How Low Will Diesel Go?

While it’s hard to say just how low the retail price of diesel will go, what is fairly certain is the trend line in place since last autumn will continue to run its positive course at least through the rest of the year. What’s more, it looks like the price of diesel won’t rise markedly until 2016. And at that point, it’s expected to increase to an average well below that recorded in 2014.

According to the U.S. Energy Information Administration, the retail price of diesel fuel, which averaged $3.83/gal in 2014, is projected to fall to an average of $2.88/gal in 2015 and then rise to a $3.12/gal average in 2016.

That’s good news for U.S. truckers and for American consumers, the largest driver of our economic growth. Indeed, consider the impact of what economist Kenny Vieth, president and senior analyst of ACT Research, Columbus, Ind., terms the “oil price windfall.” Speaking at April’s National Private Truck Council meeting, he said lower oil prices will help drive GDP growth at least into the second half of 2017.

Vieth pointed out both that “lower fuel costs provide a top-line offset to fleets” and “oil price declines push up discretionary spending [by consumers].” He predicted that diesel may fall perhaps another 25 cents before prices again start to rise.

A sharp and lingering drop in world oil prices has been suppressing the cost of diesel fuel and gasoline in the U.S. That is largely due to oil production booming here of late, and the decision of overseas competitors (chiefly Saudi Arabia) to cut prices, not production, to buy market share.

That strategy backfired. Domestic oil production did not fall off significantly when crude prices did, because “shale-oil producers have gotten so much better at what they do,” says Denton Cinquegrana, chief oil analyst for the Oil Price Information Service, Gaithersburg, Md.

“It used to be said that frackers will go out of business if oil gets below $50 a barrel,” he explains. “But the technology and techniques they use have improved to where they may only need $50 to $55 to break even. So, domestic crude oil is not going away even though prices dropped. The floor of the market is not $70 to $80 anymore. That’s more like the ceiling.”

Cinquegrana contends that provides “plenty of motivation for refiners to turn crude into products.” He adds that the rise in domestic crude production is helping insulate the U.S. oil market from geopolitical shocks, including the crisis in Ukraine and the advance by ISIS. While “crude was at $100 a barrel last year, now it’s at $60, and there’s talk of crude rebounding later in 2015 into 2016 to reach $70 to $80,” he says.

Looking at how those numbers translate into retail diesel pricing, Cinquegrana expects a gallon to run between $2.50 and $2.75 over the next few months, ahead of seasonal harvest and winter heating oil demands. “Diesel will be at the top end of that range by year’s end,” he predicts. “And the expectation for 2016 is that going in, diesel will be [priced] similar to 2015.”

“My current thinking, based on all that I read and have analyzed, is that the price of oil, and therefore diesel prices, will range in the vicinity of where they are currently over the next year or so,” says Jon Gabrielsen, president and CEO of J.T. Gabrielsen Consulting, Smyrna, Ga. He puts that estimate at plus or minus 10-20%, “with some risk that the trend is more likely to go somewhat higher, than lower, but not to a major degree.”

Gabrielsen adds that the key driver of diesel prices is the price of oil. “While in a given week, diesel prices may not track to oil prices precisely, over even a month or so there is a 98% correlation between the price of oil and the price of diesel per gallon.”

In the long run, however, “fuel prices are trending upwards as we exhaust easy-to-recover reserves,” says economist Noel Perry of FTR, Bloomington, Ind. “The recent drop in oil is due to the invention of a new relatively cheap method, the fracking technique. It freed up enough oil to overwhelm the $100 price.” Now, he says, the cheapest fracked oil costs $40/barrel, while oil from tar sands is at about $70 and from really deep water or the Arctic is at $80 or more. 

“Now that the price of crude is at $60 a barrel,” he says, “there is pressure to raise it, because some of the fracked crude comes out above that number, and all the Canadian tar sands and much of the deep water [crude] is also above that. Most experts say that the price will eventually stabilize around $80/barrel. That would keep all the fracking rigs working as well as the Canadian tar sands.”

As Perry sees it, the key question is “when the price will make that major move. I think late this year. U.S. production has stopped growing because drilling is down by half. It should soon start to decline. In the meantime, there is enough inventory around that lower prices are still possible, but they won›t last. Crude will average somewhere around $60/barrel this year and $80 next year.”

However, he notes that “short-run fluctuations could take us back to below $50 this year and get us over $100 temporarily once the market begins its real move up. Such volatility is the nature of commodity markets. The move from $60 to $80 is the equivalent of a 15% increase in diesel.”

Economist Chris Brady, principal at Commercial Motor Vehicle Consulting, Manhasset, N.Y., points out the impact market volatility plays. “While oil prices are determined by supply/demand factors, short-term volatility is a result of financial factors. Since the financial crisis, crude oil has become more of a financial asset. Crude prices in the short term are influenced by changes in relationships among financial assets — stocks, bonds and commodity prices, including for crude, and currency exchange rates.”

He says to expect short-term volatility in crude prices. That’s why in his view, retail pricing is not the only marker in this game. “I believe fleet executives should focus on a diesel fuel strategy related to volatility up as well as down,” he suggests. “However, this makes hedging difficult, since hedges are usually related to a change in prices in one direction.”