Until about 2004, diesel fuel’s average cost very often fell below the average price for gasoline.
While there were some winters where demand outpaced supply – driving prices up, this was more the exception than the rule.
In the fall of 2004, the ULSD – the Ultra-Low Sulfur Diesel production standards became effective, ultimately impacting the cost of production and distribution of diesel fuel.
The cost of diesel fuel may have recently caught your attention as diesel’s average post-tax cost now exceeds that of gasoline across the country – from coast to coast.
And while diesel and gas prices tend to fluctuate over time (like any commodity in a free and open market economy), the recent price jump is significantly higher than any year-over-year increase for the past decade.
Why is Diesel So Expensive? (Top 10 Reasons)
1. Diesel Fuel is assessed at a Higher Federal Excise Tax
Both diesel and gasoline fuel are taxed on a federal level but may also include other taxes, depending on the state and local authority.
And, in some cases, diesel fuel can be assessed with higher taxes at the state (rather than federal) level.
In February 2021, the retail price of diesel fuel exceeded that of gasoline by $.35, or more specifically, $2.50 vs. $2.85.
As noted by the graphic below from the United States Energy Information Administration, the average retail price for on-highway diesel fuel – during 2020 – including 22% of federal and state taxes.
Source – EIG.gov
The federal excise tax on diesel fuel is 6 cents more per gallon than the federal excise tax for gasoline (regular-grade) – $.184 vs. $.244, which both include .1 cents for a Leaking Underground Storage Tank fee per gallon.
In addition, the average of each state’s total tax on gasoline is less than that for diesel fuel, as follows – $.306 (gas) vs. $31.92 (diesel). Note – tax rates are as of 1/1/2021.
2. The Market Reaction to Supply & Demand Changes
The price of crude oil, and thus, diesel and gasoline prices, like any other commodity, tend to fluctuate as a result of changes to the market’s supply/demand curve.
Basic economics teaches that when demand for a commodity increases, the result is likely an increase in the price to meet the increased demand.
Conversely, when the demand decreases, the expected result is a decrease in the commodity’s price to encourage consumers to purchase the commodity as supplies begin to increase as a result of the decrease in demand.
An example of this demand/supply & price interdependence with regard to gas and diesel fuel is the summer travel season.
When summer arrives, consumers (in a typical year) crisscross the country, traveling on summer vacations, increasing the demand for fuel.
When the summer season wraps up, the demand for fuel drops and prices as well.
3. Refining Costs Have Increased
Another aspect that impacts diesel fuel costs lies in the area of production.
Refineries in the United States have long been optimized to produce one gallon of diesel and two gallons of gas from each barrel of oil.
As such, when demand for diesel increases, the pressure on the supply-side of the curve results in a price increase simply because of the limited ‘scales of production’ present in the oil production industry.
And while the global demand continues to grow, U.S. diesel production has been increased to meet this global demand.
However, the global demand has caused a price increase due to the demand across international markets.
As noted previously, the production costs for diesel fuel have increased due to a slew of regulations enacted to protect the environment from the consequences of climate change.
Among these regulations are the ULSD (Ultra Low Sulfur Diesel) requirements in which diesel fuel cannot have more than 15 ppm (parts per million) sulfur.
ULSD helps reduce harmful diesel emissions more effectively.
As of December 2010, all diesel that is sold in the United States must meet this requirement.
Diesel suppliers have been quite vocal about the challenges of producing ULSD and note the difficulty in developing additional capacity in refining as one of the top reasons why diesel is more expensive than its gasoline counterpart.
4. Changes to Production Quotas by Global Producers
OPEC is the acronym that represents the Organization of the Petroleum Exporting Countries.
They are also tasked with the responsibility of setting oil production targets in an effort to manage oil production among its members, with Saudi Arabia, the largest OPEC producing/exporting member.
OPEC plays a key role in the production and pricing of crude oil on a global scale as its member countries are responsible for the production of about 40% of the globe’s crude oil production.
And OPEC exports about sixty percent of the petroleum that is traded on the international market.
Because of its significant market share and the fact that most reserves of crude oil are situated in regions on the globe that are prone to political upheaval, oil production has been disrupted internationally due to political events happening at the local level.
