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Diesel Shortages Point to Pain for Consumers

• US distillate inventories, which includes diesel fuels and heating oils, are below ten-year lows as diesel prices hit record highs.

• Because diesel is heavily relied upon for goods transport, this tightness adds to already stressed supply chains, and relief in the form of additional production is uncertain at best.

• A reduction in geopolitical tensions and a Chinese reopening have the potential to release some of this pressure, but neither of these is likely in the near term.

• US consumers will face increased inflation pressure from the rise in prices, but firms involved in related industries with pricing power stand to benefit.

The headlines in the US generally focus on gasoline prices as the transfer mechanism of higher oil prices to individuals, but a lesser-known burden (at least to those of us not on the F-150 bandwagon) is the price of diesel. Global shipping and inter- and intra-state ground transport rely heavily on diesel as a fuel source, and shortages and high prices are transferred to consumers either directly through price hikes or indirectly through goods shortages.20220531-chart-1Current distillate inventories (which includes diesel and heating oil) in the US have dropped to lows not seen since 2005, in a nearly two standard deviation move relative to the 10 year average. We do see significant seasonality in the data, and, unlike gasoline, 52-week lows in distillate supply heading into summer is not uncommon.1 However, the size of the drawdown is certainly unusual, and can be broadly attributed to geopolitical tensions (Russia’s war in Ukraine) and hangover pandemic effects (China’s lockdowns).20220531-chart-2Chinese exports of diesel fuel have dropped off this year, as strict lockdowns in Shanghai, the largest city in and center of the Yangtze River Delta megalopolis have dramatically reduced all activity in the region. China remains one of the biggest unknowns for this market (and most others) going forward, as it’s unclear how much longer the leadership will maintain their zero-COVID policy. There’s plenty of speculation that China will bring both its massive consumption and massive production back online in the next few months, but new lockdowns in Beijing over the May 21-22 weekend hint that there is no near-term plan to shift toward a more lenient posture.

Russia’s diesel export numbers haven’t been updated since December, but it’s not a stretch of the imagination to think they have dropped off in the past few months as well. While the US alone consumed an average of 12.7 thousand tons of diesel in 20192, more than the highest single-month exports of Russia and China combined in the same year, exports falling off the table to this degree in a globally connected market is undoubtedly adding pressure.20220531-chart-3Meanwhile, the US is seeing automotive diesel prices near four standard deviation highs relative to the average of the last ten years. An oft-repeated adage in commodity markets is “the cure for high prices is high prices.” While we don’t intend to imply the fundamentals of supply and demand are broken, we do want to point out that imbalances can persist for years. As we’ve pointed out in previous Two Minute Tuesdays (TMTs), there has been significant underinvestment in every component of the US oil industry over the past decade or more, including in refinement capacity, meaning a simple ramp in refinement to restore inventories may not be possible.20220531-chart-4While higher fuel prices are transferred to consumers wherever possible, US oil- and gas-related firms stand to benefit from continued higher prices. In addition to benefiting from higher raw commodity prices, firms involved in oil and gas transport (midstream) often have inflation protection (which would compensate for rising diesel prices) built into their contracts.3 Exposure to firms with these characteristics may help offset the upcoming pain at the pump felt both directly when filling our tanks and indirectly when purchasing products reliant on diesel-based transports.

The spread of possible outcomes for the US economy remains wide, and the biggest input variables in every expected return calculation right now depend on the decisions of powerful leaders in a few countries. It remains as important as ever to be flexible and engaged.

Important Disclosures & Definitions

1 Source: Bloomberg, SS&C ALPS Advisors Research

2 Source: Statista

3 Source: Alerian, “Midstream/MLPs: Well-Positioned for Inflation”

Z-Score: a numerical measurement that describes a value's relationship to the mean of a group of values, measured as standard deviations from the mean. If a Z-score is 0, it indicates that the data point's score is identical to the mean score. A Z-score of 1.0 would indicate a value that is one standard deviation from the mean.

Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.

AAI000184 06/30/2023

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