline. They're more familiar with the barrel of oil that's often the quoted benchmark in the market. But what has been happening to these diesel prices?

SPEAKER_2 (4:09)

Yeah. So the way to really tell that story is to look at what we call the crack spread. So making a barrel of refined product including diesel, of course, you start with crude oil. So the price of crude oil impacts the price of the refined product. So quite often we focus more on the uplift from the price of crude to get to the price of the refined product and we call that the crack spread. Under normal conditions, say a year ago, crude was $70 and then the price of diesel was another $20 on top of that. And so you got to diesel being 70 plus 20 is $90 per barrel.