Why Diesel Prices Are Rising

MT. JULIET, Tenn. (DTN) -- Reid Thompson spotted a missed opportunity in the thick of the COVID-19 pandemic: Farm diesel prices tumbled, but he couldn't take advantage because he couldn't take delivery.

He added 20,000 gallons of fuel storage to his central Illinois farm before the 2022 season began, and when diesel supplies tightened up right before harvest season, he was able to take delivery of two semi-truck loads.

"The idea of bulk storage is you're in control, not only of your inventory so you can get a crop put in, but you're controlling the price," he told DTN in an interview. "To take the unknown off the table and know what your cost is, that's a big deal right now."

Farmers are facing elevated production costs for the 2023 growing season, with University of Illinois economists estimating that it will cost $854 to produce an acre of corn on high-productivity soil in central Illinois. That's up from $761 last year.

"We've seen fuel costs increase quite dramatically," University of Illinois agricultural economist Gary Schnitkey said on a webinar. "They're significant enough that they begin to matter in our budget."

Current retail diesel prices are hovering around $1 higher than last year, and experts expect prices to stay elevated amid production capacity shortfalls, Europe's tightening restrictions on Russian oil and refinery products, and China's decision to drop COVID-19 travel restrictions. However, the threat of recession, both globally and in the U.S., complicates the outlook.

Traditionally, January and February are good months for farmers to buy their fuel needs, Kansas State University agricultural economist Greg Ibendahl said in a recent webinar. (You can find that webinar here: https://www.agmanager.info/…)

"To me, there's a lot more risk of prices going way high than there are of prices going much lower than what we're seeing currently," he said.

DTN refined fuels analyst Brian Milne said when the market presents that many competing variables, he usually advises gradual purchases.

"Maybe you look for opportunities when there's a low in the market and you get a deal, and maybe buy a little less quantity and gradually fill up," he said.

QUESTIONS LURK IN BULLISH GLOBAL MARKET DYNAMICS

In the near term, fuel markets are focused on Europe and Group of Seven countries' plan to set a price cap on Russian refined fuel products, like gasoline and diesel, similar to the $60-per-barrel price cap on crude oil those countries initiated in December.

"When it happened with crude in December, you saw a lot of bluster going on, but you didn't see a significant impact on the market," he said. Because the December price cap on Russian oil was below where prices traded, it acted essentially as a ban on purchases, but supply chains rerouted, keeping global supplies the same.

"But products are different," Milne said, adding the supply impact could be much larger. Europe currently buys more refined fuels from Russia than oil, and after Russia cut off much of the flow of natural gas, Milne said there were expectations that it could have prompted a significant amount of gas-to-oil switching.

But on the other hand, Europe has had a relatively mild winter that's reduced demand for heating fuels. They've also been buying heavily to build up diesel and other fuel supplies ahead of the price cap.

"We're not sure what the dynamics will be come Feb. 5," Milne said.

Another situation that appears bullish for demand also comes with its share of question marks.

CHINA OPENED TO TRAVEL

In ending its zero-tolerance COVID policy, China opened up travel to its citizens again. The time coincides with the Lunar New Year when travel within the country is high. Milne added that many Chinese people make one or more international trips each year, another potentially bullish demand factor.

The flip side is that COVID cases and deaths are rising in China, and the government doesn't provide a clear picture. "Will it limit how many people are able to go to the factory or work at the docks? Looking at the macroeconomic side of it, does China take off?" Milne said. "That's why we're a little hesitant to think it's clearly bullish."

Milne added there are some available cargoes of crude in Africa that haven't been purchased. "So, if Chinese demand was really off to the races, we would expect to see some of those offers picked up. So, there's a little bit of softness out there."

REFINING CAPACITY LIMITS U.S. SUPPLIES

When the West Texas Intermediate crude oil contract trades around $75 per barrel, like it does today, gasoline typically costs $3.20 per gallon and diesel $3.50 per gallon, Ibendahl said. Diesel historically carries a 30- to 40-cent premium to gasoline, but it shot as high as $1.50 shortly after the Russian-Ukraine war began. It currently is about a dollar more expensive.

The U.S. lost 1 million barrels per day of refining capacity during COVID due to shutdowns and a refinery explosion, and Ibendahl said it's unlikely the U.S. will regain that capacity. As a result of low capacity, domestic diesel inventories are well-below normal.

"That would reduce demand. That would give refiners a chance to build back up some of the stocks, and we could probably get that price differential between gas and diesel lower than what it currently is," Ibendahl said. "But that doesn't happen if the economy stays strong. I would expect that price premium for diesel fuel to remain in place for quite a while. It may take years."

INTEREST RATES COMPLICATE BUYING DECISIONS

In Colfax, Illinois, Thompson is still learning the nuances of the fuel market and is discussing potential ways to hedge with his fuel supplier since contracts on the future board cover more gallons than his farm needs.

But for now, the focus is on buying when the time is right. He missed an opportunity last week to buy farm diesel for less than $3 per gallon -- his target -- because his advisor suggested waiting.

"I should have said, no we're where we want to be. It's like waiting for $7 corn and then deciding you want $7.50," he joked.

There's another aspect to the fuel buying equation that Thompson didn't consider when he expanded his storage: interest rates.

"The cost of carry is a lot different than it was in January last year," he said. Diesel might cost "$3.50 two months from now, but that's no different than what it could have been if I bought it six months ago and carried it on my line of credit."

He uses a spreadsheet to track the profitability of various farms and updated the interest expense figure earlier this year, bumping it up from a 4% to 7% average rate.

"It's not crippling, but you take a line item that we, quite frankly, quit paying attention to and it's as big as my soybean seed costs for the year," he said. "It became a real number, real quick."

To see Reporter's Notebook about diesel prices, see https://www.dtnpf.com/….

Katie Dehlinger can be reached at katie.dehlinger@dtn.com

Follow her on Twitter at @KatieD_DTN

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