An example of a geopolitical event can be seen as far back as the early to mid-1970s when the Arab Oil Embargo (1973 – 1974) rattled the crude oil market.
And for those that remember, there were long lines just to fill your gas tank.
In fact, many states enacted rules that only allowed cars with license plates ending in an odd number on certain days and vice versa to manage the shortage.
At the end of 2020 (and into the beginning of 2021), oil prices begin to increase with significant momentum due to newly defined OPEC+ (now a 24-member organization) production quotas, in combination with a resistance of non-OPEC nations to increase supply.
Amid a plummeting demand for oil on a global basis – due to the pandemic and travel restrictions, OPEC+ began to fracture internally.
To gain market share (over Russia), Saudi Arabia increased production, which led to a price drop that fell below $20 per barrel in April 2020.
As a result, an agreement was made among members to reduce production by 10 million barrels per day.
These continued production quotas will likely place upward pricing pressure – especially during the typically busy summer months and the anticipated end to pandemic restrictions across the country and the globe.
5. Crude Oil Prices, which are Subject to Fluctuation & Manipulation
The cost of crude oil accounts for the largest component that makes up the price of retail diesel fuel.
Crude oil’s cost accounted for about 50 percent of the monthly average cost for the price of U.S. retail diesel from 2000 through 2020.
Crude oil is generally considered the most volatile part of the diesel retail price development.
Source – EIA.gov
Because most major transportations use diesel fuel, the demand for diesel generally follows current trends in the economy.
Professional shippers and oil executives often pay close attention to crude oil inventories as these are the fundamental economic factors that can offer guidance with regard to the near-future price of diesel fuel.
During the pandemic, oil inventories ballooned to some of the highest levels ever recorded because the demand for refined petroleum products plummeted when lockdowns were implemented in the Spring of 2020 – when COVID-19 gripped the nation and the world.
This historic inventory build-up reached its peak in mid-May.
By 2020’s year-end, with the hopes of a viable vaccine (and the lifting of lockdowns), inventories for crude oil fell to a 35 day supply – although still considered an oversupply but nearer to the five year average of crude oil inventories of 29 days (see graph above).
Additionally, as the above chart notes, the price of crude per barrel did not rise above $60 until crude oil inventories fell below a 27-day supply level.
6. The Time of Year is a Factor
Traditionally, fuel prices are at their lowest during the beginning of February, peaking around Memorial Day.
And while there is an increase in the demand for fuel and diesel that is related to consumer vacations and extended travel, there are some production-related factors that also impact the pricing of diesel at this time of the year.
The Environmental Protection Agency (the EPA) specifically defines the months from April to June as a transition season with regard to fuel production.
In general, it is usually a safe bet to anticipate that fuel prices will remain high approaching (and through) the summer months because of this increase in demand and the need for refineries to switch the production processes as they transition from winter to summer blend.
The cost to produce a summer blend is higher as the process takes longer and the overall yield/barrel is reduced.
When demand drops in winter, prices typically follow suit.
However, both diesel and heating oil are made using the same petroleum distillate, so both final products fight for the same resource during the colder months.
7. Unusual/Severe Weather Events that Disrupt Supply/Distribution
Severe weather can disrupt the supply of crude oil and related petroleum products, which ultimately will impact prices due to the shortage created by any sort of disruption.
The latest shock to diesel prices can be sourced from the massive disruptions in supply at the well & refinery levels in Texas, which was rocked by an unusual cold snap that included several days of snow, ice, and bitter cold temps.
Ultimately, this weather event resulted in widespread blackouts of oil production infrastructure shutdowns with regard to natural gas and oil.
Disruptions in Texas are not uncommon but are often caused when a hurricane threatens the Gulf of Mexico and the Texas oil refineries along the coast.
Weather events such as these create market uncertainty with regard to the future supply of oil, which leads to increased price volatility.
Price volatility is also tied to the inelastic nature of crude oil production, with its production processes relatively fixed for the near term.
It simply takes time to modify or develop production processes and efficiencies in the area of oil refinery production.
