Is there a setting which I am missing which allows battreies to ofset peak load and diesels can run at lower level?

In a diesel/battery system, whatever energy is in the batteries must come from the diesel.  The AC-AC roundtrip efficiency (through the rectifier, into and out of the battery, back through the inverter to the load) in your system is 61% .  So if you generate 1 kWh with the generator, why would you put it in the battery bank instead of putting it directly towards the load? 

Actually, there are two reasons why you might.  First, the generator might not be big enough to serve the load peaks.  In that case the battery helps out to serve the peaks, and the generator recharges the batteries during lower load periods.  The second reason is that the generator is inefficient at low output.  So if the load drops to a very low level, serving it with the diesel is so expensive that it makes sense to use the battery instead, and recharge the battery with the diesel at some later time when the diesel is operating more efficiently.