Iran isn’t the only conflict vexing the global oil market

[LONDON] The end of the Iran war, despite all the ups and downs in the ceasefire talks, has solved one oil problem.

The price of crude has fallen to less than US$75 a barrel, roughly where it was before the conflict began in February.

But the almost simultaneous escalation of the Russia-Ukraine war in recent weeks is creating another – and less discussed – oil headache: The price of refined petroleum products remain as high as if crude oil was still changing hands above US$100 a barrel.

Although Wall Street tracks the price of oil, particularly the West Texas Intermediate (WTI) benchmark, what matters for Main Street is not the cost of unrefined crude, but the price of fuels such as petrol, diesel and jet fuel that we use to run cars, trucks and airplanes.

For inflation and interest rates, it is refined products, rather than crude, that count.

Typically, the price of crude and the price of refined products move mostly in tandem.

What is in between is a refining margin, plus a small retail markup. In normal times, WTI and Brent are a handy price shorthand for the entirety of the petroleum market.

So when, say, US President Donald Trump looks at WTI, he should get a simple snapshot of the entire energy market.

Right now, however, Trump is not liking what he sees because the traditional relationship between crude and refined products is broken. 

In a social media post, Trump has blamed price gouging. “The big Oil Companies are not dropping their price at the pump commensurate with the sharply lower prices they are paying for Oil,” he wrote on Jun 24.

Speaking to reporters later, he doubled down, naming and shaming some of the industry’s biggest names including ExxonMobil and Chevron.

Trump is correct about the problem – but he is dead wrong on the cause. It is not corporate malfeasance, but geopolitical upheaval.

The cost of  petrol, diesel and jet fuel is much higher than the price of crude would suggest because of several crises.

Above all, a significant chunk of the world’s refining capacity is, literally, on fire after Ukraine targeted Russian refineries on an almost daily basis for several weeks.

The attacks, seeking to pressure the Kremlin into negotiations by creating fuel shortages in Russia, have reached plants as far away as 2,700 km from the Ukrainian border.

Last week, Ukraine hit at least a refinery every day, including the largest in Russia.

In total, Kyiv has cut its rival’s diesel production capacity by about a third, according to industry estimates, with significant drops in petrol and jet fuel too. 

Over the last two months, Ukraine has attacked 19 Russian refineries, hitting some of the plants as many as four times over that period.

Together, the refineries have a processing capacity of nearly 4.9 million barrels a day, or about 70 per cent of the country’s total.

In normal times, Russia is a large exporter of refined products, particularly of diesel. Right now, it has banned exports and the market is abuzz with talk that Moscow is importing fuel from China and India, putting upward pressure on global fuel prices.

At the same time, unable to process the crude at home, Russia is dumping more unrefined oil than ever into the export market, exacerbating the mini glut created by the reopening, fits and starts aside, of the Strait of Hormuz.

That is putting downward pressure on crude prices. 

The attacks have exacerbated a shortage in global oil processing capacity, triggering a huge rally in refining margins.

Oil refineries are complex machines, capable of processing multiple streams of crude into dozens of different petroleum products.

For simplicity’s sake, the industry measures refining margins using a rough calculation called the “3-2-1 crack spread”: for every three barrels of WTI the refinery processes, it makes two barrels of petrol and one barrel of distillate fuel like diesel.

This month, the 3-2-1 refining spread has surged to about US$60 a barrel, a record high.

History shows the magnitude of the rally. From 1985 to 2021, the crack spread averaged about US$10.50 a barrel. Even between 2004 and 2008, during the so-called golden age of refining that saw strong margins, the crack spread never surpassed US$30.

The war between Russia and Ukraine is not the only reason why the cost of refined products remains sky-high.

The US has tapped its strategic petroleum reserves to cap the rally in oil prices since Washington launched its attack on Iran in February.

That has provided extra crude, which has put a lid on WTI prices, but it has not addressed the tightness in refined products.

Oil refining in the Middle East remains well below the pre-war level, too, lagging the recovery in crude oil exports.

On top, China has not been exporting any fuel since the US-Israeli conflict with Iran broke out, instead reducing its imports of crude significantly to keep its refining processing rates lower than normal.  

In total, about 10 per cent of the world’s refining capacity is probably out of operation currently, according to industry estimates.

That’s about eight million barrels a day of processing capacity, more than the fuel consumption of France, Germany, Italy, Spain and the UK combined.

The longer the world’s refining capacity remains constrained, the longer the cost of fuels such as petrol and diesel will remain elevated, even if the crude price remains low.

With seasonal demand ramping up with the start of the Northern Hemisphere summer holiday, consumers are in for more pain. BLOOMBERG