8. COVID-19 Vaccination Rollout
At the end of 2020, crude oil (and thus diesel) prices rose quickly in response to the announcement of the rollout of vaccinations in the United States, along with production quota cuts by OPEC [See #4 Above].
The market reaction to the rollout of COVID-19 vaccines reveals the most open path towards anticipated pre-pandemic consumer activity.
When vaccinations begin to reduce the danger of COVID-19, this will likely cause a shift in consumer spending and lead to a shift in consumer spending from goods to services, specifically in terms of travel and entertainment.
The renewed demand for fuel encourages refineries to increase production to match pre-pandemic levels.
An increase in production will increase the amount of diesel available in the marketplace.
An increase in diesel inventories will likely cause downward pressure on diesel prices, although there are many other factors that impact the current price of diesel.
9. Changes in Consumer Spending Habits Due to the Pandemic & the Advent of E-Commerce
Consumer spending and sentiment are fluid measurements that are in constant flux.
There are many factors that impact consumer spending, some more potent than others.
The onset of COVID-19 in January 2020 is a prime example of how non-financial factors can rock the global and domestic economy.
While the demand for diesel fuel remained relatively constant during the pandemic, refineries dropped production to account for the significantly reduced demand for jet fuel and other gas products.
Ultimately, this decreased refining capacity reduced the production of diesel, and inventories fell during 2020 in response to the five-year average.
With the reduction of inventories and steady demand, diesel prices began to rise – especially during the last quarter of 2020 and into the beginning of 2021.
The freight industry has experienced strong demand during the pandemic as the result of robust consumer spending on groceries.
The demand for freight shipments of retail products increased more than 30 percent – from August 2019 to August 2020.
The reality is the pandemic caused the majority of consumers to reallocate spending dollars earmarked for services toward an ongoing need for durable and nondurable goods.
This reallocation of spending triggered a significant uptick in manufacturing and also permitted the housing market to remain robust despite the machinations of a pandemic that most believed would cause the housing market to falter.
Let’s review some real-time data regarding the demand for discretionary and nondiscretionary goods.
The reality is the demand, with regard to discretionary and nondiscretionary spending, took entirely different routes through the COVID-19 pandemic; however, each is now characterized by exceptional growth.
The chart below highlights consumer spending behavior for the past 40+ years, including the pandemic.
The drop in the graph is clearly visible (and stark!) during 2020. However, the graph also reveals a robust rebound at present.
In addition, e-commerce has exploded over the past twenty years, which has changed the transportation industry’s demands.
Most everyone enjoys the convenience of shopping online, which also includes returns!
The COVID-19 pandemic has caused an even larger percentage of deliveries overall.
Despite consumers being unable to physically shop in person, many businesses modified their business models to include safer delivery options, which included contactless pickup and improved shipping options.
These revised business strategies ultimately caused a significant uptick in e-commerce in 2020-Q2, only weeks after lockdowns had been implemented through the country and the world.
10. West Coast Diesel Prices Tend to Outprice the Rest of Country
Businesses and consumers living and working on the west coast – especially California, will typically find that diesel fuel prices are higher than the rest of the nation due to two fundamental reasons –
- In July 2020, the state of California increased taxes on fuels across the board. Those purchasing diesel will pay an excise tax of $.385 per gallon, which is an increase from $.36. It is noted that this is the third increase in gas taxes in the past four years for the state. As such, the retail price for on-highway diesel fuel in the Golden State was $.6666 per gallon, compared to the average of all states of $.3176. The chart below follows the price of diesel from March 1 to April 5, 2021, for the west coast.
- The state of California is especially sensitive to oil supplies on the west coast. The west coast is dissimilar to most other oil markets, which are interconnected by pipelines and river systems. The gas and diesel supply on the West Coast is considered somewhat isolated because it is mostly supplied by local refinery production. Because of this logistics dilemma, it can be expensive to transport supplies from outside the region if a shortage occurs.
West Coast Diesel Prices
Source – EIA.gov
As 2021 began, the crude oil & diesel markets entered bullishly, as the overall commodity price of diesel was where it was when COVID-19 lockdowns began.
This is likely because inventories fell because of production quota reductions and increasing demand across the world.NEXT: Why Is Art School So Expensive? (Top 10 Reasons)