Feature Article: Drilling for diesel

Todd Dills | March 01, 2010

Drilling for diesel

A price anatomy of trucking’s most volatile cost component

Drilling down into the component parts of the diesel price per gallon is a tricky business and involves assumptions that don’t and couldn’t possibly take into account the full complex reality of the fuel production, distribution and marketing businesses.

For instance, the primary governmental authority on the pieces of the diesel price pie, the U.S. Energy Information Administration, regularly provides a breakout of the percentages of diesel’s price that covers four broad areas — crude oil, refining, distribution and marketing, and tax. “It’s a very simple methodology,” says EIA Energy Information Specialist Jonathan Cogan, “measuring pricing at different points along the way.” But it’s an effective categorization, as it gives observers a way to determine the forces behind price increases or declines and to educate the consumers of diesel fuel — that’s you — about the way the market works.

“There are literally hundreds of thousands of individual decisions that go into the price at the pump, and they’re being made every day over and over again,” says Rayola Dougher of the American Petroleum Institute, pointing out the complexity of the world fossil-fuel-based energy markets.


CoverStoryGraph1This article uses $2.74 per gallon of diesel, which was the average price for October-December 2009, according to the U.S. Energy’s Information Administration.


Crude/diesel prices as economic indicators

It can take weeks for the price of oil to be reflected in the price of diesel.

What’s happened since 2005 with the dramatic rise in the price of crude is that a margin squeeze has been put on all parties down the chain, and it’s rippled throughout the wider economy. “Every recession we’ve had that I can remember, from the mid-’70s on,” says Jay Thompson, president of Transportation Business Associates, “you see spikes in oil prices driving it. [2008] was this turbo spike.” Immediately following that spike, as demand for all manner of things from diesel to toasters plummeted, we hit what Thompson says traditional economic models would in our times see as an appropriate crude level, the $30-40 a barrel of early 2009. “But we’ve doubled that again now,” says Thompson. “Any time you double that you expect an economic slowdown.”

Tom Kloza, in a post to his Speaking of Oil blog (speakingofoil.com) early this year, said the biggest fundamental in the 21st century oil market wasn’t supply or demand but “money flow” itself. “Large amounts of investment money tend to pour into mostly long positions in crude oil and refined products futures or options in the first few January sessions of a new year,” he wrote.

Kloza accounted for late 2009 and early 2010 gains in crude price with this, but Jonathan Kingston, news director at analyst and information service Platts, might well disagree. Much has been made of oil and fuels futures investment as a large part of the run-up in price the trucking industry suffered through in 2007-08, but Kingston’s “Diesel Dominance and Demand Destruction” article, written after the quick fallback of prices in late 2008, sings a different tune.

“A strong argument can be made that it was an unprecedented rise in the price of diesel fuel, not speculation or geopolitics, that dragged up the price of crude in its wake,” he wrote. “And similarly, it was a degree of demand destruction, and changes in refineries’ output mix, that sent it on its downward ride.” To read his analysis, search the article title on Google.

Crude oil:

65 percent/$1.78

The biggest contributor to the price of diesel and its constant up and down fluctuations is the world market for crude oil, which is bought by oil refiners on the big commodity exchanges, like the New York Mercantile Exchange, whose spot market index is the most commonly referenced on the airwaves for crude prices. For the week ending Jan. 22, 2010, NYMEX spot market average stood at $74.54 per barrel. Considering there are 42 gallons in a barrel, that equates to a price of $1.77 a gallon, and it was trending downward at the end of the week but in the longer-term moving up from the last half of 2009, when prices in the $60s per barrel were more common.

As goes crude, so goes diesel, says the EIA’s Cogan. “The crude oil market is the world market,” he says, and as such it can take several weeks for fluctuations in the cost increase of a barrel of crude to show up in the diesel price at the pump. In analyzing price, says Rayola Dougher of the American Petroleum Institute, that’s why “you need an average over time — a season, maybe — to accurately characterize who makes what and what they’re spending.”

The EIA does its price-per-gallon breakdown by looking at averages over time, publishing monthly.

As world market prices for crude oil have risen dramatically in the past decade, they’ve come to represent in the EIA’s analysis a much larger share of the price per gallon. In 2002, the first year for which historical price breakdown data from the EIA exists, crude typically accounted for just 45 percent of the price per gallon. It began to trend into the 50-percent and above range in March of 2005, a year in which crude jumped almost 50 percent in price to the $50 per barrel range by yearend. Average diesel prices pushed over $3 a gallon for the first time in the decade in October of that year, portending things to come.