The evidence is mounting that the US might just encounter the first real crisis of the oil depletion age before the year is out. The crisis at first will be one of spiraling prices for diesel [see chart] and heating oil that will cause considerable economic havoc, and then there may be actual shortages right here in the United States. Within the last three weeks the wholesale price of heating oil has moved up by nearly 70 cents a gallon and no end is in sight. Many observers are noting that what they call “a tight market for distillates” –- the industry’s term for diesel and heating oil – is the main factor driving up the price of crude and consequently gasoline.
The reasons for this surge in distillate prices are easy to understand. Conventional oil production, from which distillates are made, has been flat for the last three years while demand from Asia and the Middle East has been increasing rapidly. The trend into higher-mileage diesel-powered cars in Europe and other places, which has been underway for many years, is having a major impact on the demand for diesel. In some European countries, diesels now account for over 70 percent of new car registrations.
Moreover, a worldwide mismatch is developing between the demand for distillates and for gasoline. A recent OPEC report claims that in the last seven years, the demand for distillates grew by 5.2 million b/d while the demand for gasoline increased by 2 million b/d. OPEC notes that during the same period, refiners added 1.2 million b/d of fluid catalytic cracking and coking capacity used to produce gasoline while adding only 700,000 b/d of hydrocracking capacity used to make more distillates.
This change in demand and refining capabilities is leaving European and Asian refiners with a surplus of gasoline and a shortage of diesel. The overseas refiners are happy to sell their surplus gasoline to America which still wants it in prodigious quantities. This, believe it or not, helps keep gasoline prices lower than the price of crude suggests it should be as unusually large amounts of gasoline and blending components keep arriving at our shores.
This past winter America was awash in gasoline which in turn discouraged refiners from making more as they were not making much money for their efforts and presumably were running out of storage space. US refinery utilization dropped to abnormally low levels. Now this was fine for gasoline consumers, who continued to drive around burning cheap--in comparison to the price of crude and diesel--imported gasoline. It did nothing, however, for those who find diesel and heating oil increasingly unaffordable.
Prices for distillates went up and up and inventories went down and down as we were no longer making enough to satisfy demand even at outrageous prices, and our imports of distillates dropped as everybody in the world wanted more diesel. Imports which were running 300-400,000 b/d early last year have been 200,000 b/d or less in recent weeks. Most of our distillate imports currently are coming from Canada as nobody else seems willing or able to sell us this increasingly scarce and valuable commodity.
At the same time as our imports have been falling, our exports of finished distillates jumped from 275,000 b/d last fall to over 400,000 b/d this spring, according to the most recently available data. Much of our diesel exports, by the way, are going to Chile which is suffering from a drought-caused electric power shortage and has to have power to keep the copper mines going. The wave of electricity shortages and rolling blackouts around the world is not helping the situation as the demand for diesel to power emergency generators is growing rapidly and seems destined to become a significant source of new demand.
The arithmetic is simple; US refineries have been producing about 4.2 million b/d of diesel in recent weeks. (It did jump to 4.4 the week before last as refiners cashed in on the high prices). However, the net of our imports and exports is taking away about 0.2 million b/d. Since we use about 4.2 million b/d in the US at this time of year, our stockpiles have been shrinking and prices rising.
Next fall, when it comes time to start filling all those heating oil tanks, demand will increase to 4.4-4.5 million b/d. During the next four or five months, we will have to build our stockpiles by 15 to 20 million barrels to get ready for the next winter. There was a small increase in stocks last week, but there is a long way to go before fall and the recent earthquake in China suggests Beijing will be increasing its demand for diesel markedly over the next few months. While this may or may not directly affect the US, it will surely drive up prices still further.
By last week, the average cost of gasoline in the US had increased by 68 cents a gallon over a year ago, while the average gallon of diesel had increased by $1.71. Unless the situation stabilizes during the next few weeks, there will clearly be trouble before the year is out. High prices so far have not resulted in a significant drop in demand for distillates and the EIA is reporting that in the last month consumption is up by nearly one percent over last year.
There is little on the horizon to suggest a major reversal of this situation. Worldwide demand for distillates is likely to continue increasing over the rest of the year. Very high prices may tamp demand in the US and other OECD countries a bit. So far the EIA is reporting that demand for gasoline is only down by 0.2 percent over last year, despite reports from other sources that the demand is dropping much more.
Most observers agree that we have another five or six months before serious problems develop for we can always divert next winter’s heating oil supplies into our trucks, tractors, and heavy equipment. This may require a waiver or two of air pollution regulations, but that does not seem to be a problem these days.
Serious difficulties could come as early as next winter’s heating season when there simply is not enough fuel available or we could muddle along for another year or two with increasing prices. How this will play out is difficult to foresee. There obviously will be more increases in prices for diesel and heating oil, probably to the point where it simply becomes unaffordable for many. As governments are unlikely to let people freeze or crops go unharvested, some form of government intervention, subsidy, or allocation seems likely. From there on all bets are off as one can conjure up many scenarios – debates in the Congress, posturing politicians, hoarding, black markets, truckers’ strikes, food shortages.
The next President is likely to be facing some very big problems, one of which could just be a serious shortage of distillates.
Tom Whipple, editor of the Peak Oil Review, is a columnist for the Falls Church News Press, where an earlier version of this article appeared.