Opinion: The Fuel Price Outlook

By Robert Costello, Chief Economist, American Trucking Associations

Many in trucking want to know where diesel fuel prices are likely to go, now that the Organization of the Petroleum Exporting Countries has agreed to boost crude oil production.

Relief is likely to come, but how much, when and for how long is just not clear. To understand why it is difficult to predict price trends, let us review why and how the market got where it is now.

Over the past year, a couple of developments put upward pressure on fuel prices. First, OPEC cut crude oil production in April 1999 to push prices higher. Up to that point, the price of oil had declined steadily, hitting a cyclical low in December 1998, when the price per barrel dipped to $10.73. This very low price stemmed primarily from a miscalculation on the cartel’s part.

Specifically, OPEC increased production of crude as the group believed world demand for oil was picking up. But the opposite occurred, as an economic collapse caused by a financial crisis dampened demand in several Asian countries. As their industrial output contracted, their demand for oil fell.

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Simultaneously, Europe, while still in an economic expansion, was growing at a much more moderate rate than the Asian countries before their financial collapse. The United States was the only major country in the midst of an economic boom. But despite U.S. vigor, oil demand in the entire Northern Hemisphere declined substantially between 1997 and 1998 as a result of one of the mildest winters in history.

These factors led to a glut in world oil supplies, driving the price of crude to very low levels. After prices collapsed in 1998, the oil-producing countries began devising a plan to save their economies by driving up the price through limiting production.

Their strategy was straightforward and by no means new: reduce production quotas to eliminate excess inventories. The plan was implemented in April 1999 with a one-year window.

In the past, OPEC members had little success in achieving sustainable compliance with self-imposed quotas, with most nations “cheating” by producing above the quota to take advantage of higher prices. This time, the big surprise, even to the most experienced oil-market watchers, was that the often-fractious cartel did manage to unify and produce mostly within the allotted levels, with compliance ranging between 80% and 90%.

The drop in crude production and OPEC’s high compliance caused oil prices to rise from a low of $10.73 in December 1998 to the $25-$27 a barrel range a year later.

The average price of diesel fuel in this country followed a similar pattern, bottoming out in February 1999 at a mere 95 cents per gallon, thereafter steadily rising to nearly $1.30 by the year’s end.

If that was not bad enough, all hell broke loose as the new century started. As crude oil inventories continued to fall to dangerously low levels, the commodity’s price had nowhere to go but up, peaking near $35 per barrel in March.

Simultaneously, the East Coast was hit with its first major cold spell in a couple of years. The demand for heating oil surged, driving the price of diesel up along with it. In just five weeks, the average New England price of diesel, according to the Department of Energy, surged nearly 55% to $2, and in some places more than $2.50 a gallon — double where it was a year earlier.

While diesel prices on the East Coast moderated after the extreme cold subsided, the average national price continued upward for some weeks as the rest of the country reported significantly higher diesel prices.

That brings us to March 28 when OPEC announced it would boost production of crude oil by an additional 1.45 million barrels per day. The total increase should amount to 1.7 million barrels after accounting for non-OPEC countries.

While this is a step in the right direction, there are a couple of important points to remember. First, many OPEC members were already “cheating” in anticipation of increased production quotas. So the actual number of additional barrels to be produced will be less than the announced 1.45 million. Second, the oil deficit is estimated to be around 2.5 million barrels per day, so OPEC will still not be producing enough crude to meet worldwide demand.

In other words, the producers are continuing a policy of forced scarcity.

What does all this mean for diesel, especially since the Energy Department recently revised downward its forecast for gasoline prices? The added supply of crude will help, but there will be some bumps in the road. Economists like to say that prices are often “sticky” when falling — that is, prices fall slower than they rise — so expect any price adjustments to take time. This is especially true given the current peculiar situtation in heating oil futures where current delivery prices are higher than future prices.

Further, distillate inventories are extremely low, so there very well could be price spikes in the near future.

Finally, with inventories for both crude and diesel at extremely low levels, there is little room for unexpected supply disruptions, whose effects would be magnified by such levels. Californians remember how bad it was in 1998 when there were refinery outages.

If it happens this year, anywhere in the country, the outcome could be far worse.