Benchmark diesel number up more than 50 cents in just 2 weeks

But with the normal lags in retail prices, the increases of more than 50 cents over the past two DOE/EIA numbers can be seen as reacting to those earlier gains.

The ULSD on CME added another 10.5 cents in trading Monday. What was more significant was that the 2.64% increase on the day came as global crude benchmark Brent barely moved. 

The continued strength of diesel relative to both crude and gasoline is starting to suggest that there has been a possible permanent realignment in what is considered a “normal” spread between crude and diesel.

If the issue were one of just refinery capacity being squeezed, the gap between gasoline and diesel prices would be relatively steady. But as can be seen at the pump, the gap between the two of them has exploded this year.

You can see it also in the futures market. The most indicative numbers from the CME commodity exchange come by comparing two spreads. One is between Brent crude oil — the international benchmark — and RBOB gasoline, the unfinished gasoline product that serves as a proxy for gasoline in commodity trading, and the spread between Brent and ULSD.

In 2019, the average spread between the Brent-gasoline spread and the Brent-ULSD spread was about $9 per gallon, with the ULSD spread that much higher than the gasoline spread. Tossing out 2020 because the pandemic skewed many price relationships, the spread in 2021 was actually negative $1.30, with the Brent-gasoline spread stronger than the Brent-ULSD gap.

But in 2022, the full-year average through last week is $17.14. And since July 1, it’s been about $24.90.

Philip Verleger, a longtime energy economist who produces a widely read weekly report, reiterated in his latest edition that it is IMO 2020 that is blowing out diesel prices relative to the rest of the market. 

IMO 2020 is an international rule, years in the making, that requires the fuel oil that powers ships to have a sulfur content of no more than 0.5%. Several steps had been taken to get there incrementally from what had been much higher limits (or no limits at all). But the 0.5% rule, mandated by the International Maritime Organization, took effect at the start of the year for which it is named.

One of the pathways to make the lower sulfur fuel involves a product known as vacuum gasoil (VGO), which is often used to produce finished diesel. But with VGO diverted to make lower sulfur marine fuel, there was concern among many analysts — Verleger included — that diesel prices could spike as a result of IMO 2020.

With the pandemic creating a surplus of all sorts of oil products, that theory never got its test in 2020. But as economic activity has bounced back, it is getting a workout now, and Verleger points to IMO 2020 as a key reason for diesel to be soaring well above gasoline and crude. 

“While the IMO rule went into effect in 2020 as planned, thanks to the coronavirus, its impact was delayed until 2022,” Verleger wrote in his latest weekly report. “This November, voters may go to the polls … with diesel selling for $7.”

He noted that California gasoline prices, which were at record highs just a few weeks ago, have come down considerably. One of the reasons, Verleger said, is a relaxing of some environmental rules that impact the quality of California gasoline. 

“On several occasions, we suggested that governments could force the IMO to relax its rule  and allow more sulfur to be blended into marine fuels,” Verleger said. “Our advice has been ignored even though it reached individuals in the Treasury Department. The inflexibility … contrasts starkly with the flexibility observed in California.”

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