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How much worse can it get?

CALGARY, Alta. - How much higher can diesel prices climb and how long will the pain last? As diesel prices squirt ever closer to $1 per litre, understanding the factors driving the trend may not allev...

BLEEDING: Will O/Os be able to survive the price hikes?
BLEEDING: Will O/Os be able to survive the price hikes?

CALGARY, Alta. – How much higher can diesel prices climb and how long will the pain last? As diesel prices squirt ever closer to $1 per litre, understanding the factors driving the trend may not alleviate the associated financial pain but it can help owner/operators and carriers better understand how much longer they can expect to feel the squeeze and just how much more squeezed they should expect to get.

According to price survey information from MJ Ervin & Associates, the national average retail diesel price was 84.4 cents per litre for the week ending Mar. 11. This is up from 72.1 cents per litre for the week ending Feb. 4, which was up from 71.0 cents for the week ending Jan. 7. Local diesel price hotspots on Mar. 11 were Fredericton at 96.9 cents per litre and Montreal at 96.5 cents per litre. Prices in most of Ontario hovered at the mid-80’s, while Edmonton had the lowest diesel price in the country of 70.2 cents per litre.

Still, fuel analysts are predicting the possibility of even higher diesel prices.

“It’s probably going to get a little worse in the next few weeks…The average diesel price across the U.S. today (Feb. 27th) is about US$1.77 retail and that will go up a little bit more. Maybe it’s got another 10 cents to the upside, worse case scenario,” says Tom Kloza of the Price Information Service (U.S.). In Canadian currency, those numbers convert to diesel prices in the neighborhood of $1 per litre. Kloza predicts the highest prices will hit in March.

Michael J. Ervin of Ervin & Associates, a Calgary-based consultant to the petroleum marketing industry, says, “Diesel is being pushed up primarily because of crude oil costs, which have risen since the start of last year in the order of about $17 per barrel.”

A number of supply and demand issues set the stage more than a year ago for crude oil’s price climb. The Organization of the Petroleum Exporting Countries cut production in response to a weak global economy following 9-11. The threat of war in the Persian Gulf spread fears of crude oil supply shortages as a result of collateral damages to other Middle East oilfields. At the same time, the cold snap in the U.S. has left stocks in the oil-guzzling economy a third down on last year and a Venezuelan oil workers strike in December 2002 cumulatively forced the price of a barrel of crude to the peak of US$39.99 in New York on Feb. 27, the highest since Iraq invaded Kuwait in 1990.

Venezuela’s state-owned oil company, Petruleos de Venezuela S.A., is the fifth biggest oil exporter in the world and the fourth largest U.S. supplier of oil. In addition to oil imported directly from Venezuela, the United States also imports oil products (i.e., diesel, gasoline, heating oil) refined in the Caribbean. Two-thirds of those supplies are refined from Venezuelan crude oil.

“So you have a (compounded situation). You have a decrease of crude to the U.S. And you have a decrease of refined product through that refinery in the U.S. Virgin Islands during an extremely cold winter,” says Ron Rosnak of En-Pro International.

According to Kloza, it is not so much that the winter has been cold, but that it is the first time the U.S. has had a sustained cold winter since inventories were downsized over the last 15 years to “just-in-time inventories.”

“The U.S. inventory system for oil has become like the Bay of Fundy. It’s shallow. It fills quick and it empties quick. It certainly emptied quick here in the last 40 days or so,” Kloza says.

What accounts for the varying diesel prices across Canada, apart from differing tax regimes, are cross-border supply and demand issues. A region’s proximity to a large U.S. urban population is referred to as the import-export alternative. Because the primary heating fuel in the East is oil, a cold winter can increase demand for diesel as well – and consequently drive up its price.

“If you have major demand for heating oil, diesel can be used for furnace oil. Furnaces run very well on diesel. Furnace oil is basically regular diesel. Some oil companies will stock one product and the furnace oil can be diesel quality,” Rosnak says.

A further demand factor is that many large institutions and companies in the East use natural gas for heating, but are on “interruptible service.” They get special pricing on their natural gas on the condition that if demand outstrips supply, their gas can be cut off.

“With the cold weather, you’ve had residential customers turning up the thermostats. The pressure in the pipelines has fallen, so institutional and industrial clients have had to switch to stand-by fuel,” Rosnak says.

On the West Coast of Canada, Vancouver’s proximity to Seattle similarly effects rack (wholesale) diesel prices. In the Canadian mid-west, lacking a major U.S. urban market for oil companies to alternately sell to, diesel prices have traditionally been the most directly based on the price of crude oil.

So what do the experts say about diesel prices dropping?

Only one thing is for certain. Winter will give way to spring. As a result, one demand stream will fall away for middle distillates (diesel and furnace oil). So diesel prices should fall in response, however, the demand for gasoline in the summer driving season also plays a role.

“Right about now refineries make the switch from producing middle distillates to lighter products like gasoline for the summer driving season. With the colder weather, the conversion could be delayed. Also, if refiners feel the price of crude is too high and that it could drop, they may be hesitant to buy crude so as not to put themselves at a disadvantage against their competition who may wait for lower prices to buy,” Rosnak says. This doesn’t bode well for a sharp decrease in diesel prices.

Less certain is whether Venezuela can return to its pre-strike oil production. According to the latest Venezuelan government announcements, daily production has been restored to 84 per cent of pre-strike production. But some analysts forecast 2003 production levels at one-third below 2002 levels due to fiscal and labor problems. The detractors cite the company’s exploration budget, which has been cut by 30 per cent, and the loss of 9,000 skilled workers fired during the strike. Then there is the situation in Iraq, the aching leg on which all of this stands.

“(Pricing) is so highly contingent on what happens in Iraq that any form of prediction will make a liar of the person trying to make the guess…There is more potential for the price to go downwards than upwards once some kind of calm is restored to that area,” says Ervin.

Kloza: “I think the worst happens in the next 30 days in terms of retail…Let me make this clear. These numbers, whether it’s for crude or whether it’s for diesel fuel, are bubble numbers. These are numbers comparable to the NASDAQ when it was up to 5,000. These are not sustainable numbers long term. I mean if these numbers persist you’re talking world wide recession – world wide depression even.”

Rosnak: “If a war is declared, crude prices may spike another US$10 per barrel…if the war (does not become protracted), crude prices would start to fall. Possibly, by the end of the year, you could have crude down to $22 or $24 per barrel.”

But ultimately, any war is an unknown and a peaceful resolution is an option. As Kloza says, “I can make a case for US$15 per barrel oil and I can make a case for US$60 per barrel oil.”

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