The Global Diesel Problem

Diesel is at the center of an international supply squeeze, with prices rising to historic highs. Andrew Sheets and Martijn Rats unpack why this industrial fuel matters far beyond the pump. Read more insights from Morgan Stanley.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley. Martijn Rats: And I'm Martijn Rats, Head of Commodity Research at Morgan Stanley. Andrew Sheets: Today, the secret life of diesel and why there's so much attention on it. It's Thursday, September 24th at 2pm 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? Martijn Rats: Yeah. When people talk about diesel at the moment, they really talk about sort of 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 in agriculture, excavators, generators, home heating. It is a molecule that has a tremendously broad range of applications. It's 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. Andrew Sheets: And why has there been so much on diesel recently, given the current energy disruption in these geopolitical events? Martijn Rats: 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 to 5 million barrels a day on a 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 sort of 4 or 5 million barrels a day of refineries that are currently not running, they are fifty-fifty, 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 sort of 4 to 5 million barrels a day of refining capacity that is not running. 40 percent 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 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 1.5 million barrels out of an 8 million barrel a day traded… Andrew Sheets: A pretty large percentage, yeah. Martijn Rats: Absolutely. That is very, very large, and that is hard to offset. Every other r