Of Donald and Diesel

Never mind crude oil; distillates are the problem now

A Moscow refinery burning

A little over a week ago Donald Trump, who has made many unreasonable demands on Volodymyr Zelenskyy, the Ukrainian president, added a new one:

Mr. Zelensky has to do one thing. He has to stop knocking out diesel fuel in Russia. Let him go after targets but not diesel fuel, because he’s causing a shortage of diesel fuel.

Even for a New Yorker, the chutzpah was striking. For those not familiar with the term, chutzpah is when you murder your mother and father, then plead for leniency because you’re an orphan.

Trump has effectively created this situation by cutting off all aid to Ukraine, while in addition denying the Ukrainians even the ability to buy Patriot interceptors. Those missiles would have allowed them to fend off Vladimir Putin’s relentless missile attacks on civilian targets. Trump’s actions were clearly intended to leave Ukraine defenseless. But the Ukrainians — with help from the democracies of Europe — have survived, responding to Putin’s attacks by using their own, home-grown, drones and cruise missiles to make effective strikes against Russia’s energy infrastructure.

Last night, for example, a massive, coordinated Ukrainian assault set Moscow’s largest oil refinery ablaze.

Now Trump, having already betrayed Ukraine to Putin, is demanding that Zelenskyy commit strategic suicide. He wants the Ukrainians to go easy on Russia because the indirect effects of those attacks are hurting Republicans’ prospects in the midterm elections. As I said, chutzpah.

Aside from the outrageous nature of his demands, Trump’s remarks were interesting because they reveal the extent to which refined products, especially diesel, have replaced crude oil as the key bottleneck in the global energy crisis.

I still sometimes see commentators asserting that fears about the effects of Trump’s disastrous Iran war on energy prices were overstated, because the price of crude oil is “only” $102 a barrel, far above prewar prices but well below the $150-$200 range some analysts warned was possible. But nobody burns crude oil; they burn products refined from crude oil, mainly gasoline and diesel. And here’s what has happened to the price of diesel:

Diesel is currently selling at more than $200 a barrel. It’s true that there is always a “crack spread” between crude and diesel, but it’s typically on the order of $20. So the price of diesel is currently roughly what we would normally expect with crude at around $190.

The current world energy crisis, then, is largely a crisis in petroleum products, refined from crude oil, rather than in petroleum itself. And its proximate cause is a global shortage of refining capacity. As an informative report by Matthew Dalton in the Wall Street Journal put it, “Refineries Are Now the Main Chokepoint for Global Energy Supplies.”

Regular readers may recall that I’ve been making this point for a couple of months. And the shortage of refining capacity is, in turn, helping to keep crude prices down. As I wrote last month, “Buyers aren’t willing to pay extremely high prices for oil they can’t refine.”

So, chutzpah aside, is Trump right to attribute high diesel prices to Ukraine’s campaign against Russian refineries? No and yes.

Much of the world’s refining capacity is located in the Middle East, where it has been disrupted by Trump’s war. As Dalton notes,

the diesel blocked in the Persian Gulf is around three times as large as supplies missing from Russia compared with before the Iran war

However, the way refineries have replaced crude production as the world’s main energy chokepoint reflects the fact that refining capacity has been reduced more than crude production. And the disruption of shipments through the Strait of Hormuz has reduced world supplies of both crude and refined products. It’s at least arguable that Ukraine’s air campaign, which has done much more damage to Russia’s refining than to its crude production, has therefore played a disproportionate role in driving up diesel prices.

And expensive diesel is a big problem for the economy.

High diesel prices raise the cost of living, mainly through indirect effects. Relatively few passenger cars burn diesel — but diesel powers almost all large commercial trucks and two thirds of farm and construction equipment. So high diesel prices raise the cost of production across the economy, cost increases that eventually get passed on in the form of higher inflation.

Furthermore, rising diesel prices are even more likely than rising gasoline prices to drive up interest rates.

Why? The Federal Reserve, which sets short-term interest rates, normally focuses on “core” inflation, which excludes volatile food and energy prices. I’ve written many times about the reasons this focus makes sense. And the focus on core inflation typically leads the Fed to “look through” surges in gasoline prices, which affect headline inflation but not core inflation.

However, because surging diesel prices mostly raise inflation indirectly, via producer costs, they drive up core inflation in a way rising gas prices don’t. And this makes it hard for the Fed to avoid raising rates in the face of higher inflation.

One could argue that the Fed should adjust its measure of core inflation to exclude the effects of diesel prices too. But right now the Fed’s credibility is wobbly: It’s under constant pressure from Trump to cut rates, and many people are still suspicious about the motives of Kevin Warsh, Trump’s hand-picked Fed chair. So this is not a time when the Fed can afford to be seen changing its criteria for monetary policy in a way that might weaken its fight against inflation.

Between their direct effect on inflation and their indirect effect on interest rates, then, high diesel prices are an economic problem for America and a political problem for Donald Trump. Ukraine’s strikes on Russia are contributing to that problem. So Trump actually has good reasons to want Ukraine to stop its highly effective air campaign.

But he neither should nor will get what he wants. Remember the chutzpah factor. You don’t get to betray a nation, then demand that it help you politically, offering nothing in return.

MUSICAL CODA