By Laura Sanicola

(Reuters) -The U.S. has a declining supply of diesel fuels and refiners have difficulty replenishing it, leading to higher prices for months.

Strong manufacturing activity, trucking activity, and greater exports to Europe have all contributed to strong demand for distillates. Production has been slowing down as several refineries shut down since the pandemic. Others have put off maintenance.

Consumers and end users have been affected by the situation, which has led to an increase in inflation. Analysts believe that this could lead to higher prices as it becomes harder for refiners make enough product.

Heating oil futures prices were $2.83 as of Thursday. It was the highest level in seven years.

Cold temperatures across most of the United States are already testing fuel availability. They will continue for many days and have been predicted to last. This has increased demand for electricity generation. Some utilities that are in direct contact with the cold will use additional distillate fuel oil to satisfy this demand.

U.S. distillate demand in 2021 has been running at about 5% above pre-pandemic levels, putting inventories at 15% less than the five-year moving average https://graphics.reuters.com/USA-DISTILLATE/lgpdwxordvo, according to U.S. Energy Information Administration data. Stockpiles on the East Coast of America are down to their lowest level since April 2020.

Refiners respond to low inventories by increasing their output. Global refining capacity declined by more than 2,000,000 barrels per hour during the pandemic. However, U.S. refining capability fell 4.5% to 18.1 Million barrels per Day (bpd) according to federal data.

U.S. refiners still operate their plants at lower rates over the average five-year period to prevent producing jet fuel too often. 2019 is still far behind 2019, so they are operating them at lower rates.

“We really don’t see the clear path in near future to be capable of restocking diesel inventories,” Gary Simmons, chief commercial officers at Valero said during last week’s earnings call.

Since September 2014, the average national diesel prices was at $3.78 per g. Oil-fired generation in New England is on the rise, and this could lead to higher prices. Grid operator ISO New England reported that oil-fired production was at 11% as of Friday. There is also forecasted to be colder weather.

According to Troy Vincent (senior market analyst, researcher DTN Markets), prices should fall as demand drops for heating fuel and winter subsidies. This will allow inventories to increase again. Fuel prices may remain elevated if distillate costs are high.

Vincent said that “There have been some unique dynamics this winter, which has helped pressure inventories. So it’s hard for us to get an idea of what the fuel market will be like in spring.”

MARCHINGBACKWARDS

Backwardation refers to an eventual situation in which future oil prices will be higher than current ones.

Traders said that many traders have decided to terminate lucrative long-term contracts for storage of diesel fuel because they don’t see any financial incentives to do so.

Trader make money May to February. They pay for storage of distillate fuels and then sell them later when the price rises. However, the current high price makes this a less attractive option.

European refiners are cutting production due to record-high natural gasoline prices. This has resulted in tighter inventories, which have boosted European diesel’s six month spread to the largest backwardation since March 2008. Due to high demand, U.S. distillates exports to Europe have increased.