Making Sense of the Diesel Export Limitation Discussion

Making Sense of the Diesel Export Limitation Discussion

Director’s Blog XXX by Stephen V. Arbogast

In 2007-08, light crude oil prices hit a peak of ~$145/B.  At that time Saudi Arabia made an unexpected comment – they said the reason for high crude price was a refining shortage.  People were surprised but it turned out to be mostly true.  At that time the only surplus crudes available were Saudi heavy grades and worldwide refining ‘conversion capacity’ was fully utilized.  Running an extra barrel of Saudi heavy through simple distillation refining provided very little incremental gasoline and diesel.  The market responded by bidding up the prices of ‘benchmark’ light crudes which could be refined more easily.

Scroll forward to 2026 and something similar has materialized.  It is common knowledge that the war with Iran has restricted global crude oil supplies.  Crude oil prices have risen, but not as much as was widely predicted. Crude prices peaked during the war in the $130-140B range, and these didn’t last long.  As of 9/25, Brent crude closed at $104.32, down over 2% on the day, while West Texas Intermediate (WTI) closed at $92.42/b, also down 2%.  On that same day, US wholesale diesel prices checked in at $4.99/gallon ex-US Gulf Coast, equivalent to $210/B.  It’s not an exact comparison, but the $118/B gross spread between the crude price and diesel is extraordinarily high.  Moreover, US diesel prices have not tended to follow crude prices down when the latter decline.

Ex-refinery prices for US producers are today set by overseas prices, a condition known as ‘export parity.’  US refiners produce more diesel than the US market needs, so their marginal barrels go to export so long as selling abroad is more lucrative than cutting production.  Given today’s high global prices, export sales are very lucrative.  This means a US refiner will keep exporting at the margin until domestic prices rise to make it indifferent between producing another diesel barrel for home versus abroad.  In this fashion, what Europe is willing to pay for a diesel barrel landed in say Rotterdam now sets the US ex-refinery price, i.e., landed Rotterdam price minus transportation/insurance/handling costs sets the ‘indifference price’ for the US refiner versus producing for its domestic market.

The diesel retail spread has also widened materially, reflecting taxes, logistics costs, inventory lags and elevated distribution/retail margins.  US average diesel prices closed at $6.50/gallon on 9/25.  This is a spread of $1.50/gallon, or $66/B, versus the Gulf Coast ex-refinery price, and is large by all historical standards.  So, refiners are earning record level diesel margins today while distributor/retail margins have widened as well.  Why are these now so elevated versus the price of underlying crude oil?  The surprise answer is, again, a shortage of global refining capacity.

Three components of refining capacity have been taken ‘off-line’ in response to ongoing conflicts.  These have materialized in widely different locations, and not all have been in response to the same event.  Russian refining has been the first to see capacity shutdowns.  It has been repeatedly attacked this year by deep strike Ukrainian drones and missiles.  Prior to 2026, Russia exported several million barrels per day of refined products, much of this diesel.  Russian diesel exports have fallen sharply as refinery damage and Moscow’s own export restrictions divert scarce production toward the domestic market.

The second event involves China.  Prior to the Iran conflict, Chinese refiners imported millions of barrels per day of Persian Gulf crude production.  Some of this was refined and then re-exported as fuel products.  In response to the Iran conflict, China curtailed these fuel exports for some time.  This helped China by containing the price rise on their very large crude oil imports, but it also resulted in elevated refined product prices in East Asia.  More recent data suggests China has resumed exporting refined products, so this impact seems to be diminishing if not disappearing altogether.

The third capacity lost involves the recent attacks on Saudi Arabia’s Petroline pipeline.  This east-west line carries crude oil for export plus ~2 MB/D for Saudi Aramco’s west coast refineries.  Those refineries in turn export fuel products, much of it diesel.  With their crude supplies disrupted, those refined product exports have also been impacted.  The Houthi seizure of pressure points along the Bab el-Mandeb Strait at the Red Sea’s south end cuts in the same direction and may entail a longer disruption.

These events constitute the refining ‘shortage’ behind recent diesel prices and record refining margins.  International diesel prices have jumped, and one can see an especially tight ‘export-parity’ relationship between US Gulf Coast ex-refinery prices and diesel prices ex-Rotterdam.

