Diesel Says Economic Crash
Back in November I wrote Clearing the Smoke: Diesel Edition. I speculated about what could be happening in the economy with diesel in a massive topping pattern and crude already breaking lower. One scenario was a breakdown in diesel:
If diesel falls about 10 percent, it will complete a topping pattern. Crude will probably be at a new 52-week low if that happens. Whatever the media says, that will be a clear sign that the shortage is with demand, not diesel.
That has happened. Crude hit a new 52-week low on Friday. Diesel has broken below a massive topping pattern. The target for diesel is conservatively around $1.60 in the futures market. Retail prices will be higher because of taxes, transportation costs and so on, but should follow the futures price lower.
However, the retail price of diesel hasn’t budged much yet. This chart shows diesel futures down 30 percent, but diesel retail price down only 10 percent since the start of November. The spread between the two has exploded by nearly $1, up more than 100 percent in this time period.
Aside from wide spread during the 2020 lockdown (when oil futures collapsed to near zero and distorted the number) when was there a similarly huge spread? Right as the economy and financial markets were falling off a cliff in October 2008, December 2014 (for commodities) and December 2018 (when the Fed abandoned rate hikes suddenly as markets were melting down).
The current spread is the highest ever.
Occam’s Razor Says Diesel Will Fall in Price
Taking the financial market data alone, it says retail diesel prices will crater soon as they catch down to falling prices. Inventories are rising and this looks like the prior periods with low inventory, high retail price vs cratering futures price, followed by a weak economy and collapse in retail price.
An alternative explanation is out there: the government is trying to cripple the economy in pursuit of its climate agenda.
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If government climate policies have damaged diesel supply chains, then perhaps prices won’t come down as much. That will have an important butterfly effect on the economy because diesel is an important fuel in the supply chain. Consumer price inflation could be elevated by stubbornly high fuel costs. It could lead to runaway inflation in the future. It could mean a higher terminal rate in 2023. It could mean the Federal Reserve cannot cut rates in a recession. It could also collapse the economy as the cost of fuel becomes prohibitive for trade, resulting in economic activity falling much lower than it would in a healthy market where diesel prices fall to meet demand.
Recession
At this point, I expect diesel prices will fall. That’s the more probable outcome given the history. Whether the retail price falls or not, the decline in the futures price is screaming recession.
If retail prices don’t fall, then something different is happening and it will have very serious implications for GDP growth, inflation and politics.