Why Diesel Is Breaking the Economy – A Refining Crisis

 

Last week, the price of diesel in the US hit $5.85 a gallon, beating the record of June 2022. This sharp rise in fuel price threatens everything from food prices to bond yields. Oil prices have risen this year, but at around $90 is not particularly remarkable. But, unlike 2008 when oil prices surged to $140, this time we are seeing a refining shock and it is affecting a critical element of the economy.

The margin between crude oil and the price of diesel has soared to $100 a barrel, approaching the 2022 peak. 2022 was of course a time of 10% inflation and a devastating impact on real wages, so it begs the question how much damage will rising fuel prices cause to the economy today?

If you look at fuel prices in the UK, there is a similar story, with diesel 20p above the price of petrol.

And if you look at the amount of  waterborne diesel exports we can see the world economy has 47 million fewer barrels of diesel, and it is this supply loss, which is pushing up prices. What happened was three factors all co-inciding. Firstly, shipping through the straits of Hormuz has been severely curtailed since February. That hasn’t only blocked crude exports, it has also blocked refined products too — and the conflict has knocked out refineries directly.

Responding to Hormuz closure, China curtailed its exports of refined fuel, redirecting it to domestic economy. Secondly, Ukrainian drone strikes have impacted 80% of Russian refineries, leading to loss of roughly 3 million out of 7 million barrels a day of Russian capacity. Russia was roughly 11% of global diesel supply, but now it has its own export ban and is importing from India. Thirdly, the oil disruption has led to shortage of oil suited for diesel refining. For example, the US has produced more oil, but its diesel refineries rely on sour oil from the Middle-east and Canada.

The extra US oil is light sweet shale, which yields more petrol than diesel. The barrels suited to diesel are the ones that have gone missing.

But, this isn’t just short-term news, In Europe, refining capacity has been in structural decline since 2000. It has fallen from 14 million barrels in 2000 to 11 million barrels today, just last year, Europe lost another half a million barrels. In 2025 Grangemouth stopped refining altogether. Scotland’s only refinery now exists to import the fuel it used to make.” Ironically, the diesel market was expected to shrink so nobody wanted to invest in 30 year refineries when it was cheaper to import.

The US strategic oil reserve has been drained to keep oil prices from rising. It currently sits just 36 million barrels above the 250 emergency floor. But, the truth is even if you release more crude oil, it doesn’t solve the diesel and jet fuel shortage, because US refineries are already running at 98%. If we look at overall storage of crude, gasoline and distillate, we can see 2026 is significantly lower than the previous years, including 2022, when prices soared.

China returning to buying table?

And whilst the price of crude looks relatively benign given the disruption, this may not last. One of the most important stories of the past few months was the big drop in China demand as they reverted to using their own inventories. But, there are now signs that China is coming back to the market, no longer willing to keep using stocks forever. This could put upward pressure on crude and crude products this autumn.

But, with diesel the economic pain is already here. 81% of Britain’s freight moves by road, and road freight runs on diesel. With diesel rising, this means higher transport costs, and this will be passed onto consumers.

In the US, it is similar story, in fact diesel prices have risen by more in the US. Farmers in particular rely on diesel and rising fuel prices along with bad weather and higher fertiliser costs threaten higher food prices and a rise in farm bankruptcies. The US is facing a real crisis in agriculture, not helped by the impact of tariffs.

The cumulative effect of higher diesel prices is that they will feed through into inflation. In turn, this puts pressure on Central Banks to increase interest rates to reduce inflationary pressures. Already, rising diesel prices are a factor behind rising bond yields, which is also pushing up mortgages rates and causing the housing market to freeze and house prices to drop in certain areas. Ultimately, if there is a shortage, diesel prices will have to rise sufficiently to reduce demand. This means lower economic activity as we cut back on travel and consumption. Thus, the supply shock of rising diesel prices means the economy faces the worst of both worlds – inflation and lower growth or stagflation. The problem with stagflation is that it is really difficult to deal with. And for the government, it will mean a worsening fiscal trade off, with higher bond yields increasing interest rate costs, leaving less spending power.

Now, it is worth pointing out a few counterpoints. In 2022, when diesel rose to similar price, inflation was much worse because there was also excess demand in economy and cost-push inflation from the end of Covid. Although inflation is ticking up, it is not the same problem, at least not yet. In fact UK inflation has been better than expectations. Secondly, even since 2022, the global economy has made progress in diversifying away from oil-based products, there are more electric vehicles and the oil intensity is less than in past-crisis.

Evidence suggests that in China, overall oil use dropped by 9%, and 16% fall for transportation as the country rolls out electric lorries. Electric heavy-truck sales rose an astonishing 77% in the second quarter, year-on-year. But EVs explain only about a third of the fall in consumption, and the consumption fall itself explains only half the drop in imports — the rest is China running down its stockpiles.

Economies like the UK and US are lagging behind in the electric transition and diesel is still overwhelmingly important but, on current trends, electric is the future.

We should also look at the real price, the inflation adjusted level. So although US diesel prices reached record levels in nominal terms, adjusted for inflation, it was higher in 2008. If we look at oil prices in real terms, we can also see how much higher oil prices were in 2008. Admittedly, they were a factor in causing the recession.

But, in comparison today real prices are 57% lower.

Now, the good news is that whilst it is hard to deal with diesel shock, if Hormuz re-opens a lot unwinds quite quickly. In June, don’t forget we had the largest monthly fall in pump prices since records began. But hoping for a resolution to the  Middle East has been a disappointing experience. Six months is longer than many predicted back in Feb. It is true that crude oil hasn’t soared as much as expected, but diesel in the US is now breaking records, and this will have a large economic and political impact. As we learnt in 2022, voters really hate inflation, especially this kind of cost-push inflation that exceeds wage growth. The lesson from 2024, is that even if inflation rate comes down, people only notice the fact the price level is permanently higher.

If it was just inflation caused by strong growth, the Central bank could raise interest rates and slow down the economy. But, it isn’t. Higher interest rates, threaten to further slow down the economy. So diesel is rising and it will be a big story.

 

Sources

Articles

Price and inventory data

Other sources

• Global waterborne diesel export volumes and Russian refining capacity – S&P Global Commodities at Sea and S&P Global Energy
• Share of UK freight moved by road – Department for Transport, Transport Statistics Great Britain

Notes on the numbers

The $5.85 a gallon US diesel record is a nominal retail price. Adjusted for inflation, diesel was more expensive in both 2008 and 2022.

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