While oil markets adapted remarkably well to the abrupt loss of a fifth of global crude supplies from the Middle East during the conflict, workarounds for the refining industry have been far more limited.
The divergence between crude and fuel prices tells the story. Benchmark Brent crude oil is currently around $90 a barrel. Even though that is up about 25% from levels at the outbreak of the conflict on February 28, it is a significant retreat from the wartime peak at $118.
Refined products have not enjoyed the same relief. European diesel prices have surged more than 70% since the war began, while U.S. gasoline prices have climbed around 60%.
This reflects a dramatic decline in refining output. The war knocked out more than 20% of the Middle East's 9.6 million barrels per day of refining capacity, according to the International Energy Agency, while fuel exports remain suppressed due to the closure of the Strait of Hormuz. The loss of Gulf crude, in turn, led many refiners, particularly in Asia, to curtail operations.
That strain was then amplified by months of relentless Ukrainian strikes on Russian energy infrastructure. These attacks have cut Russia’s refining throughput by nearly 30% to below 4 million bpd in recent months, forcing Moscow to ban diesel exports in July.
Meanwhile, diesel refining margins in Europe, Asia and the U.S. have surged to unprecedented levels. European diesel cracks have more than tripled since February to above $75 a barrel. U.S. diesel margins have climbed more than 140%, reaching a record $100 earlier this week.
The crisis has been mitigated somewhat by pre-war fuel stockpiles – but that buffer is essentially gone.
Global oil stocks fell at a rate of 3.5 million bpd between March and July, equivalent to more than 3% of global oil demand, and are expected to continue declining until year-end, according to the U.S. Energy Information Administration. U.S. diesel inventories are at their lowest for this time of year in three decades, while gasoline stocks are at their weakest seasonal level since 2012.
A GAPING HOLE
Taken together, the disruptions have created a hole in global fuel production that the industry is struggling to fill.
Global refinery runs in the second quarter were 5.1 million bpd lower than a year earlier, according to the IEA.
Sky-high prices also reduced demand among businesses and consumers, but not by enough to fully offset the supply crunch. Demand for refined products last quarter fell by 4 million bpd, leaving a more than 1 million bpd shortfall.
The balance is expected to deteriorate further in the third quarter. Refinery runs are projected to be 4.1 million bpd lower year-on-year, while demand is expected to decline by just 2.4 million bpd.
These projections remain highly uncertain, given the fluid geopolitical situation in both the Middle East and Russia. But the direction is clear: fuel supply is shrinking faster than demand.
INFLATIONARY PRESSURE
That’s because more than 20 refineries across the Gulf suffered damage during the war, many of which will require extensive repairs. Lead times for crucial equipment — including compressors, heat exchangers and specialised catalysts — were already stretched before the conflict began, making a speedy recovery implausible.
China's response to the tightening supplies will also be critical. The world's second-largest refiner sharply reduced its processing rates and curtailed fuel exports during the war.
Demand destruction could prove more significant than currently projected as consumers and businesses pull back on spending in the face of eye-watering energy bills.
But the urgent need to replenish – and in some cases expand – global fuel inventories should add upward pressure to refining demand, potentially for years.
This dynamic raises the prospect of a sustained bout of energy-driven inflation this winter and beyond.
Recent inflation data is already pointing in that direction.
U.S. consumer prices rose 3.4% in July from a year earlier, driven in large part by a 14.7% increase in energy costs, including a 24.6% jump in gasoline prices. Euro-zone inflation accelerated to 2.9%, led by a 10% rise in energy costs, while Japan’s producer price index rose 7.2% in July.
Many Wall Street analysts and economists still assume the energy price spike will be a short-term phenomenon unlikely to feed through to core inflation. But if the refined product crisis is as serious as current data suggests, that assumption may be too optimistic.
This is especially true in Europe and Asia, where liquefied natural gas prices have also spiked. The U.S. has not been immune to rising energy prices, and the risk to current projections through year-end is clearly tilted to the upside.
U.S. President Donald Trump, who has made lowering the cost of living a central pillar of his second term, has seemingly acknowledged this, warning Americans last week to prepare for higher energy prices.
Nearly six months into the Iran war, the world appears to be witnessing a slow-motion crash. The fuel market’s safety buffer has been stripped away as inventories have been depleted, while disruptions caused by the war continue to strain the overstressed refining system.
The energy crisis that really matters to the global economy is just getting started.
(The opinions expressed here are those of Ron Bousso, a columnist for Reuters.)
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