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9 November 2022

What the price of diesel tells us about the coming recession

Industry and agriculture run on diesel; when it becomes unaffordable, the business cycle turns.

By Will Dunn

While economists delve into the numbers of the purchasing managers’ index, the labour force survey and the yield curve, there’s one economic indicator that is displayed in foot-high digits across the country: the price of diesel. It’s a number many drivers will have noticed recently. The average price of diesel rose more than twice as quickly as petrol in October, and the average difference between a litre of diesel and petrol stretched to more than 20p for the first time; on some forecourts, the gap is over 30p.

The price of diesel has a lot to tell us about the global economy, and where it’s going. John Kemp, senior energy market analyst at Reuters, explains that diesel is “the fuel that is most aligned with the business cycle”; it powers the ships and lorries of global trade and the machinery of manufacturing, agriculture, construction and the energy industry itself. While diesel cars are popular in Britain and Europe, at a global level diesel is “the lifeblood of the industrial economy”.

This also makes diesel “the most cyclical of all the fuels”. When there’s economic growth, demand for diesel begins to outstrip supply and prices rise sharply; in a slump, stocks build up again and prices fall. The situation with diesel now reflects the wider economy: prices are high, but not because business is booming.

So why are diesel prices so high? Again, for reasons that will be familiar from other parts of the global economy. The strong growth of the pandemic recovery period has put pressure on prices at a time when supply was already constricted, with several major refineries in the United States having been shut for some time. Diesel exports from China have been limited, further disrupting the great trade route between East and West. Trade with the world’s largest producer of petroleum products, Russia, has also been disrupted by sanctions following its invasion of Ukraine, and Russia may decide to restrict diesel sales when the G7 imposes a price cap on Russian diesel in February 2023.

The result, says Kemp, is that “diesel prices are rising very strongly, and they’re rising much faster than prices for gasoline or for crude oil”. Low stocks and high prices have become a political issue, particularly in the US, where the Republican Party and its pundits spent the weeks before the midterm elections on Tuesday (8 November) threatening a doomsday scenario in which the US economy runs out of diesel and grinds to a halt. But while stocks are at their lowest level since 1951, Kemp says they are unlikely to run out.

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“When we talk about a shortage of diesel – in a market world, there’s never a shortage. There’ll always be diesel available, it’s just at a very high price. So the problem is not necessarily that diesel stocks will run out as much as they will become completely unaffordable.”

Because diesel is so integral to the work of extracting, growing, making and moving all of the goods in the global economy, it’s probably fair to point to a peak in diesel prices as the point at which a downturn begins. In the UK, this is already under way: construction is starting to slow, freight volumes are reduced, manufacturing is subdued. “The same thing is true across the euro area, and we’re seeing something very similar in China,” says Kemp. “And although the US economy is growing, it’s growing much more slowly than it was at the start of the year.”

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The people who trade diesel futures know this, of course, and these markets predict that the “tightness” in the diesel market will ease over the next year, as a recession reduces demand and allows stocks to be replenished. This also tells us something important about the extent to which economic policy can manage a recession. The government may look for growth by bringing more people into employment, and in doing this inflation is not necessarily its enemy: higher wages are an incentive to work, after all. But if the underlying energy budget isn’t there to support that growth, it becomes what Kemp calls a “binding constraint”. The great complex machine of the economy can only run at the speed of its most abrasive component without overheating. “That’s what you’re seeing at the moment. The most binding constraint turned out to be the energy system.”

In the short term, all the government and the Bank of England can do is to reduce that friction with tighter monetary policy – but in the long run, the years to come should serve as a lesson in what we risk when we lean too heavily on certain fuels.

[See also: Are we heading for the next credit crunch?]

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