Crude reality

What do crude oil supply and demand factors imply about the future price of diesel fuel? In the short term, crude oil supply and demand factors are not a good predictor of crude oil prices as crude oil has become a financial asset like stocks, bonds and currency exchange rates since the financial crisis in 2008. Commodities, including crude oil, have become part of the trading scheme of financial

What do crude oil supply and demand factors imply about the future price of diesel fuel? In the short term, crude oil supply and demand factors are not a good predictor of crude oil prices as crude oil has become a financial asset like stocks, bonds and currency exchange rates since the financial crisis in 2008. Commodities, including crude oil, have become part of the trading scheme of financial institutions and hedge funds, so the price of crude is now linked to stock and bond prices and currency exchange rates and is subject to volatility. The Energy Information Administration estimates that crude oil makes up 64% of the price of a gallon of diesel fuel; in the short term, this implies volatility in diesel fuel prices as well.

The other factors in the price of a gallon of diesel fuel — taxes, distribution/marketing and refining — are relatively stable. Crude oil supply and demand factors will influence the long-term price of crude oil, but not as much in the short term.

ADAPTATION

Carriers and fleets must adapt to volatile diesel fuel prices and develop strategies to limit disruptions to profitability. Looking back at the 2008 fuel crisis gives an indication that just as fuel prices rise, crude oil prices may drop. The price of a barrel of West Texas Intermediate crude oil decreased to $39.16 by February 2009 from $133.93 in June 2008. During this time period, the price of diesel fuel decreased to about $2.20/gal. from about $4.70/gal. in June 2008. Developing hedging schemes to offset only rising diesel fuel prices may not be successful. This is because carriers and fleets may pay higher than retail prices due to this hedging scheme if diesel fuel prices suddenly decrease. Carriers and fleets must adopt strategies to deal with the volatility of diesel fuel prices since changes in financial assets, i.e., stock/bond prices and currency exchange rates (see chart), are just as likely to cause crude oil prices to drop as they are to cause prices to rise.

The global financial system remains weak from the financial crisis, which implies volatility in financial markets, i.e., stocks, bonds, currency exchange rates and commodities. Central banks in the U.S., England, Europe and Japan are printing money. This signals just how fragile the global financial system is and how the printing of money is distorting the financial markets. Distortions or imbalances typically result in large adjustments; since the price of commodities are now linked with stock and bond prices and currency exchange rates, large adjustments in stock and bond prices and currency exchange rates will impact crude oil prices.

STILL FRAGILE

In short, a fragile financial system implies volatile crude oil prices, and that the global financial system will remain fragile for some time as Europe deals with its sovereign debt crisis; the U.S. financial system continues to recover from the residential real estate bubble; England deals with an overleveraged financial system; and Japan continues to deal with deflation.

Carriers and fleets must develop strategies and tactics to minimize the negative impact of volatile diesel fuel prices, and the strategy should not be to just offset rising prices because recent history has shown steep decreases in diesel fuel prices as well.

The financial crisis has changed the way crude oil prices are determined in the short term and the development of crude oil as a financial asset like stocks, bonds and currency exchange rates implies continued volatility.


Commercial Motor Vehicle Consulting publishes the monthly newsletter “Visibility of the Supply Chain” for general freight carriers. To order a copy, contact Chris Brady of CMVC at [email protected] or 516-869-5954.

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