Blows Your Mind Drastically, Fantastically

Win, spin back, rewind, diesel power

Blows your mind drastically, fantastically

It has to be automatically

Check it out, you’d better work it out

Change to another route

-The Prodigy, Diesel Power, written by Keith Thornton, Liam Howlett

Diesel is a distillate of crude oil invented by Rudolf Diesel in the 1890’s. It’s known for its high efficiency and torque.

Russia is the world’s #2 exporter of diesel, but it banned exports this past week, due to Ukrainian drone strikes damaging Russian energy infrastructure. Gonna go ahead and speculate that Ukraine is not incentivized to stop their drone attacks.

Further, the Iran/US ceasefire is off and traffic through the Straight of I’m-tired-of-seeing-the-name-Hormuz has slowed to a trickle. Approximately 29% of global oil and oil products flow through the Straight, and about 10% of global diesel (also called Gasoil and Heating Oil) flows through this chokepoint.

Diesel demand is relatively inelastic when compared with other energy products (like gasoline) because diesel’s main uses include: global maritime and freight, construction, agriculture, public transit and backup power — and these sources of essential industrial demand do not necessarily contract when prices increase.

You see above - the black line shows US distillate fuel inventories (including diesel, gasoline, naptha, kerosene, etc.) are at extremely low levels. In fact, more recent data from the EIA released this week shows that these inventories are at a 23-year low. 1

You can see below that, while distillate inventories are low - refiners that make these oil products are running at max capacity. (Again 2026 is the black line.)

Further, we can see below that crude oil at Cushing (the primary hub for US oil) from which diesel is distilled - is abnormally low.

Demand is high, supply is low.

This is all incredibly bullish for diesel, and ominous for the outlook on inflation. You can see below that as the price of diesel goes, so goes the consumer price index. The price of diesel is part of the price of everything else.

But then why has the price of diesel come down at all? Why is inflation not much higher?

China.

During the US-Iran war, China imposed export controls on finished oil products like diesel, gasoline and jet fuel… Thus it was able to drastically reduce imports of crude oil from the Middle East, instead drawing down its reserve stocks by an estimated 1mn barrels per day.2

This strategic draw on reserves by the world’s #1 importer of oil, has (so far) held oil and oil distillate prices in check, even with the geopolitically-driven price shock.

Now though, China has begun quietly re-filling their stocks of crude with a recent outsized purchase of 26mn barrels of heavily discounted Saudi oil.3

Short and medium term, this all adds up to a bullish outlook for diesel, distillates and crude, as the US will likewise need to refill stocks of oil. But as traders - we also have to look at 2nd and 3rd order effects of any market dynamic. Not so much thinking ahead as all the way around.

Long term, there’s an ill-publicized dynamic at work. China’s electrification of consumer and industrial transportation fleets — which has accelerated due to the war. The data below — compiled by energy analytics firm Kpler — shows clear trends of battery electric vehicles (BEV’s in green) and plug-in-hybrid electric vehicles (PHEV’s in yellow) replacing gasoline and diesel powered vehicles.

The same displacement of diesel dynamic is at work in China’s fleet of heavy trucks - via both heavily subsidized liquified natural gas and ‘new energy’ vehicles:

To further complicate the demand outlook for oil, this excellent article by Kpler analyst Elif Binici, shows that while diesel demand destruction is material — the growth in other petrochemicals and distillates more than offsets declines. The below chart shows China’s petro-derived liquids demand growth and decline in thousands of barrels per day:

So what does all of this mean — how do we trade in lieu of this context? In short, we don’t trade in lieu of any of it. We trade price. We don’t trade reasons or research. Research like this is like the rest of the orchestra. It’s important to hear, but we play our part.

We remain long energy across multiple trades in the portfolio. The energy etf DBC is our only current exposure to diesel.

We also look for 2nd order effects that open up other trading opportunities. Chinese battery manufacturer CATL (Contemporary Amperex Technology Company) is one such opportunity we are adding to our watch list. This company has come up with the nifty technological trick of battery swapping, alongside more rapidly (think minutes) charging EV batteries.

The chart looks terrible - like price is going to break down here. But if we see support and an upward reversal at this prior low of 341.85, it’s on.

And here’s a really art-y version of the CATL chart useful to no one, but then images don’t need to be useful to be expressive.

Have a great week,

-Andy

ICYMI: