Diesel Prices Drop. It’s an Economic Danger Sign.

Lower demand for diesel has led to falling prices for the fuel.

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Diesel prices at the pump have fallen to their lowest in over a year. That’s good news for consumers, but the decline in prices for the fuel suggests a gloomy outlook when it comes to the U.S. economy.

“Diesel fuel is ubiquitous in our economy,” says Brian Milne, product manager, editor, and analyst at DTN. It’s a “critical component in industrial production and…supply-chain dynamics.”

Weaker demand, however, has led to lower diesel prices. U.S. government data show diesel demand in the first 10 weeks of this year down 12.6% from the comparable period in 2022, says Milne, with the steep drop in demand due to slowing growth in parts of the economy, especially for heavy industry and construction. This slowdown is further pressured by higher interest rates and the recent bank failures increasing expectations for a recession, he says.

On March 22, U.S. retail diesel prices averaged $4.279 a gallon, down from $5.04 a year ago, according to AAA.

While retail gasoline prices have been occasionally rising, diesel so far this year has declined, and prices could eventually fall below $4 a gallon in the weeks ahead, says Patrick De Haan, head of petroleum analysis at GasBuddy.

That’s a significant shift from last year, when diesel prices climbed to a record because of higher underlying prices for crude, higher natural-gas prices, and tighter refined product supply and demand, says Jason Gabelman, an analyst at TD Cowen.

The fuel reached its highest recorded average of $5.816 on June 19, 2022, AAA data show. The post Covid-19 lockdown spike in consumer consumption accelerated economic growth in the second half of 2020 and through all of 2021, says DTN’s Milne, with the surge in demand outstripping capacity, pushing costs in moving freight on water and land to record highs.

The surge came after a loss in U.S. refining capacity, and Russia’s invasion of Ukraine in February 2022 “fragmented” the global energy supply chain, he says.

U.S. inflation reached a 40-year high in June 2022, with diesel and gasoline as key components underpinning the surge in prices paid by businesses and consumers, says Milne. Consumers continued to spend, but higher costs for businesses began to “curtail activity” in home-building and, later, for manufacturing, leading these industries—heavy users of diesel fuel—to contract, easing diesel demand.

Meanwhile, the U.S. Federal Reserve began to lift the benchmark federal-funds rate to lower inflation. So, rate-sensitive industries such as housing slowed further, while concern over recession grew—denting consumer confidence, he says.

“Numerous economic indicators” point to a strong likelihood of recession in the second half of 2023 or early 2024, says Milne. Given that U.S. diesel consumption is closely correlated with economic growth, demand would decline further amid a recession, he says.

Still, the diesel market is tighter than before the Russia-Ukraine war, and “most clearly expressed in diesel cracks at $30” a barrel, which is around two times historical levels, says Gabelman. The crack spread refers to the price difference between crude oil and diesel.

The diesel premium to crude could ease somewhat as new refining capacity comes online, though this may be offset if natural-gas prices move higher, says Gabelman, noting that natural gas may push up the cost for refining crude and can be a substitute for diesel.

For now, U.S. independent refiners provide the highest exposure to diesel cracks, and within that group, Gabelman says TD Cowen is “most positive” on oil-and-gas exploration and production outfit Par Pacific Holdings (ticker: PARR) and petroleum refining, marketing, and transportation firm Marathon Petroleum (MPC).

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