Two other factors also deserve mention.  Global diesel inventories are very low.  The US is in the best shape, with its diesel stocks perhaps only 15% below normal.  Other locations are more directly impacted by the lost supplies listed just above.  Tight inventories mean that prices will be more volatile.  Any new development suggesting further supply curtailment will see a larger price response due to recognition that it cannot be readily handled via an inventory draw down.  The second issue concerns the condition of US refining.  It is running ‘flat out’ and deferring scheduled maintenance in many cases.  Running hard makes sense when the world needs supplies and there are attractive margins to capture.  That said, maintenance cannot be deferred indefinitely, and risks of accidents/shutdowns are rising.  Any such events among the US refining industry would see diesel prices soar even higher.

Record diesel prices driven by foreign refining problems are not popular with US voters, so it is no surprise that the idea of a ban on diesel exports has gained currency.  Would such a ban work, or would it, as the oil industry quickly argued, just make other oil prices worse?  We turn now to the effects of such a ban and whether the alternative of industry ‘voluntary action’ would offer more effective relief?

In simple terms, supporters of the export ban presume it would result in surplus domestic diesel supplies and thus lower prices.  A more nuanced version argues that the ban would have multiple effects that would cool prices.  First, it would ‘break the link’ between foreign and US prices.  US retail markets would know that they will no longer have to ‘compete’ with foreign buyers for supplies, and any increase in US diesel demand could be readily met by refiners eager to sell another barrel at home.  An export ban would also allow US refiners to normalize product inventories, rendering the whole diesel supply chain more robust.  Finally, since diesel is traded on US commodity markets, prices there can acquire a ‘speculative premium’ when supplies are known to be tight.  Redirecting US diesel supplies towards a more adequate, even oversupplied condition could remove any such premium from trading.

Interestingly, US refiners are not directly disputing these arguments.  Rather, they assert that their refineries will have to ‘cut crude runs’ if forced to give up their export markets.  This, they argue, will tighten supplies of other products, specifically gasoline and jet fuel.  They also argue that logistical bottlenecks will prevent any export ban’s relief from reaching several regional US markets.

The industry’s reality is both more complicated and more manageable.  In the short run, an export ban would probably allow refiners to take steps they’ve deferred in favor of chasing lucrative foreign sales.  Some deferred maintenance would now be performed.  Some inventory restocking could occur.  Refinery runs would be managed with these objectives in mind.  Refiners also have other flexibilities, switching the crudes they run and the operating conditions among their units, such that less diesel is made versus more gasoline and jet fuel per refined barrel.  For some time, US refiners could probably handle an export ban without causing an immediate price spike for other products.

Longer term might be a different story.  A long-term ban could see the industry exhaust these operating flexibilities and then need to operate at a lower level of capacity utilization.  This may be what the industry truly fears.  Export bans can attract domestic political support which renders them hard to overturn.  The oil industry saw US crude exports banned in 1975, a policy that endured until 2015.  Lower fuel prices are always politically popular.  A 2026 diesel export embargo that lowered prices, as one very well could, might well endure beyond the November midterm elections.

This industry concern appears to have led to discussions about a possible informal understanding with the administration. Reuters reports that Energy Secretary Chris Wright contacted several refiners to gauge their willingness to limit diesel exports and rebuild domestic inventories. No agreement has been publicly disclosed, but subsequent administration statements suggest that voluntary industry action is being given an opportunity before any mandatory export restriction is considered.  No details have yet emerged as regards informal export quotas or domestic inventory rebuild targets.

Assuming this is the understanding around voluntary action, refiners will limit some export sales, redirecting diesel barrels into replenished inventories and regional distributor stocks.  Crude runs would not need to be cut. Traders would then see two new statistics: 1) continued high refinery production with 2) lower diesel exports.  The results would be twofold: a break in the link to foreign prices (which might well rise) and curtailment of the traders’ speculative premium for US diesel.  The administration could tout their actions as having lowered diesel prices without any reflex spike in gasoline or jet fuel.  If somehow this could be managed to coincide with restored Saudi diesel exports, even the global impact on diesel prices might be limited.

For now, all we know is that something caused the administration to back off on a diesel export ban, even after President Trump commented publicly it deserved consideration.  The next two weeks should give some indication of what voluntary restraints the US industry proposed.  Watch three metrics in particular, the level of US refinery runs, domestic distillate inventories and the level of diesel exports.  If the latter declines while the first stays steady and the second grows, the administration/industry understanding outlined above would seem to be working as planned.