Quiet diesel market awaits potential tariff impacts on Canadian oil

For a market that has been muted in its up-and-down swings, there have been plenty of movements playing out in the background that ultimately may have a larger impact on the price of oil and by extension the price of diesel.

The lack of movement in the diesel market was driven home Tuesday by the latest release of the Department of Energy/Energy Information Administration average weekly retail diesel price. It roseby 1.2 cents a gallon to $2.677, meaning that in the past three weeks, the price has moved just 1.8 cents a gallon. That price is the basis for most fuel surcharges.

However, the overall picture is one of slow upward creep. The DOE/EIA price has moved up seven of the past eight weeks. The latest price is just over 20 cents a gallon higher than it was on Dec. 23, with most of the upward move coming after the outgoing Biden administration slapped on tighter sanctions against Russian oil shipments. Market reaction to that move in early January was an expectation that the sanctions had teeth and could restrict Russian supplies to the market.

In the futures market, where the road to whatever is set at the pump begins, volatility also has been limited. Although there have been some big intraday movements, they have tended to offset each other. For example, a more than 6-cent rise Feb. 11 in the price of ultra low sulfur diesel (ULSD) was followed a day later by an almost identical downward move.

The end result is that ULSD settled Feb. 7 at $2.4308 a gallon. On Tuesday, the settlement was $2.4406, almost exactly 1 cent apart.

Contrast that with the market between July 8 and Sept. 16, 2024, when the DOE/EIA price declined from $3.865 a gallon to $2.525. Or the movement between July 10, 2023, and Sept. 18 of that year, when prices climbed to $4.633 a gallon from $3.806.

Canadian and Mexican imports as tariff targets

Oil markets today are awaiting word on the potential impact of tariffs on crude imports, with Canada specifically in focus. An initial Trump administration plan to implement the tariffs earlier this month on all imports, not just energy, was delayed until March 4.

Under the original proposal, Mexico and Canada would be subject to 25% tariffs on all exports, with Canadian energy exports seeing only a 10% tariff.

Canada’s imports will receive most of the attention because they mostly arrive in the U.S. through pipeline connections, which means they can’t easily be diverted elsewhere.

The infrastructure to send that oil elsewhere has limited capability to take on more oil, unlike Mexico, where its waterborne exports can be shipped somewhere else (and be replaced in the U.S. crude supply mix by grades from other countries not facing the U.S. tariffs that may be applied to its North American neighbors.)

A review of the latest EIA monthly data report, which lags by two months, shows what is at stake.

Canadian exports of crude to the U.S. in November were just under 4 million barrels a day. Total imports of crude were about 6.6 million barrels a day, with Canada accounting for roughly 40% of that.

Canada was far and away the biggest exporter of crude to the U.S. Mexico was second at about 450,000 barrels a day.

Canadian imports of ultra low sulfur diesel at 119,000 barrels a day were about 97% of diesel imports. But the U.S. is overall a significant exporter of diesel to Latin America and Europe.

Upper Midwest likely to feel the most pain

The biggest impact of tariffs on crude would fall on the Upper Midwest, which is designated as PADD2 in the EIA’s geographic data divisions. PADD is short for Petroleum Administration for Defense Districts; there are five of them in the U.S.

According to the latest report, PADD2 imported about 2.66 million barrels a day of crude in November, accounting for 100% of all crude imports into the region. PADD2 would include the refineries in Chicago and those scattered through the Great Plains, most of them heavy users of Canadian crude.

Canada can export crude to other countries by shipping oil on the Trans Mountain Pipeline to the Canadian west coast. And while it can expand in the future, there is no immediate way of expanding the pipeline by an amount large enough to take on a significant amount of crude trying to escape U.S. tariffs on Canadian sales into its neighbor to the south.

The Energy Policy Research Foundation (EPRINC) published a short overview of what the tariffs would mean for the price of oil products if tariffs of 10% were imposed, as opposed to the 25% proposed for everything but oil.

EPRINC started its analysis by using the price of Western Canadian Select (WCS), the benchmark crude coming from Canada. WCS generally trades $14 a barrel less than West Texas Intermediate, according to EPRINC, though that differential can vary.

The discount for Mexican Maya crude, that country’s benchmark, is about $5 a barrel, EPRINC said. Putting those prices against import totals provides a total value in 2024 of $92 billion in Canadian oil imports and $12 billion for Mexico, which EPRINC said is about 12% of all trade with the two countries.

“Of total U.S. crude oil consumption, Canadian and Mexican imports account for almost 30%,” EPRINC said. “Applying the stated tariff rates in President Trump’s executive orders, the implied annual increase to the cost of Canadian and Mexican imports would be an additional $10.4 billion, or 2.9%. Since crude oil costs are passed on to product prices, this would imply, in the aggregate, an increase of 9 cents per gallon using the current U.S. national average of $3 for regular gasoline.”

The group did not provide a number for diesel, but given that diesel is priced higher than gasoline, the percentage impact would result in a number more than 9 cents a gallon.

How do supply lines change?

The question, however, is given that the PADD2 area is so dependent on Canadian imports of crude, would it be facing significantly higher prices than other parts of the country?

In a world of perfect economics, markets in the U.S. would rebalance by product moving to the PADD2 area if it had higher prices than the rest of the country. And that could happen. But pipeline systems are not set up to take, for example, gasoline out of the East Coast and ship it to the Chicago area. (In fact, pipelines like the Buckeye system do exactly the opposite.)

There are other solutions, such as putting product on barges and moving it on inland waterways, or via rail. But it’s not a movement that transportation systems are now set up to do with any regularity, and it would take time to get it in place. There’s also no guarantee that the premium of the PADD2 would be adequate to justify the costs of those unusual movements.

As Argus Media noted in a recent article on the impact of tariffs, “energy trade across North America has been tariff-free for decades.” The article quoted Vinson & Elkins partner Jason Fleischer as saying, “It’s been a long time since oil and gas pipelines have really had to deal with anything quite like this.”

The other significant piece of news in oil markets in the past week is that yet again, the OPEC+ group is likely to delay increasing production.

The OPEC+ group has had cuts in production in place since 2023. If the 120,000-barrel-per-day increase set for April is delayed, it will be the fourth time since 2022 that OPEC+ – consisting of OPEC and a group of non-OPEC exporters nominally led by Russia – has pulled back on plans to increase output.

The current plan calls for more than 2 million barrels a day of planned cuts to be restored by the end of next year.

But as a Bloomberg report said, quoting an unidentified OPEC+ delegate, “global oil markets remain too fragile to revive production now. No decision has been made yet and the group is split on how to proceed, said another [delegate]. A decision may be finalized in coming weeks.”