[Diesel Price Shock] Why Did It Increase? (Comprehensive)

Rapid Shift to Renewable Energy as Structural Cause... Ukraine War Adds Fuel to the Fire

[Asia Economy Sejong=Reporters Haeyoung Kwon, Donghoon Jeong, Chaeseok Moon] #Cargo driver Park Jongwon (44) saw his income drop to the high 2 million KRW range last month. While there were months when his income exceeded 5 million KRW during periods of high logistics volume, the sharp rise in diesel prices wiped out all his earnings. In May last year, diesel prices were around 1,340 KRW per liter, but recently they have been at the 1,900?2,000 KRW level. Filling a 100-liter fuel tank of a cargo truck now costs about 60,000 to 70,000 KRW more than a year ago. Park said, "Although logistics costs are increasing, cargo drivers still find it hard to feel the impact in their income," adding, "Due to the rising fuel costs from long-distance driving, there is even a trend among cargo drivers to take fewer long-distance jobs." On the 27th, according to the Korea National Oil Corporation's oil price information service OPINET, the average diesel price at gas stations nationwide at noon on the 26th was 2,003.56 KRW, up 0.88 KRW from the previous day. Diesel prices have been higher than gasoline prices since the 11th (1,947.59 KRW vs. 1,946.11 KRW), continuing this reversal for over two weeks. This also surpassed the previous record high of 1,947.75 KRW set in July 2008 during the financial crisis.

Premature Renewable Energy Transition... The ‘Structural Surge’ in Diesel Prices

The structural cause of the recent sharp rise in diesel prices is widely believed to be the rapid global shift to renewable energy policies after COVID-19. In April 2020, following the outbreak of COVID-19, global demand was expected to decline, causing diesel prices to fall below 1,000 KRW per liter, hitting 954 KRW?a 25% decrease from 1,273 KRW five months earlier. Major countries announced carbon neutrality and renewable energy investment plans one after another. The profitability of energy sources like oil and gas declined, and massive subsidies for renewable energy disrupted the balance of energy supply and demand. The ‘global misstep’ in energy transition became apparent as COVID-19 vaccines were distributed and global demand recovered. In March last year, diesel prices rose to 1,231 KRW per liter, recovering to pre-pandemic levels.

The situation worsened with Russia’s invasion of Ukraine in February. A global shortage of diesel inventory, especially in Europe where diesel vehicles are common, was a key factor. On February 24, when Russia invaded Ukraine, international oil prices began to surge. Europe depends on Russia for about 60% of its diesel imports, and sanctions on Russian oil products following the invasion caused diesel prices to rise sharply. Consequently, domestic diesel prices also increased by 46% in just four months, from 1,364 KRW in January before the war to around 2,003 KRW now.

Since Korea refines imported crude oil to produce diesel, international diesel supply shortages do not immediately affect domestic diesel prices. However, domestic gasoline and diesel prices are determined by a ‘linked system’ based on international prices traded in Singapore. This means diesel cannot be sold cheaply domestically when it is expensive overseas. Therefore, when international diesel prices rise, domestic diesel prices naturally follow.

Baek Youngchan, a researcher at KB Securities, said, "Since there have been no significant supply expansions by refiners recently, diesel prices are expected to remain strong due to supply shortages in the second half of the year, and demand is unlikely to drop sharply due to factors like COVID-19 becoming endemic. Although it is difficult to specify price forecasts, it can be said that prices may not fall below current levels for a considerable period."

The logistics industry, which has a high proportion of fuel costs, is directly impacted. A logistics industry official explained, "Individual truck owners sometimes operate only short distances because long-distance driving results in losses," adding, "From the perspective of logistics companies, there are difficulties in meeting order volumes." For example, Korean Air’s fuel costs doubled from 325 billion KRW in Q1 last year to 660 billion KRW in Q1 this year. During the same period, HMM’s fuel costs rose from 208 billion KRW to 332.9 billion KRW. Hyundai Glovis also saw transportation and vessel operation costs surge from 769.3 billion KRW and 283.2 billion KRW to 2.0203 trillion KRW and 388.9 billion KRW, respectively. Before the COVID-19 crisis, Hankook Tire paid 200 billion KRW for shipping costs, but last year paid 440 to 450 billion KRW for logistics. This year, logistics expenses are expected to approach 1 trillion KRW.

Government Rapidly Increasing Subsidies as Cargo and Taxi Drivers Face ‘Livelihood Emergency’

As the sharp rise in diesel prices, a ‘fuel for the common people,’ exacerbates difficulties for livelihood-type business operators, the government has decided to increase diesel subsidies starting next month. This decision was made based on the urgent need to support cargo truck drivers and others.

Accordingly, the price threshold for fuel-linked subsidy payments will be lowered from the current 1,850 KRW per liter to 1,750 KRW starting June 1. The government will subsidize half of the amount exceeding the threshold. For example, if the diesel price is set at 2,000 KRW, the government previously subsidized 75 KRW but will now increase the subsidy to 125 KRW. The subsidy targets include approximately 445,000 cargo trucks, 21,000 buses, 9,300 diesel taxis, and 1,300 coastal cargo ships.

However, expanding fuel-linked subsidies alone is insufficient to ease the deficit burden on livelihood workers such as cargo truck and taxi drivers. The fact that the government has exhausted nearly all policy options to stabilize fuel prices, including fuel tax cuts, is a bigger problem. Last year, the government cut fuel taxes by 20%, and from this month, the reduction was expanded to the legal maximum of 30%. Considering the flexible tax rate adjusted according to economic conditions, the fuel tax cut could be increased up to 37%. However, if international oil prices rise further, the effect of the fuel tax cut diminishes, and the government’s policy capacity is further reduced.